Cindy Richey, CFP, president of Prosperity Planning Inc. in Kansas City, Mo., has found that many retirees spend everything they make.
She cites a case where the husband receives a $2,000 monthly retirement benefit. His wife lacks an extensive work history and receives one-half ($1,000) of his amount as her spousal benefit. He dies and her benefit is bumped up to his $2,000.
If she dies, her benefit stops. That means the incoming Social Security payments drop from $3,000 combined to $2,000 for either survivor, a cut of 33 percent.
Consider a second scenario with two high earners. Each spouse receives a $2,000 monthly benefit and one dies. Now the income drops from $4,000 combined to $2,000—a 50 percent decrease for the survivor.
“Hopefully they have saved more because they had two incomes for many years,” says Richey. “But, if they didn’t, and a lot of people don’t, then you’ve lost half the Social Security benefits just like that. I think a 50 percent reduction is more likely for a little higher income type of situation.”
Life insurance can provide the funds to replace at least part of the lost income for both spouses. When Richey does a financial inventory with new retirement planning clients and learns they have a cash-value life policy, she rarely recommends that they drop it. “If they’re married and they have it and the premiums aren’t a hardship to them, and they usually aren’t, if it’s an old policy, we almost always say keep it,” she says.
In Richey’s experience, buying new insurance for the retirement income drop-off is a challenge for several reasons. New coverage is expensive for older clients. Additionally, the insurance should cover both lives, because both spouses will suffer an economic loss at the first one’s death.
Another twist is that the amount of coverage needed decreases over time. For example, if both spouses start their Social Security benefit at age 67 and one dies at 70, the surviving spouse has a life expectancy of 14 to 16 years, according to Social Security’s tables. But if the first spouse dies at 80, the survivor’s life expectancy is 8 to 9 years, so the duration of the income loss is reduced.
That pattern suggests a policy with decreasing coverage, similar to decreasing-term mortgage insurance. These circumstances create an unusual set of policy features, Richey admits: “The ideal product is joint, first-to-die with a decreasing death benefit. But I don’t even know if it exists.”
Employees with defined benefit pension plans face a choice at retirement. Should they take the higher life-only benefit that stops at their death or choose some form of a joint and survivor payment? If their only goal is to boost their pension income, the life-only option can be attractive because the joint and survivor annuity can be costly. For example, if the life-only pension pays $2,100 per month, the joint 100 percent option might pay $1,850 for both lives. That $250 could mean the difference between comfort and scraping by for clients on tight budgets.
Proponents of pension maximization recommend an alternative approach. The retiree takes the life-only option and uses part of the pension payment to buy life insurance on his or her life. The policy’s premium can be structured so that the retiree’s take-home, net of the premium, still exceeds the joint and survivor payout. That results in higher take-home pension income, greater planning flexibility because the retiree owns the life policy, and a sale for the advisor.
David Hultstrom, CFP, CFA, ChFC with Financial Architects, LLC in Woodstock, Ga., is not a “huge fan” of life insurance in retirement unless there is a specific case for it. Nonetheless, he notes that pension maximization can work in theory under the right circumstances. For example, suppose one retiring spouse is healthy but the other is unhealthy, older or both.