Should You Surrender Your Life Insurance Policies When You Retire?
Squarespace Excerpt: As individuals approach retirement, they often begin reviewing their annual expenses, looking for ways to trim unnecessary expenses so their retirement savings last as long as possible now that their paychecks are about to stop for their working years. A common question that comes up during these client meetings is “Should I get rid of my life insurance policy now that I will be retiring?”
As individuals approach retirement, they often begin reviewing their annual expenses, looking for ways to trim unnecessary expenses so their retirement savings last as long as possible now that their paychecks are about to stop for their working years. A common question that comes up during these client meetings is “Should I get rid of my life insurance policy now that I will be retiring?”
Very often, the answer is “Yes, you should surrender your life insurance policy”, because by the time individuals reach retirement, their mortgage is paid off, kids are through college and out of the house, they have no debt outside of maybe a car loan, and they have accumulated large sums in their retirement accounts. So, what is the need for life insurance?
However, for some individuals, the answer is “No, you should keep your life insurance policies in force,” and we will review several of those scenarios in this article as well.
Retirees That Should Surrender Their Life Insurance Policies
Since this is the more common scenario, we will start with the situations where it may make sense to surrender your life insurance policies when you retire.
Remember Why You Have Life Insurance In The First Place
Let’s start off with the most basic reason why individuals have life insurance to begin with. Life insurance is a financial safety net that protects you and your family against the risk if you unexpectedly pass away before you're able to accumulate enough assets to support you and your family for the rest of their lives, there is a big insurance policy that pays out to provide your family with the financial support that they need to sustain their standard of living.
Once you have paid off mortgages, the kids are out of the house, and you have accumulated enough wealth in investment accounts to support you, your spouse, and any dependents for the rest of their lives, there is very little need for life insurance.
For example, if we have a married couple, both age 67, who want to retire this year and they have accumulated $800,000 in their 401(K) accounts, we can show them via retirement projections that, based on their estimated expenses in retirement, the $800,000 in their 401(K) accounts in addition to their social security benefits is more than enough to sustain their expenses until age 95. So, why would they need to keep paying into their life insurance policies when they are essentially self-insured. If something happens to one of the spouses, there may be enough assets to provide support for the surviving spouse for the rest of their life. So again, instead of paying $3,000 per year for a life insurance policy that they no longer need, why not surrender the policy, and spend the money on more travel, gifts for the kids, or just maintain a larger retirement nest egg to better hedge against inflation over time?
It's simple. If there is no longer a financial need for life insurance protection, why are you continuing to pay for financial protection that you don’t need? There are a lot of retirees that fall into this category.
Individuals That Should KEEP Their Life Insurance Policies in Retirement
So, who are the individuals who should keep their life insurance policies after they retire? They fall into a few categories.
#1: Still Have A Mortgage or Debt
If a married couple is about to retire and they still have a mortgage or debt, it may make sense to continue to sustain their life insurance policies until the mortgage and/or debt have been satisfied, because if something happens to one of the spouses and they lose one of the social security benefits or part-time retirement income, it could put the surviving spouse in a difficult financial situation without a life insurance policy to pay off the mortgage.
#2: Single Life Pension Election
If an individual has a pension, when they retire, they have to elect a survivor benefit for their pension. If they elect a single life with no survivor benefit and that pension is a large portion of the household income and that spouse passes away, that pension would just stop, so a life insurance policy may be needed to protect against that pension spouse passing away unexpectedly.
#3: Estate Tax Liability
Uber wealthy individuals who pass away with over $13 Million in assets may have to pay estate tax at the federal level. Knowing they are going to have an estate tax liability, oftentimes these individuals will purchase a whole life insurance policy and place it in an ILIT (Irrevocable Life Insurance Trust) to remove it from their estate, but the policy will pay the estate tax liability on behalf of the beneficiaries of the estate.
#4: Tax-Free Inheritance
Some individuals will buy a whole life insurance policy so they have an inheritance asset earmarked for their children or heirs. The plan is to maintain that policy forever, and after the second spouse passes, the kids receive their inheritance in the form of a tax-free life insurance payout. This one can be a wishy-washy reason to maintain an insurance policy in retirement, because you have to pay into the insurance policy for a long time, and if you run an apple-to-apple comparison of accumulating the inheritance in a life insurance policy versus accumulating all of the life insurance premium dollars in another type of account, like a brokerage account, sometimes the latter is the more advantageous way to go.
#5: Illiquid Asset Within the Estate
An individual may have ownership in a privately held business or investment real estate which, if they were to pass away, the estate may have expenses that need to be paid. Or, if a business owner has two kids, and one child inherits the business, they may want a life insurance policy to be the inheritance asset for the child not receiving ownership in the family business. In these illiquid estate situations, the individual may maintain a life insurance policy to provide liquidity to the estate for any number of reasons.
#6: Poor Health Status
The final reason to potentially keep your life insurance in retirement is for individuals who are in poor health. Sometimes an individual is forced into retirement due to a health issue. Until that health issue is resolved, it probably makes sense to keep the life insurance policy in force. Even though they may no longer “need” that insurance policy to support a spouse or dependents, it may be a prudent investment decision to keep that policy in force if the individual has a shortened life expectancy and the policy may pay out within the next 10 years.
While “keeping” the life insurance policy in retirement is less commonly the optimal solution, there are situations like the ones listed above, where keeping the policy makes sense.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
How Much Life Insurance Should You Have? Top 8 Factors
When we are assisting clients in building their personal financial plan, inevitably one of the most frequent questions that comes up is: “How much life insurance should I have?”
how much life insurance do you need
When we are assisting clients in building their personal financial plan, inevitably one of the most frequent questions that comes up is: “How much life insurance should I have?” It's an important question to ask because if something unexpected were to ever happen to you or your spouse, it could put your family in a very difficult financial situation. To help mitigate this risk, people buy life insurance to guard against this type of unfortunate event but it’s important to know how much life insurance protection you should have. If you have too little, the coverage might not be enough to meet your family’s financial needs. If you have too much, you might be wasting money on insurance that you don’t need.
In this article we're going to go over the top 8 variables that factor into how much life insurance you should have, as well as, what type of insurance might make sense for you.
#1: Amount of Debt
First, you should tally up the total value of all of your outstanding debt.
Mortgage
Student Loans
HELOC
Credit Cards
Car Loans
Any other debt…………..
If you have dependents and something were to happen to you, the goal is to minimize the future annual expenses for your family. If you are married and you are used to having two incomes in the household to pay the mortgage, student loans, and car loans, if one spouse passes away, the family loses that income stream and it could be very difficult to meet the monthly payment on the debt with only one income. The life insurance would payout at the death of the insured spouse and those proceeds can be used to wipe out all of the debt which in turn reduces the monthly expense burden on the family.
#2: Income Level of Each Spouse
If you are married, the income level of each spouse will factor into how much life insurance each spouse should have. If spouse 1 makes $200K per year and spouse 2 makes $40K per year, typically you will need more insurance on spouse 1 than spouse 2. If Spouse 1 passes away, over the next 5 years, that’s $1 million in income that would need to potentially be replaced ($200K x 5 Years). However, if spouse 2 passes away, there would only need to be $200K to cover the next 5 years of income ($40K x 5 years).
A common mistake that married couples make is they blindly go in and purchase two insurance policies with the same death benefit without taking the different income levels into account. For possibly the same combined premium amount, in many but not all cases, couples can be better served by shifting more of the insurance coverage to the spouse with the higher income.
#3: Future College Expenses
If you have children and you expect those children to attend college, if you do not expect to receive large amounts of need based financial aid, it's important to factor in future college expenses into the amount of the insurance coverage. If you have 3 children and you planned on paying for their first 4 years of college, assuming college tuition with room and board is $25,000 per year, that’s $100,000 per child, multiplied by 3, for a grand total of $300,000 in anticipated college costs.
#4: Household Expenses
Everyone has a different lifestyle. One couple that has a combined income of $300,000 may need $250,000 to support household expenses if one of the spouses were to pass away. But another couple making the same $300,000 per year may only need $150,000 per year in income to support the household if one of the spouses passes away. You have to determine how your annual expenses would be impacted based on the untimely death of each spouse.
#5: Outside Savings
The amount of wealth that you have already accumulated absolutely factors into the amount of insurance that you may need. For example, if you sold your business and have $2 million in cash and non-retirement investment accounts, you may essentially be self-insured, meaning if something happened to you, you have accumulated enough savings to meet all of your family’s future financial needs without the need for additional insurance coverage.
However, if you and your spouse are both below the age of 50, have 2 children, and all of your wealth is tied up in 401(k)’s or retirement accounts, if you or your spouse were to pass away, the surviving spouse would have to withdrawal that money from the retirement accounts to meet expenses and pay tax on those distributions. So that $200,000 in their 401(K) may only be $150,000 after the taxes are paid but it depending on your tax bracket. By comparison, personal life insurance policies that you pay for out of pocket, the insurance proceeds are received tax free when paid to your beneficiaries.
So it’s not just a question of how much you have accumulated but also how accessible are those assets to your beneficiaries if they need to use those assets to supplement their income.
#6: Retirement Savings
You also have to consider the impact of an untimely death of a spouse on your retirement projections. If you or your spouse are covered by an employer sponsored retirement plan, like a 401(k) or 403(b), your retirement projections probably have you both making those regular annual contributions up until your retirement date. If one spouse passes away, those retirement contributions that were supposed to be there, no longer will be, which could force the surviving spouse to work longer than they wanted too.
You have to pay close attention to individuals that have pensions. Some pensions require the employee to turn on their pension benefit to reserve the survivor benefit for their spouse. If the employee passes away prior to their pension start date, the generous pension benefit which the family was depending on could be replaced by a much lower lump sum death benefit. In addition, retirees that elect a pension benefit with no survivor benefits to their spouse will sometimes use life insurance to cover the risk that they pass away and the pension stops within the early years of retirement.
#7: Adult Children with Disabilities
For families that have adult children with disabilities, it's not uncommon for the parents to be providing some form of continued financial support for their disabled child for the duration of their adulthood. If the parents were to pass away, the concern is that there has to be enough assets inherited by the child to provide them with support for the remainder of their life. Parents will often set up a Special Needs Trust to serve as the beneficiary of these life insurance policies so if the policies do payout it does not jeopardize the Social Security, Medicaid, Medicare or other government assistance that the disabled child may be receiving.
#8: Estate Plan
For some clients, it’s part of their estate plan that no matter what happens they want to know that $500,000 will go to each child, their favorite charity, to a trust for their grandchildren, or for clients with larger estates to pay the anticipated estate tax. To guarantee that those amounts will be available to meet their estate wishes, individuals can purchase permanent life insurance that will payout at the death of the insured.
Case Study
Let's run through a simple example given the following fact set:
Spouse 1 Income: $200,000 (Age 30)
Spouse 2 Income; $50,000 (Age 31)
Children: Susan Age 4 and Rebecca Age 2
Mortgage: $250,000
Student Loans: $20,000
The couple above has the college savings goal to pay for the first 4 years of the kid’s college expenses which is anticipated to be $25,000 per year.
Total Debt: $270,000
Total Estimated Future College Expense: $200,000 ($25K per year for each child)
From an income replacement standpoint, we would be looking to provide this family with a minimum of 5 years of income replacement. For the coverage on Spouse 1 that would be:
$200K Annual Income x 5 Years = $1M
Total Debt and College Costs = $470K
Total Insurance Coverage on Spouse 1: $1.5M (round up)
For the coverage on Spouse 2 that calculation would be: $50K Annual Income x 5 Years = $250KTotal Debt & College Costs = $470KTotal Insurance Coverage on Spouse 2 = $750K (round up)
How Much Does Insurance Cost?
In general, term insurance is cheap and permanent insurance is more expensive. For 90% of the individuals that we work with for their financial plan, term insurance typically makes the most sense. To give you an idea, a $1M 30 Year Term policy with William Penn Insurance Company, for an individual with the following fact set:
Age 30
Gender: Male
Resident of New York
Non-Smoker
Preferred Health Class
The monthly premium would only be $70.46 per month as of July 2020.
New York Residents: We Can Help
Michael Ruger & Rob Mangold are independent insurance agents which means we are not tied to a single insurance company. If you are a resident of New York, we can consult with you, help you to determine the amount of insurance that you need, evaluate you current life insurance coverage, and run free quotes for you across the major life insurance carriers in NY to determine the most appropriate carrier for your insurance policy. Contact Us
Michael Ruger
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
