How to Plan for Early Retirement Due to Disability

As much as you plan for your life after employment, not everyone gets to choose the best time to retire. Unexpected life changes could potentially force retirement before you expect to stop working, so it's wise to plan ahead in case you face early retirement due to disability.

While not always easy, considering the unexpected can help, especially when it comes to disability and retirement. And there's a good chance this might be necessary.

Why Planning for Potential Disabilities is Important

According to the Social Security Administration, a 20-year-old worker has a 25% chance of becoming disabled before reaching full retirement age.¹ And since the pandemic started, 5.6% reported early retirement due to COVID-19.²

The Disability Benefits Center also notes that people are twice as likely to collect Social Security disability insurance at the age of 50 as at age 40, and twice as likely at age 60 as at age 50.³ Bottom line: Life can be unpredictable, but planning for potential curveballs can help.

How Can Disability Impact Your Finances?

Should you face a major health event that causes you to become disabled, your finances could be severely impacted. It can be helpful to know what situations you may face as you plan for retirement due to disability.

Disability typically affects earnings, total family income and the ability to pay for things like food and housing. You might face medical expenses associated with the health issue, as well as a reduced income from the inability to work. Your retirement savings could also be affected, as you won't be contributing and the money will have less time to grow.

The associated expenses could include personal assistance services and the general costs of accommodations. For example, you might need to pay more to have things delivered when in-person pickup is not an option. Or you may need a more expensive car to accommodate a wheelchair, or food for a special diet. Accessible housing may also be more expensive.

Understanding Social Security Disability Benefits

Some general financial issues may be partially offset by government Social Security disability benefits, which are for people whose medical condition will totally prevent them from working for at least a year or will result in death. For this, there are two programs: Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI).

SSDI is for workers who have accumulated enough work credits to qualify, whereas SSI is for people with low income who haven't worked enough to qualify for disability insurance. Both programs have the same medical requirements.

The programs pay the equivalent of the non-disability Social Security benefits you would receive at full retirement age, even if you qualify for benefits and retire before you reach that age. When you reach full retirement age, your disability benefits then become Social Security retirement benefits.

Full retirement age is when Social Security considers you eligible for 100% of your benefits based on lifetime earnings. If you want more information about Social Security disability benefits, you can visit the Social Security website.⁴

In addition to providing your disability and retirement income, Social Security disability may pay benefits to some of your family members based on your work. Eligible family members include:

• A spouse aged 62 or older
• A spouse of any age caring for a child who's under age 16 or disabled
• An unmarried child under age 18 or still in high school and younger than 19

After receiving Social Security disability benefits for two years, you automatically qualify to receive Medicare — even if you haven't reached the age of 65, which is the normal age to qualify for benefits under the government health insurance program.

A financial professional may be able to help you understand how Social Security disability benefits fit into your retirement planning.

Additional Options

Another government benefit to consider is the ability to itemize and deduct out-of-pocket medical care costs that exceed 10% of your adjusted gross income. That's a high bar for deductions, but it could be helpful if you face high medical costs. Depending on your state, Medicaid may also provide benefits, including personal care, to help you remain in your home or community rather than face institutional care.

Before becoming eligible for Social Security disability benefits, you may receive income from a private disability income insurance plan. These plans are often provided or facilitated by employers, but they can also be purchased individually. You may consider researching your options for a private plan.

If you have a 401(k) retirement savings account, you ordinarily can't make any withdrawals without paying a 10% penalty before owning the account for five years and reaching the age of 59½. However, if you have documentation from a medical professional proving that your condition meets the IRS definition of totally disabled, you can withdraw earlier without facing a penalty.⁵

The Bottom Line

Therefore, when planning your 401(k) contributions, you might consider the possibility of early retirement due to disability — and increase your contributions accordingly. You may also want to consider critical illness insurance and disability income insurance to prepare for the unexpected. Of course, it's wise to compare all your options with a knowledgeable professional who can help you decide the strategy that best suits your situation.

Sources

1. Disability Benefits. https://www.ssa.gov/pubs/EN-05-10029.pdf.
2. Pandemic Disrupted Labor Markets but Had Modest Impact on Retirement Timing. https://www.census.gov/library/stories/2022/09/did-covid-19-change-retirement-timing.html.
3. SSDI Approval Rate by Age. https://www.disabilitybenefitscenter.org/faq/approval-rate-old-age.
4. Disability Benefits. https://www.ssa.gov/benefits/disability/.
5. Publication 524 (2022), Credit for the Elderly or the Disabled. https://www.irs.gov/publications/p524.