The benefit advisers should be talking about with 401(k) plan sponsors

The job of 401(k) advisers is to help all plan participants attain a respectable retirement, including those who have lost the ability to earn money.

Imagine this for a minute: You are a promising, 25-year-old computer engineer working for a start-up. The future seems entirely exciting, brimming with possibilities. One Saturday afternoon you’re riding your bike and get hit by a car. The accident leaves you with slight brain damage and without the ability to use your right arm.

This might seem like an improbability, but more than one in four 20-year-olds will become disabled before reaching retirement age, according to the Social Security Administration. And more than 50% of the 37 million disabled Americans are in their working years, between the ages of 18 and 64, according to U.S. Census Bureau data.

The odds change for different ages and sexes but, as the statistics show, a retirement plan participant’s ability to continue building wealth via a workplace retirement plan could be interrupted by disability.

What makes this especially serious: Many adult Americans don’t have any savings earmarked for emergencies, and most private-sector workers don’t have access to private long-term disability insurance, which typically lasts for the length of the disability or until retirement.

Access to long-term disability insurance ranges from roughly 10% to 60% of employers, depending on their occupation, and participation rates, though on the rise, are still low.

As retirement plan advisers, we talk endlessly about the probability of a stock market decline and what participants should do to plan for that. But how often do we speak with participants (or plan sponsors) to educate them about how to plan for the more likely thing: a disability claim?

There are two ways companies can protect their employees from suffering a major blow to their human capital. The first is to make sure they offer long-term disability insurance. According to Bureau of Labor Statistics, only a third of all Americans have access to long-term disability insurance. And the coverage is lower in certain professions and types of work.

As a retirement plan adviser, you would want to advocate that your client, the plan sponsor, offers the benefit and pays for it in full. Most do pay in full already (less than 10% of private-sector employers require an employee contribution for long-term disability) but this is something to bear in mind.

Additionally, advisers should advocate that employers increase the insurance coverage to replace the maximum amount available. The Bureau of Labor Statistics says 64% of companies have their replacement insurance income set at 60%. (So roughly two-thirds of the time, a person qualifying for a long-term disability incident can expect to receive about 60% of their pay in lieu of a regular paycheck.) This is the norm, but certainly doesn’t have to be the standard.

A plan adviser should also educate clients about products that perpetuate participants’ retirement savings if they are on long-term disability, and advocate for them if they make sense.

Income received from long-term disability typically comes from an insurance company and is not eligible to be deferred into an employer-sponsored retirement plan.

There are now products available through insurance carriers that will protect employer-sponsored plan participants’ deferrals and continue those deferrals should participants become disabled. The premiums for such products are paid for by participants from within their 401(k).

To illustrate the potential impact of lost retirement savings, let’s go back to the example of the 25-year-old hit by the car. Let’s say this 25-year-old had been saving $18,000 a year in a 401(k), part of which reflected his company’s employer match. And let’s say that individual is not able to re-enter the workforce after the incident, basically making the person dependent on Social Security disability payments and any savings or help from family. The individual’s ability to accumulate money for the future is virtually eliminated.

In fact, if that 25-year-old were to continue saving $18,000 per year for the next 30 years and earn a modest 4% per year, he or she could potentially accumulate over $1 million in a 401(k).

As retirement plan advisers, our job is to help all plan participants attain a respectable retirement. That includes helping those who have lost the ability to accumulate money.

Implementing programs like these and insuring for the right amount of long-term disability insurance are the right steps to ensuring plan participants are protected not just for if, but when the worst happens.

And, when it does, your plan sponsor clients will appreciate that advisers took proactive steps to have a conversation about it.

Aaron Pottichen is the retirement services president at CLS Partners, an Austin, Texas-based financial advisory firm.