If You Couldn’t Work, Where Would the Money Come From?

Most people don’t spend much time thinking about what would happen financially if they became disabled.

Over the years, I have had many people contact me looking for Disability Insurance after an illness or injury has already occurred. Unfortunately, at that point there often isn’t much I can do.

Those conversations are one of the reasons I believe so strongly in educating people about Disability Insurance before they need it.

According to the Canadian Life and Health Insurance Association, 1 in 3 people, on average, will experience a disability lasting 90 days or longer before age 65.

The question isn’t simply whether you could pay your bills for a few months.

The bigger question is: If your income stopped, where would the money come from?

Assume you are a professional earning a strong income and an illness or injury prevents you from working for 12 months.

If your Disability Insurance policy would have paid $10,000 per month, that represents:

$120,000 of income replacement over one year.

For personally owned Disability Insurance where premiums are paid personally, benefits are generally received tax-free.

Without that insurance, you still need to find that $120,000 somewhere.

Some people assume they could simply self-insure and rely on other financial resources if they were unable to work.

Maybe you borrow the money. Maybe you access the equity in your home. Maybe you draw down your investments.

Those options may be available, but they can come with significant financial consequences and, in some cases, may be more difficult to access once your income has stopped.

Let’s look at a few of the most common alternatives.

Option 1: Borrow the Money

Maybe you use a line of credit or take out a loan.

If you borrowed $120,000 at 5% and wanted to repay it over 10 years, your payments would be approximately $1,270 per month.

By the time the loan was repaid, you would have paid approximately $152,000.

There is also a practical issue:

Will a lender extend you $120,000 of new credit after your income has stopped?

Your ability to borrow is generally strongest when you are healthy and earning an income. If you wait until after becoming disabled to apply for additional credit, qualifying may be considerably more difficult.

So while borrowing may be an option, it shouldn’t necessarily be assumed that the money will be available when you need it.

Option 2: Refinance Your Home

Maybe you have significant equity in your home.

You could potentially refinance and add the $120,000 to your mortgage.

Using a 4.5% interest rate and amortizing that additional $120,000 over 25 years, the payment would be approximately $665 per month.

That certainly sounds more manageable than paying back a loan over 10 years.

But there are 2 problems.

First, over 25 years, you could end up repaying approximately $200,000 to replace the $120,000 of income you lost during a single year of disability.

Second, can you actually qualify for the refinance?

A refinance is not simply a matter of having equity in your home. The lender will generally need to qualify you based on your financial situation, including income and existing debts.

If you are unable to work and your employment income has stopped, accessing that equity may be much more difficult than it would have been while you were healthy and working.

You could also face appraisal costs, legal costs and potentially mortgage penalties depending on how the refinancing is structured.

In other words, you may have hundreds of thousands of dollars of equity in your home but still have difficulty accessing it when you need it most.

And even if you can access it, a 12-month disability could result in debt attached to your home for the next 25 years.

Option 3: Use Your Investments

Maybe you don’t need to borrow because you have accumulated significant investments.

That’s certainly better than having no assets available, but there is still a cost.

If the money is coming from an RRSP, the withdrawal itself is taxable income.

Assuming an effective tax rate of 40%, you could need to withdraw approximately $200,000 from your RRSP to have $120,000 available after tax.

Your actual tax liability would depend on your province and overall taxable income for the year.

But taxation is only part of the story.

Assume that $200,000 could otherwise remain invested for another 25 years earning an average return of 7%.

It could grow to approximately $1.09 million.

Think about how long it took to accumulate that $200,000 in the first place.

A 12-month disability could force you to use years of savings and give up decades of future investment growth, significantly affecting what you have available for retirement.

What About Your TFSA or Non-Registered Investments?

You could use those as well.

But ask yourself why you accumulated those assets in the first place.

Retirement? Your children’s education? Buying another property? Travel? Financial independence?

Every dollar you withdraw to replace lost income is a dollar that is no longer available for another financial goal.

And This Example Is Only One Year

This is the part I think sometimes gets overlooked.

Our example assumes you are unable to work for 12 months.

What happens if your disability lasts 2 years?

5 years?

Or permanently prevents you from returning to your previous occupation?

At $10,000 per month, a 5-year disability represents $600,000 of income replacement.

Very few people would be comfortable funding that entirely through savings, investments or additional debt.

Disability Insurance Protects More Than Your Income

This is why I don’t look at Disability Insurance as simply another monthly expense.

It protects the rest of your financial plan.

Your investments can remain invested.

Your home equity can remain intact.

Your retirement savings can continue compounding.

And you don’t have to take on significant debt at exactly the point in your life when your income has been interrupted.

For high-income professionals, executives and business owners, your ability to earn an income may be one of your most valuable financial assets.

Protecting that income can help protect everything else you have worked hard to build.

– Jeff

*Disclaimer: This article is intended for general informational and educational purposes only and does not constitute personalized insurance, financial, legal, or tax advice. Insurance needs, policy features, costs, and suitability vary based on individual circumstances and specific contract provisions. Coverage availability and terms are subject to insurer underwriting and approval. Readers should review their own situation carefully and consult with a licensed insurance advisor before making any insurance decisions or changes to existing coverage.