Written by: Corey Janoff
This post was originally published on our previous blog website on June 20, 2017 and has since been revised and updated.
One of the most overlooked components of financial planning is income protection. Income is the linchpin that holds your entire financial world together. Unless you are independently wealthy and don’t need to work anymore, you probably rely pretty heavily on your earnings. If this is the case, you should probably do everything in your power to ensure your income continues to flow, even if you are unable to work.
Not protecting your income is the equivalent of having Patrick Mahomes as your quarterback and not putting an offensive line out on the field to protect him. Andy Reid wouldn’t run plays with Mahomes at QB and ten wide receivers. That may work in backyard football where the defenders have to count to five alligators before they can rush the passer. But in the real world, that’s not a very smart strategy. He’s one hit away from being out for the season, so the coaching staff makes sure to put a line of protection in front of their most important asset.
For the same reasons football teams put a protective line in front of their quarterbacks, you should put a protective shield around your income. If you lose your income, you will have a lot of trouble winning in this game called life.
So How Much Income Protection Do I Need?
That is a great question! Glad you asked. It is actually quite simple to calculate. To figure it out, we need to know several things:
- Your current monthly expenses.
- The amount you need to invest each month to be able to retire by a reasonable age (I would say your mid 60’s at the latest).
- Additional anticipated expenses if you lose your job due to health reasons, such as increase medical costs and out-of-pocket health insurance premiums.
This includes your rent/mortgage, utilities, car payments, food/groceries, home/auto insurance/umbrella/life insurance, student loan payments, child related expenses, and miscellaneous expenses (including some fun money).
Calculating this is an inexact science, because we don’t know how long we will live, we don’t know what are expenses might look like in retirement, and we don’t know what our future investment returns will be. However, most financial advisors recommend investing at least 15% of income for retirement purposes (preferably 20% if you want to retire in your mid 60’s and plan to live into your 90’s). Read more in our recent post, How Much Money Does a Doctor Need to Retire.
Anticipated Expenses Due to Job Loss
This one is also tough to predict, but if you lose your job, you probably lose your health insurance at work. If you need to purchase health insurance on your own outside of work and have health issues, it can be quite expensive. Also, you will probably have an increase in monthly costs to cover health related expenses (prescriptions, treatment, therapy, insurance deductible, etc.).
Show Me Some Examples
Let’s assume you currently have $4,000 of monthly living expenses. You and your financial planner have determined you need to be investing $1,500/month in order to retire sometime in your mid-60’s. If you have to purchase health insurance on your own and have an increase in out-of-pocket medical expenses, let’s assume that will add an additional $1,000/month to your budget. By adding those three figures up, we get a monthly income protection need of $6,500. So, if you are looking to protect your income, be sure to get a policy with at least a $6,500/month benefit (tax-free) and ideally tack on an inflation rider to the policy so if you are permanently disabled, benefits will increase to account for inflation.
Let’s look at another scenario. Let’s assume you currently have $7,000/month of expenses. You need to save $2,500/month to hit your retirement goals. And we anticipate $1,000/month of additional healthcare expenses if you become disabled. You should probably get a policy that pays $10,500 of monthly benefit.
Ideally these policies adjust for inflation, as cost of living will increase over time.
What if My Spouse Also Earns Income?
That is excellent! If you are a dual-income earning couple, you may not need as much income protection coverage. However, it is still prudent to estimate each spouse’s share of the total household expenses. You can run through the above exercise and multiply your percentage of the household income by the total expenses/retirement savings need.
If you and your spouse earn $200,000/year combined for a round number, you earn $140,000 (70%) and your spouse earns $60,000 (30%). If your total combined household expenses + retirement savings + medical expenses is $8,000, you should get 70% of $8,000 in disability income benefit and your spouse should get 30% of $8,000 in disability income benefit. So you would get a policy with a $5,600/month benefit and your spouse would get a policy with a $2,400/month benefit.
Based on incomes, the above individuals would each likely qualify for a larger monthly benefit, but because they live below their means, they don’t need to protect 100% of their incomes.
The Future is Difficult to Predict
Because we don’t know what the future holds for us, if you are early on in your career, it is probably smart to protect as much income as possible, even if you don’t rely on 100% of your income. Nobody likes paying for unnecessary insurance, however if you become sick or injured and unable to work, you will be thankful you have that additional cash flow. I’ve never heard anyone say, “I wish I had less money.”
So if you don’t already have a solid disability insurance policy that protects your income if you can’t do your job, go get one. Now. Please. You’ll thank me if you ever need to use it.