How Disability Income Affects Retirement Planning

Disability and Healthcare Planning | by Jules Buxbaum | Tuesday, January 28, 2025

If you rely on disability income to manage everyday costs, you might wonder how it impacts your plan for life after work. This topic frequently arises among business owners, finance pros, and those seeking clarity on how health challenges could amend their saving and investing approach.

Although disability benefits provide financial relief, extending that support throughout your retirement years requires careful coordination. For a closer look at the basics of coverage, consider our guide on short-term vs. long-term disability coverage.

Defining Disability Income and Its Key Forms

Disability income generally comes from sources like government programs, employer-sponsored coverage, or a private policy. The two most common federal benefits in the United States are Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI).

SSDI is funded through payroll taxes. Eligibility hinges on your work history and the number of credits you have paid into Social Security. By contrast, SSI is for those with limited resources and offers monthly payments based on financial need rather than work history.

Private policies or employer-based plans often replace around 60% of your pre-disability salary. They can be vital for bridging the gap between expenses and any partial coverage from government benefits. As of January 2025, around 8,294,000 people receive Disability Insurance benefits, representing 12.1% of all Social Security beneficiaries, with an average monthly payment hovering near $1,580.671.

Each source has distinct rules about eligibility, payment calculations, and length of coverage. Understanding their differences now can help avert stressful surprises later.

When Disability Leads to Early Retirement

For some, a health setback hastens their departure from the workforce. Research indicates that around 46% of Americans who retire earlier than planned do so because of medical issues or a disability2. This outcome reduces the years available to build savings and can change the trajectory of your entire retirement plan.

With reduced contributions to your 401(k) or IRA, the nest egg may be smaller than intended. Funds you had hoped would compound for decades might be tapped sooner to cover living costs. Additionally, you may lose out on employer matching contributions if you leave the job prematurely.

Government benefits can partially fill this gap, though they rarely match your former earnings. SSDI recipients sometimes worry about having fewer peak-income years included in their calculation for Social Security. Because the Social Security retirement benefit is determined by your highest 35 years of earnings, a forced early exit can lower your eventual retirement payouts.

Longer Retirement Span, Larger Challenges

If you depart the workforce years ahead of schedule, you might spend more time relying on your savings. For those with limited employment prospects, establishing stable income streams becomes crucial. Some individuals in their 50s or 60s still have potential earning capacity, but not everyone can easily reenter the workforce.

This scenario highlights the importance of planning with a realistic time horizon. Even if you anticipate returning to the job market, reevaluating your retirement plan right away can keep you from depleting funds too quickly.

Tax Implications and Healthcare Costs

People often underestimate the tax responsibilities that accompany certain disability benefits. While SSI benefits are not taxed, SSDI may be subject to income tax below or above specific thresholds, leaving some recipients with smaller take-home amounts.

Meanwhile, private disability insurance benefits can be taxable if premiums were paid with pre-tax dollars. A portion of these payouts might be counted as ordinary income, complicating the calculations when mapping out monthly budgets.

Healthcare expenses present an ongoing worry as well. Medicare eligibility typically begins 24 months after SSDI approval, but medical out-of-pocket costs can still be significant. Some individuals receive Medicaid or become “dual eligible” (qualifying for both Medicare and Medicaid), which often helps reduce expenses. Even so, prescription drugs, specialist visits, or specialized equipment can drain your resources.

Why Unique Portfolios Matter

At 2Pi Financial, we hold the perspective that many retirees end up taking too little market-based risk, assuming that their age alone dictates that they pull back on stocks. Security selection matters, but the link between potential earnings and total wealth can matter even more. If your disability sidetracks your career, you no longer have the donor capacity of future wages to cushion volatility. Still, a higher equity allocation could offer better long-term growth for those needing to preserve or expand smaller savings.

On the other hand, not everyone with a disability must automatically embrace extra equities. If you already possess substantial wealth, an ultra-conservative approach may suffice. The key, we believe, is aligning risk exposure with real life factors—especially how workplace changes can influence your financial base.

Refining Your Retirement Strategy

Disability income can upend your plans, but you can make targeted moves to keep your retirement goals reachable. Below are a few methods to consider:

• Consider Additional Coverage: If you don’t have a private disability policy, investigate supplementing any existing group coverage. This extra layer may replace more of your income if you can’t perform your job duties.
• Revisit Your Asset Allocation: Many people reduce risk as they get older, but if your disability leads to a more pressing need for growth, you might allocate more to equities—or at least less to conservative investments—than standard “glide path” models suggest.
• Account for Medical Costs: Future healthcare bills can mushroom quickly. Look into Health Savings Accounts (HSAs), especially if you still have some employment, and keep track of out-of-pocket limits to avoid draining your retirement funds.
• Look at Government Program Qualifications: If you’re facing a disability claim, you might find value in exploring what qualifies under programs like SSDI. Our article on how to qualify for Social Security disability benefits goes into more detail on necessary steps.
• Establish an Emergency Fund: Although your monthly disability check sustains routine bills, a cash reserve can help with unpredictable medical costs or home modifications. Dedicating even a small amount consistently will build up over time.

A Quick Note on 2Pi's Financial Planning Engine

Managing your disability and retirement paths need not be guesswork. Our proprietary tool, Two Pi Financial Planner, walks you through inputting financial details, from current salary to retirement age goals. It then analyzes risk tolerance, possible drawdown rates, and inflation assumptions to forecast outcomes.

You can experiment with altering a target retirement year or bumping up your monthly savings, tracking how these shifts raise the chance of not running out of money. This systematic approach may be especially helpful to anyone grappling with reduced wages due to disability.

Handling Denials or Complications

Occasionally, individuals with a well-prepared application for Social Security disability face confusion or even denial. They might also run into issues with private insurers. If that resonates with your situation, check our resource on what to do if your disability benefits are denied to see how an appeal process works.

Beyond formal rejections, practical hurdles include large health bills, bureaucratic red tape, or incomplete medical files. Seeking legal counsel or specialty advisors often helps unravel eligibility details so you can focus on day-to-day obligations.

Looking Beyond Disability Coverage

It might feel tempting to stop saving for retirement once you start receiving disability payments. Yet individuals likely to rely on these benefits for many years face the same inflation and longevity risks as any retiree. A well-rounded plan accounts for possible disruptions in the broader economy and sets a steady course for the future.

For instance, a 2.5% Social Security cost-of-living adjustment (COLA) is slated for 20253, boosting monthly checks slightly. However, medical inflation can outpace these adjustments. Monitor your portfolio to preserve not only your everyday income but also any long-term objectives you hold—like retiring in a particular state or leaving assets for loved ones.

Integrating Disability Income with Retirement Accounts

If you qualify for penalty-free withdrawals from a 401(k) or IRA because of a permanent disability, you could access those funds earlier without the usual 10% penalty. Still, you must provide proper documentation to confirm your disability meets the IRS definition. This path might help cover urgent bills, but be mindful of how it shrinks your future savings potential.

Some long-term disability insurance policies also contribute to your retirement account. They deposit a portion of your former pay into a retirement vehicle, letting you continue growing assets. Although not universal, such features highlight the relevance of reading policy fine print carefully before you need to file a claim.

Final Insights

Disability income brings a layer of financial protection many people rely on when health events disrupt their ability to earn a paycheck. However, maintaining a stable lifestyle through retirement calls for a strong grasp of taxes, healthcare costs, investment choices, and potential benefit shortfalls.

If you want an in-depth look at reducing future tax burdens, our guide on how to minimize taxes on your retirement income offers practical tips. With well-chosen strategies, it is possible to support your current needs while still planning for tomorrow.

References

1. Social Security Administration. (2025). “Monthly Statistical Snapshot, January 2025.” Available at: https://www.ssa.gov/policy/docs/quickfacts/stat\_snapshot
2. Western & Southern Financial Group. (n.d.). “How to Plan for Early Retirement Due to Disability.” Available at: https://www.westernsouthern.com/retirement/how-to-plan-for-early-retirement-due-to-disability
3. AARP. (2024). “Social Security Changes in 2025: A Preview.” Available at: https://www.aarp.org/money/retirement/changes-2025/