Full pension combined with life insurance vs. pension with survivor benefit: Which is better?

Scales of Justice - shutterstock_100605031

Q: Is it bet­ter to take a reduced retire­ment annu­ity to cover a spouse in case of my death or take the full annu­ity and buy a term life pol­icy for 20 years? I am 58, spouse is 64 self employed.

I am retir­ing in June from the pub­lic school sys­tem and have a great retire­ment annu­ity from TRS. My hus­band does not have any retire­ment ben­e­fits as he is self-employed. We do have about 150,000 in IRA as well. I can choose an option of a reduced monthly annu­ity in order for my spouse to receive the entire monthly annu­ity check in the case of my death for the rest of his life; 1/2 the annu­ity check; or 3/4 the annu­ity check. This seems like a life insur­ance pol­icy and finan­cially, it seems to make bet­ter sense to take out a term life pol­icy for 20 years and take the full monthly annu­ity, hedg­ing on the bet that I will not die a pre­ma­ture death. Please advise.

- Amy, Abi­lene, Texas

A: Con­grat­u­la­tions on your soon-to-be retired sta­tus! Are you down to count­ing the days yet or are you still using months or weeks?

The con­cept to which you are refer­ring is often called Pen­sion Max­i­miza­tion and it’s a great strat­egy to con­sider, so thank you for ask­ing about it. Gen­er­ally, the main pieces to exam­ine when con­sid­er­ing this plan­ning strat­egy are:

  •  The amount of insur­ance ben­e­fit you’ll need to replace the pen­sion income if you pass away. You’ll need to cal­cu­late this for each sur­vivor option.
  •  The costs for such a pol­icy com­pared to the pen­sion reduc­tion amount.

If you deter­mine that you could buy the life insur­ance pol­icy for less than the amount of the pen­sion reduc­tion, then pur­chas­ing a life insur­ance pol­icy instead could be a good strat­egy.  To be clear though, it’s not quite this straightforward.

How much insur­ance will be needed?
For instance, since you’ll be cal­cu­lat­ing the size of the lump sum nec­es­sary today to replace a guar­an­teed sur­vivor ben­e­fit for life, it’s extremely impor­tant to be con­ser­v­a­tive with your assump­tions.  In other words, because the pos­si­ble sur­vivor ben­e­fit is guar­an­teed, you’ll want to do your insur­ance need cal­cu­la­tions assum­ing a pretty low rate of return on your insur­ance ben­e­fits (ide­ally one that you’re hus­band could be guar­an­teed to earn).  In these cal­cu­la­tions, lower assumed returns equate to higher needed insur­ance amounts, and con­se­quently higher premiums.

What type of insur­ance should you buy?
It’s also impor­tant to con­sider the type of insur­ance you’d buy.  Though a term pol­icy is prob­a­bly cheaper than a per­ma­nent pol­icy like whole or uni­ver­sal life, once the ini­tial term period expires a term pol­icy may become too expen­sive to keep, thus leav­ing your hus­band with­out his safety net.  To min­i­mize this risk, a per­ma­nent pol­icy is often a bet­ter choice.  Be aware though, that per­ma­nent poli­cies come with higher pre­mi­ums and as such, can make the strat­egy less attractive.

Finally, for pen­sion max­i­miza­tion to work, you have to be sure you’ll be able to make the insur­ance pay­ments for the rest of your life.  While that might seem pretty easy today, will that still be the case 15 or 20 years from now?

Cau­tion is key
So while this could be a work­able strat­egy for you, I would approach it very cau­tiously.  Some­times the num­bers work out and some­times they don’t.  The key is to be objec­tive and con­ser­v­a­tive as you do your cal­cu­la­tions so that you don’t make the wrong deci­sion and dis­cover it after it’s too late. Here’s the bot­tom line for me: if the num­bers don’t tell a very com­pelling story, I wouldn’t do it.

Thanks again for your ques­tion and best of luck to you in retire­ment! 


Share |

USAA or its affiliates do not provide tax advice. Taxpayers should seek advice based upon their own particular circumstances from an independent tax advisor. The information is provided for informational purposes only and is not intended to substitute for obtaining professional financial advice. Please thoroughly research and seek professional representation before acting on any information you may have found in this article. This article is in no way attempts to provide advice that relates all personal circumstances.

Examples given are hypothetical illustrations and not an indication of the benefits or features of any USAA product. You should seek policies and advice based upon your own particular circumstances. Sample loans are for illustration purposes only and are not a rate quote, pre-approval, or commitment to lend.

Scott Halliwell and JJ Montanaro are CERTIFIED FINANCIAL PLANNER™ practitioners with USAA Financial Planning Services, one of the USAA family of companies. Certified Financial Planner Board of Standards, Inc. owns the certification marks CFP® and Certified Financial Planner™ in the United States, which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

USAA Financial Planning Services® refers financial planning services and financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Company in California, Lic. #0E36312), a registered investment adviser and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer. (known as USAA Financial Insurance Agency in California), a registered investment adviser and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer.

USAA means United Services Automobile Association and its affiliates. Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers. Banking products provided by USAA Federal Savings Bank. Credit cards provided by USAA Savings Bank. Both Banks Member FDIC.