When people near retirement they often wonder how much, if any, life insurance they should have during retirement. When you are working and have financial obligations such as a mortgage, college funding, etc., you have a need for higher levels of insurance. In retirement, people often figure they don’t have to worry about replacing lost income; therefore, the need for life insurance is non-existent. However, this may not always be the case.
Generally, there are two main uses for life insurance in retirement: to replace lost income or to pay estate tax upon death. For instance, you may still have dependents that need your Social Security or pension income and would suffer a financial hardship in the event of your death. When it comes to estate planning, life insurance is often used to pay estate taxes rather than forcing heirs to liquidate other assets. To determine whether insurance in retirement would be necessary, you should start by asking yourself, “Will someone suffer a financial hardship if I die?” Remember, this “someone” could be a spouse, significant other or even a child. If the answer is yes, then you need to protect your assets or income stream. If no, then life insurance may not be necessary. Once you figure out if you do in fact need it, then it’s important to consider how much you may need.
For retirees who receive a pension, the highest benefit is generally paid for a “life only” or single life payout. While this provides a higher retirement income than a joint-life annuity, the benefit stops upon your death. In this case, life insurance would be purchased to replace the lost pension benefit for the surviving spouse or other dependents. A strategy called Pension Maximization can help. This involves using the additional income you receive by choosing the single life annuity over the joint life annuity to pay for life insurance premiums. Since life insurance costs are based on age and health status, it is important to balance the higher income with potentially higher life insurance premiums if you have health problems.
For example, a retiree could choose between the following:
- Option 1: Pension of $5,000 per month with no survivor benefit
- Option 2: Pension of $4,800 with a 50 percent survivor benefit (Survivor would receive $2,400 per month)
- Option 3: Pension of $4,500 with a 100 percent survivor benefit (Survivor will continue to receive $4,800 per month)
In this case, Pension Maximization means you choose option 1. The $500 per month additional income benefit is used to purchase enough life insurance to replace the lost pension of $4,500 per month. If the insurance will not do this, then the retiree may be better off choosing a lower payment and leaving the survivor benefit. (The above is an example of how this works and the numbers used are for illustrative purposes only.)
In the case of Social Security, if one spouse dies, the surviving spouse is entitled to the higher Social Security of the two. In other words, one check stops coming in. This loss of income may be a burden for the survivor. Purchasing life insurance on each spouse will provide death protection to replace the lost Social Security income.
Finally, when it comes to estate planning, under the current estate tax laws, most people will avoid having to pay estate taxes. You must keep in mind though that the current laws are scheduled to change in the near future and depending upon what direction Congress takes with the estate tax, you could find your estate exposed to higher taxes. Also, in some cases where your estate is made up of illiquid assets such as a business or real estate, you would not want to have to put your heirs in a position to having to sell the assets. This is where life insurance can provide much needed liquidity.
As for types of life insurance to buy, the choices can be confusing. One thing for sure is that Term Insurance is not appropriate for retirement due to the fact that this type of insurance usually ends between the ages of 70-75. Since life insurance needs in retirement are usually permanent, consider policies such as Whole life, Variable life, Universal life or Second to die (insures two and payable after the death of the second) to name a few. There are other permanent life insurance policies you may consider as well.
You need to carefully evaluate your needs and the cost for protecting those needs. Have a financial planner run the numbers. Only then can you make the right decision about whether life insurance in retirement is necessary for you.
FPA member Scott M. Kahan, CFP®, is president and founder of Financial Asset Management Corp. in New York City.