Disability Insurance Cost of Living Adjustment (COLA) Riders

Individual disability insurance is crucial to expanding your safety net and retirement planning. However, personal finance looks different for everyone, so there isn’t a one-size-fits-all policy.

Disability insurance isn’t always enough on its own to support all the policyholder’s expenses, especially if you require total disability benefits. Understanding the nuances of disability insurance coverage can help you choose the best policy for your needs.

What is a Cost of Living Adjustment Rider?

A Cost of Living Adjustment (COLA) Rider, or cost-of-living rider, can be tacked onto your disability policy so your benefits are guaranteed to keep up with the rising cost of living due to economic inflation.

This disability insurance rider typically adjusts the monthly benefit of your policy on an annual basis, either by a fixed percentage or by tying it to the Consumer Price Index (CPI).

Cost-of-living adjustments apply to residual and total disabilities and take effect when you’ve been disabled for one year.

Each insurance carrier may calculate cost-of-living adjustments differently. As such, adjustments can be calculated on a simple or compound basis.

The main purpose of a COLA Rider is to protect your purchasing power if you develop a long-term disability that inhibits your ability to work.

It ensures that you can maintain your standard of living even if the cost of goods and services increases over time by adjusting your monthly benefit to account for inflation.

The COLA Rider is particularly important for younger individuals with fewer assets and a longer time until they achieve financial independence.

Since they have more years of potential disability ahead of them, the need for a rider that keeps pace with inflation is crucial to avoid a significant reduction in their future benefits.

If you don’t maximize the coverage you qualify for based on your annual income, you may want to do without the COLA Rider. Instead, you can redirect the funds you would have spent on the rider to get more coverage through your base policy.

It is important to note that the COLA Rider only increases your monthly benefit for long-term disabilities, or disabilities that prevent you from working for at least 12 months. If you have a short-term disability, the cost-of-living adjustment rider may have a more limited impact.

COLA Rider vs. Buying Additional Coverage

Here are some factors to consider as you decide whether to purchase a COLA rider or buy additional coverage:

  1. Flexibility: A COLA rider provides flexibility by adjusting the policy’s benefits based on changes in the cost of living over time. On the other hand, buying additional coverage offers a fixed increase in the coverage amount, meaning it won’t necessarily hold value if inflation increases.
  2. Cost: Adding a COLA rider to your policy may increase the premium cost, but it protects your purchasing power in the long run. Buying additional coverage will also increase the premium, but the cost is usually lower compared to a COLA rider.
  3. Long-term needs: If you anticipate a significant increase in your living expenses over time, a COLA rider can be a valuable addition to your policy. However, if your coverage needs are more immediate and a fixed increase in coverage amount is sufficient, buying additional coverage may be a better option.
  4. Age and assets: If you’re younger and have a longer time horizon, a COLA rider can protect against future inflation. On the other hand, if you’re close to retirement or have substantial assets that can offset inflation, buying additional coverage may be a more cost-effective choice.

Economic Benefits of a Cost of Living Adjustment Rider

A COLA rider offers several economic benefits:

  • Purchasing power protection: As the cost of living increases, the COLA rider ensures that your policy benefits keep pace with inflation, maintaining your purchasing power.
  • Financial security: With a COLA rider, you can have peace of mind knowing that your insurance coverage will be adjusted to meet your changing needs, even in times of economic uncertainty.
  • Long-term planning: The COLA rider allows you to plan for the future by providing a predictable increase in benefits, which can help you maintain a certain standard of living.

If you’re deciding between a COLA rider and buying additional coverage, carefully evaluate your circumstances and future goals to make an informed choice that aligns with your financial needs.

The Impact of a Cost of Living Adjustment Rider

In this section, we’ll discuss a scenario involving a surgeon’s disability insurance policy to illustrate the impact of a Cost of Living Adjustment (COLA) rider. We’ll compare the premium with and without the COLA rider, explore the possibility of additional coverage with premium savings, and calculate the break-even period.

Imagine a surgeon who has purchased a disability insurance policy. This policy provides a monthly disability benefit of $5,000 to cover the surgeon’s expenses in the event of disability. However, without a COLA rider, the benefit amount remains fixed throughout the policy’s term, regardless of inflation.

Premiums With and Without the Cost of Living Adjustment Rider

The COLA rider adjusts the monthly disability benefit based on the Consumer Price Index, which measures inflation. By incorporating this rider, the insurance company ensures that the benefit amount keeps pace with the rising cost of living.

Suppose the surgeon decides to include a COLA rider that provides an annual adjustment based on the CPI––up to a maximum of 5% per year. With this rider, the surgeon’s monthly benefit will increase each year to account for inflation.

We can determine the additional cost associated with adding this rider by comparing premiums for an individual disability insurance policy with and without the COLA rider. It’s important to weigh this cost against the potential benefits.

Premium Savings with Additional Coverage

In some cases, adding a COLA rider may offer an opportunity for additional coverage without increasing monthly premiums. Let’s say the surgeon initially budgets $300 per month for disability insurance premiums.

Without the COLA rider, the surgeon can secure a policy with a $5,000 monthly benefit within this budget. However, by opting for the COLA rider, the surgeon may be able to secure a higher benefit amount, like $5,500 per month, while still keeping the premium at $300 per month.

Break-Even Period Calculation

It’s important to determine the break-even period when considering the cost of adding a COLA rider. The break-even period is the point at which the additional cost of the rider is offset by the increased benefits it provides over time.

To calculate the break-even period, compare the premium difference between the policy with and without the COLA rider to the additional monthly benefit it adds. This calculation helps to evaluate the long-term financial impact of the rider.

By carefully analyzing the premium costs, potential additional coverage, and break-even period, the surgeon can make an informed decision about whether to include a COLA rider in their disability insurance policy.

Other Disability Riders Worth Considering

COLA riders are one of many add-on options you can add to your disability insurance. Here are a few more to consider:

  • Basic Partial Disability Benefit Rider: Pays out if you have reduced working capacity due to an injury that doesn’t result in total disability
  • Catastrophic Disability Benefit Rider: Provides up to 100% income replacement if you are permanently disabled
  • Waiver of Premium Rider: Ensures the insurance carrier covers, or waives, premium payments in the event the policyholder is unable to work
  • Residual Disability Rider: Makes up for the portion of the income the policyholder misses out on if they are unable to work due to a partial disability
  • Future Increase Option Rider: Reserves the right for policyholders to increase coverage without undergoing additional medical underwriting
  • Student Loan Protection: Adds extra money to your monthly benefit to compensate for student loan payments

In general, the younger you are the more riders you’ll want to consider. As you approach retirement, you may consider dropping riders that inflate your premium payments unnecessarily.

Is a COLA Rider Worth It?

You may be wondering, “Is it worth it to invest in a COLA rider?” Generally, the younger you are and the fewer assets you have, the more beneficial the COLA Rider could be.

If you’re not choosing the maximum coverage you qualify for based on your income, you might want to consider ditching the COLA Rider. Instead, use the money you would’ve put toward the COLA Rider to get a larger monthly benefit.

In such cases, it might be more beneficial to allocate the funds toward purchasing a larger monthly benefit instead. Keep in mind that the COLA Rider will only increase your benefit after 12 months of disability, so if you aren’t disabled for a long-term period, it may not provide as much economic benefit.

We always recommend talking through your options with a qualified financial professional who can provide personalized recommendations for your needs. An insurance agent, broker, or financial advisor with a fiduciary responsibility can help you run a cost-benefit analysis on the riders available to you.