Time to Revisit Management of Disability Risk and its Link to Retirement Savings

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Anna Rappaport, FSA, MAAA, and Chair of the SOA’s Committee on Post-Retirement Needs and Risks

 

Traditional defined benefit plans usually protected retirement savings in the event of long term disability, either through continued crediting of service for a benefit payable at retirement age or through explicit payment of a disability pension. As companies have moved away from defined benefit to defined contribution plans, there is generally no comparable provision under defined contribution plans, and in the event of long term disability, retirement savings have simply stopped in most cases. In addition, some employees with poor disability coverage have chosen to dip into defined contribution accounts to cover current expenses rather than waiting until retirement. Those employers who recognized the importance of offering protection for long term savings in the event of disability and who wanted to offer a benefit like a waiver of premium provision were frustrated by regulatory uncertainty. For a description of the issues, see the 2013 article by David Kaleda and myself from the SOA Pension Section News and the 2012 ERISA Advisory Council Report on Disability in an Age of Individual Responsibility.

The good news is that the regulatory problem has now been solved. The recently released final regulations from the Treasury Department provide guidance on the taxation of retirement plan payments for disability coverage and give employers an opportunity to address this gap in coverage. Many employers have not recognized this gap, while a few employers have recognized it for years. The new regulations allow defined contribution plans to include provisions that would help participants to continue saving for retirement while on disability, which is similar to a waiver premium in life insurance.

The final regulations (T.D. 9665, RIN 1545-BG12), released May 9 by Treasury and the Internal Revenue Service, provide that payments from a qualified defined contribution plan to pay a participant’s accident and health insurance premiums are taxable distributions to the participant unless a statutory exception applies. They also provide an exception under which disability insurance premiums are not taxable distributions if they meet certain conditions.

The regulations state that for disability premiums to meet the standards, they must be paid directly from the plan. The plan must receive the benefit payments as required by the contract. The benefit payments under the contract must be paid, because the employee is on disability and unable to work. The benefit payments to the participant’s account can’t exceed a reasonable expectation of what the participant would have received if not on disability.

Does this solve the problem of enhancing disability coverage so that long term disability will no longer derail retirement security? No. More needs to be done. Here are some of the things that should happen:

  • The public does not understand the magnitude and importance of long term disability risk and many employers have traditionally not placed a high priority on this issue. Work needs to be done to increase awareness of this issue.
  • Products are needed for implementation of such disability coverage.
  • Conversations are needed with employers focusing on the importance of this issue, and the need to address disability risk and how it relates to retirement security.

Actuaries are experts in risk and well positioned to move ahead with these issues. I hope that our profession will provide leadership in moving ahead to get important disability coverage for more people.

And, at the same time, we should also address another issue of concern pointed out in the ERISA Advisory Council report. Less than one third of the civilian workforce have long term disability coverage beyond that provided by Social Security.

Please send in your ideas and participate in this conversation. And please work with the groups you represent to move forward on this issue.

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