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

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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! 

Scott

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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.

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