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.
Self-employed Individuals Are Allowed To Take A Tax Deduction For Their Medicare Premiums
If you are age 65 or older and self-employed, I have great news, you may be able to take a tax deduction for your Medicare Part A, B, C, and D premiums as well as the premiums that you pay for your Medicare Advantage or Medicare Supplemental coverage.
Self-employed Individuals Are Allowed To Take A Tax Deduction For Their Medicare Premiums
If you are age 65 or older and self-employed, I have great news, you may be able to take a tax deduction for your Medicare Part A, B, C, and D premiums as well as the premiums that you pay for your Medicare Advantage or Medicare Supplemental coverage. This is a huge tax benefit for business owners age 65 and older because most individuals without businesses are not able to deduct their Medicare premiums, so they have to be paid with after-tax dollars.
Individuals Without Businesses
If you do not own a business, you are age 65 or older, and on Medicare, you are only allowed to deduct “medical expenses” that exceed 7.5% of your adjusted gross income (AGI) for that tax year. Medical expenses can include Medicare premiums, deductibles, copays, coinsurance, and other noncovered services that you have to pay out of pocket. For example, if your AGI is $80,000, your total medical expenses would have to be over $6,000 ($80,000 x 7.5%) for the year before you would be eligible to start taking a tax deduction for those expenses.
But it gets worse, medical expenses are an itemized deduction which means you must forgo the standard deduction to claim a tax deduction for those expenses. For 2022, the standard deduction is $12,950 for single filers and $25,900 for married filing joint. Let’s look at another example, you are a married filer, $70,000 in AGI, and your Medicare premiums plus other medical expenses total $12,000 for the year since the 7.5% threshold is $5,250 ($70,000 x 7.5%), you would be eligible to deduct the additional $6,750 ($12,000 - $5,250) in medical expenses if you itemize. However, you would need another $13,600 in tax deductions just to get you up to the standard deduction limit of $25,900 before it would even make sense to itemize.
Self-Employed Medicare Tax Deduction
Self-employed individuals do not have that 7.5% of AGI threshold, they are able to deduct the Medicare premiums against the income generated by the business. A special note in that sentence, “against the income generated by the business”, in other words, the business has to generate a profit in order to take a deduction for the Medicare premiums, so you can’t just create a business, that has no income, for the sole purpose of taking a tax deduction for your Medicare premiums. Also, the IRS does not allow you to use the Medicare expenses to generate a loss.
For business owners, it gets even better, not only can the business owner deduct the Medicare premiums for themselves but they can also deduct the Medicare premiums for their spouse. The standard Medicare Part B premium for 2022 is $170.10 per month for EACH spouse, now let’s assume that they both also have a Medigap policy that costs $200 per month EACH, here’s how the annual deduction would work:
Business Owner Medicare Part B: $2,040 ($170 x 12 months)
Business Owner Medigap Policy: $2,400
Spouse Medicare Part B: $2,040
Spouse Medigap Policy: $2,400
Total Premiums: $8,880
If the business produces $10,000 in net profit for the year, they would be able to deduct the $8,880 against the business income, which allows the business owner to pay the Medicare premiums with pre-tax dollars. No 7.5% AGI threshold to hurdle. The full amount is deductible from dollar one and the business owner could still elect the standard deduction on their personal tax return.
The Tax Deduction Is Limited Only To Medicare Premiums
When we compare the “medical expense” deduction for individual taxpayers that carries the 7.5% AGI threshold and the deduction that business owners can take for Medicare premiums, it’s important to understand that for business owners the deduction only applies to Medicare premiums NOT their total “medical expenses” for the year which include co-pays, coinsurance, and other out of pocket costs. If a business owner has large medical expenses outside of the Medicare premiums that they deducted against the business income, they would still be eligible to itemize on their personal tax return, but the 7.5% AGI threshold for those deductions comes back into play.
What Type of Self-Employed Entities Qualify?
To be eligible to deduct the Medicare premiums as an expense against your business income your business could be set up as a sole proprietor, independent contractor, partnership, LLC, or an S-corp shareholder with at least 2% of the common stock.
The Medicare Premium Deduction Lowers Your AGI
The tax deduction for Medicare Premiums for self-employed individuals is considered an “above the line” deduction, which lowers their AGI, an added benefit that could make that taxpayer eligible for other tax credits and deductions that are income based. If your company is an S-corp, the S-corp can either pay your Medicare Premiums on your behalf as a business expense or the S-corp can reimburse you for the premiums that you paid, report those amounts on your W2, and you can then deduct it on Schedule 1 of your 1040.
Employer-Subsidized Health Plan Limitation
One limitation to be aware of, is if either the business owner or their spouse is eligible to enroll in an employer-subsidized health plan through their employer, you are no longer allowed to deduct the Medicare Premiums against your business income. For example, if you and your spouse are both age 66, and you are self-employed, but your spouse has a W2 job that offers health benefits to cover both them and their spouse, you would not be eligible to deduct the Medicare Premiums against your business income. This is true even if you voluntarily decline the coverage. If you or your spouse is eligible to participate, you cannot take a deduction for their Medicare premiums.
I receive the question, “What if they are only employed for part of the year with health coverage available?” For the month that they were eligible for employer-subsidized health plan, a deduction would not be able to be taken during those months for the Medicare premiums.
On the flip side, if the health plan through their employer is considered “credible coverage” by Medicare, you may not have to worry about Medicare premiums anyways.
Multiple Businesses
If you have multiple businesses, you will have to select a single business to be the “sponsor” of your health plan for the purpose of deducting your Medicare premiums. It’s usually wise to select the business that produces a consistent net profit because net profits are required to deduct all or a portion of the Medicare premium expense.
Forms for Tax Reporting
You will have to keep accurate records to claim this deduction. If you collect Social Security, the Medicare premiums are deducted directly from the social security benefit, but they issue you a SSA-1099 Form at the end of the year which summarized the Medicare Premiums that you paid for Part A and Part B.
If you have a Medigap Policy (Supplemental) with a Part D plan or a Medicare Advantage Plan, you normally make premium payments directly to the insurance company that you have selected to sponsor your plan. You will have to keep records of those premium payments.
No Deduction For Self-Employment Taxes
As a self-employed individual, the Medicare premiums are eligible for a federal, state, and local tax deduction but they do not impact your self-employment taxes which are the taxes that you pay to fund Medicare and Social Security.
Amending Your Tax Returns
If you have been self-employed for a few years, paying Medicare premiums, and are just finding out now about this tax deduction, the IRS allows you to amend your tax returns up to three years from the filing date. But again, the business had to produce a profit during those tax years to be eligible to take the deduction for those Medicare premiums.
DISCLOSURE: This information is for educational purposes only. For tax advice, please consult a tax professional.
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.
Buying A Second House In Retirement
More and more retires are making the decision to keep their primary residence in retirement but also own a second residence, whether that be a lake house, ski lodge, or a condo down south. Maintaining two houses in retirement requires a lot of additional planning because you need to be able to answer the following questions:
More and more retirees are making the decision to keep their primary residence in retirement but also own a second residence, whether that be a lake house, ski lodge, or a condo down south. Maintaining two houses in retirement requires a lot of additional planning because you need to be able to answer the following questions:
Do you have enough retirement savings to maintain two houses in retirement?
Should you purchase the house before you officially retire or after?
Are you planning on paying for the house in cash or taking a mortgage?
If you are taking mortgage, where will the down payment come from?
Will you have the option to claim domicile in another state for tax purposes?
Should you setup a trust to own your real estate in retirement?
Adequate Retirement Savings
The most important question is do you have enough retirement income and assets to support the carrying cost of two houses in retirement? This requires you to run detailed retirement projection to determine what your total expense will be in retirement including the expenses associates with the second house, and the spending down of your assets over your life expectancy to make sure you do not run out of money. Here are some of the most common mistakes that we see retirees make:
They underestimated the impact of inflation. The ongoing costs associated with maintaining a house such as property taxes, utilities, association dues, maintenance, homeowners insurance, water bills, etc, tend to go up each year. While it may look like you can afford both houses now, if those expenses go up by 3% per year, will you have enough income and assets to pay those higher cost in the future?
They forget about taxes. If you will have to take larger distributions out of your pre-tax retirement accounts to maintain the second house, those larger distributions could push you into a higher tax bracket, cause your Medicare premiums to increase, lose property tax credits, or change the amount of your social security benefits that are taxable income.
A house is an illiquid asset. When you look at your total net worth, you have to be careful how much of your net worth is tied up in real estate. Remember, you are retired, you are no longer receiving a paycheck, if the economy hits a big recession, and your retirement accounts take a big hit, you may be forced to sell that second house when everyone else is also trying to sell their house. It could put you a in a difficult situation if you do not have adequate retirement assets outside of your real estate holdings.
Should You Purchase A Second House Before You Retire?
Many retirees wrestle with the decision as to whether to purchase their second house before they retire or after they have retired. There are two primary advantages to purchasing the second house prior to retirement:
If you plan on taking a mortgage to buy the second house, it is usually easier to get a mortgage while you are still working. Banks typically care more about your income than they do about your level of assets. We have seen clients retire, have over $2M in retirement assets, and have difficulties getting a mortgage, due to a lack of income.
There can be large expenses associated with acquiring a new piece of real estate. You move into your second house and you learn that it needs new appliances, a new roof, or you have to buy furniture to fill the house. We typically encourage our clients to get these big expenses out of the way before their paychecks stop in case they incur larger expenses than anticipated.
Mortgage or No Mortgage?
The decision of whether or not to take a mortgage on the second house is an important one. Sometimes it makes sense to take a mortgage and sometimes is doesn’t. Many retirees are hesitant to take a mortgage because they realize having a mortgage in retirement means higher annual expenses. While we generally encourage our client to reduce their debt by as much as possible leading up to retirement, there are situations where taking out a mortgage to buy that second house makes sense.
But it’s not for the reason that you may think. It’s not because you may be able to get a mortgage rate of 3% and keep your retirement assets invested with hopes of achieving a return of over 3%. While many retirees are willing to take on that risk, we remind our clients that you will be retired, therefore there is no more money going into your retirement accounts. If you are wrong and the value of your retirement accounts drop, now you have less in assets, no more contributions going in, and you have a new mortgage payment.
In certain situations, it makes sense to take a mortgage for tax purposes. If most of your retirement saving are in pre-tax sources like Traditional IRA’s or 401(k)’s, you withdrawal a large amount from those accounts in a single year to buy your second house, you may avoid having to take a mortgage, but it may also trigger a huge tax bill. For example, if you want to purchase a second house in Florida and the purchase price is $300,000. You take a distribution out of your traditional IRA to purchase the house in full, you will have federal and state income tax on the full $300,000, meaning if you are married filer you may have to withdrawal over $400,000 to get to the $300,000 that you need after tax to purchase the house.
If you are pre-tax heavy, it may be better to take out a mortgage, withdrawal just the down payment out of your IRA or preferably from an after tax source, and then you can make the mortgage payments with monthly withdrawals out of your IRA account. This spreads the tax liability of the house purchase over multiple years potentially keeping you out of those higher tax brackets.
But outside of optimizing a tax strategy, if you have adequate after-tax resources to purchase the second house in full, more times than not, we will encourage retirees to go that route because we are big fans of lowering your fixed expenses by as much as possible in retirement.
Planning For The Down Payment
If we meet with someone who plans to purchase a second house in retirement and we know they are going to have to take a mortgage, we have to start planning for the down payment on that house. Depending on what their retirement picture looks like we may:
Determine what amount of their cash reserves they could safely commit to the down payment
Reduce contributions to retirement accounts to accumulate more cash
If their tax situation allows, take distributions from certain types of accounts prior to retirement
Weigh the pros and cons of using equity in their primary residence for the down payment
If they have permanent life insurance policies, discuss pros and cons of taking a loan against the policy
Becoming A Resident of Another State
If you maintain two separate houses in different states, you may have the opportunity to have your retirement income taxed in the more tax favorable state. This topic could be an article all in itself, but it’s a tax strategy that should not be overlook because it can have a sizable impact on your retirement projections. If your primary residence is in New York, which is a very tax heavy state, and you buy a condo in Florida and you are splitting your time between the two houses in retirement, knowing what it requires to claim domicile in Florida could save you a lot of money in state taxes. To learn more about this I would recommend watching the following two videos that we created specifically on this topic:
Video 1: Will Moving From New York to Florida In Retirement Save You Taxes?
Video 2: How Do I Change My State Residency For Tax Purposes?
Should A Trust Own Your Second House
The final topic that we are going to cover are the pros and cons of a trust owning your house in retirement. For any house that you plan to own during the retirement years, it often makes sense to have the house owned by either a Revocable Trust or Irrevocable Trust. Trust are not just for the ultra wealthy. Trust have practical uses for everyday families just as protecting the house from the spend down process triggered by a long term care event or to avoid the house having to go through probate when you or your spouse pass away. Again, this is a relate topic but one that requires its own video to understand the difference between Revocable Trust and Irrevocable Trusts:
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.
Roth Conversions In Retirement
Roth conversions in retirement are becoming a very popular tax strategy. It can help you to realize income at a lower tax rate, reduce your RMD’s, accumulate assets tax free, and pass Roth money onto your beneficiaries. However, there are pros and cons that you need to be aware of, because processing a Roth conversion involves showing more taxable income in a given year. Without proper tax planning, it could lead to unintended financial consequences such as:
· Social Security taxed at a higher rate
· Higher Medicare premiums
· Assets lost to a long term care event
· Higher taxes on long term capital gains
· Losing tax deductions and credits
· Higher property taxes
· Unexpected big tax liability
In this video, Michael Ruger will walk you through some of the strategies that he uses with his clients when implementing Roth Conversions. This can be a very effective wealth building strategy when used correctly.
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.
