On the surface, there are obvious advantages to self-funding for a long-term disability. First and foremost, self-funding allows for more control. You can control contribution amount, frequency, and duration. You can set the eligibility criteria for distributions, determine the amount accessible, and retain the unused benefits if the risk expires.
People love to have control, especially when it comes to their money.
However, a word of caution. While the intrinsic effects of full control are enticing—specifically control over contributions, distributions, timeline, and access—the disadvantages need to be addressed as well. Absolute control can have a corrosive effect on the overall goal if either the focus or motivation is interrupted. These are the most likely scenarios that could blow up your atomic emergency fund: 1) The Risk of One There is no spread of risk, and therefore no spread of premiums. Normally, insurance actuaries look at you, the client, as a fractional risk (e.g. 30% probability of claim), and therefore charge a fractional premium across you and your peer policyholders. But with self-funding, you are going it alone. That means your odds are not 1 in 3 or any other fractional statistic. It is 0 or 100. Will or won’t. So that means you’ll have to fund your atomic emergency account with a bigger initial premium or larger percentage of income if you plan to fund on an ongoing basis. 2) It Works Wow! It happened. That rainy day came and fortunately, you were prepared. But now your stockpile is fully exhausted. It’s a long and ascetic road to restoring those benefits. If another rainy day happens before your atomic emergency fund is fully replenished, you’ll likely need to tap into other resources not specifically earmarked for this risk. 3) Life Happens Unexpected child/guardianship, a need to relocate, the call to invest in your education or a new business venture, a new kitchen or a wedding fund. There are innumerable ways for life to come in and raid the account that you worked hard to accrue. It takes extreme focus and discipline to not touch an account of six to seven figures, especially when income needs are increased due to being out of work. 4) Market Forces Think timing the market is tricky? Try timing a disability that forces you to sell investments at an inopportune moment. Despite historical gains over long periods of time, market gains are never guaranteed, especially when that time horizon is cut short. And as we’ve seen lately, neither are bank deposits beyond a certain amount. 5) Perception of Risk Once you make it 20 years with diligent and disciplined contributions, it’s perfectly logical to start to assume some sense of reduced risk of illness or injury. However, this is a false sense of security. Each year we age, every individual is actuarially more susceptible to requiring time off from work or experiencing a care need due to illness or injury. So, despite your sterling health history, it’s important to stick with it in later years. The More You Know 🌈 If you plan to self-fund or discuss self-funding with your clients, please make sure all parties are aware of the potential pitfalls so you can anticipate how to combat them as they arise.