Suppose I offer you a life insurance policy with a level premium for life, that cannot be cancelled, has no cash value, does not pay anyone if the beneficiary dies before you, disallows you changing the beneficiary, cannot be assigned to anyone else, and has a decreasing death benefit.
I expect that even the least insurance savvy among us would say no thanks. Yet, there are thousands of these policies issued every day. How does that come to be?
Because they don’t call it life insurance. They call it a survivor option on your pension.
Suppose you could have a pension of $3,000 per month, guaranteed for 120 payments if you die sooner, and payable for life otherwise. Wife suggests that you might want to reconsider that choice. So you check back and find that, instead of $3,000 per month, you can have $2,432 per month as long as either of you are alive.
What does than mean?
If you give up money while you are living so that someone else can have money after you have died, you bought life insurance regardless of what it may be called.
Compare the joint life annuity to the theoretical policy above.
- Cannot cancel. It is a pension annuity and all the terms are set at the beginning
- Has no cash value. You cannot stop and get the capital
- Does not pay anyone if the beneficiary dies before you. Pays until the second death regardless of the order.
- Disallows you changing the beneficiary. All the terms are set up front
- May not be assigned to anyone else. Pension law typically prevents assignment
- Has a decreasing death benefit. The price of the annuity to the surviving wife decreases each year because annuities on older people cost less than annuities on younger people.
That is a poor plan by any measuring system. Now the planning option.
$2,435 per month is about $1,700 per month after tax and that is what the survivor needs to replace. The government can look after themselves. To get that at age 65, the surviving spouse would need about $350,000 of tax paid cash to buy a life annuity paying something around $1,700 per month after taxes. But the original choice has a 10 year guarantee so we don’t need to buy anything until age 75. At 75, the annuity would cost about $250,000. Recall declining cost to buy.
If wife had a $250,000 life insurance policy on husband, then they could take the $3,000 monthly income and use the extra $565 monthly to pay the premium. There are many variables here and you will need to work out each case on its own merits.
The essential question is, “Can you get an appropriate insurance policy for the after tax value of the foregone pension?” If you can, an individual policy would neutralize every one of the defects in the joint survivor annuity and at no cost to you. Go ahead and check.
If you wait until the last minute to do it, you will likely have trouble making a perfect fit. But you might want to consider creating the insurance when you are younger. That almost always provides you with a valuable option. Having the insurance paid for before 65 is a supplementary retirement plan that will produce $565 monthly in this particular situation. That is an investment that you can readily analyze.
If wife is medically impaired and husband is not, there is no objective reason to take the survivor annuity, but husband might not outlive the sick spouse. Who knows for sure?
Things are a bit different if the wife is the pension recipient but the concept is identical.
Successful people do better because they know their choices and they create options before they need to make a decision. That is a good habit for you to begin if you have not done so already. If you have a pension in your future, talk to an adviser now to give yourself the most control over this decision.
Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. firstname.lastname@example.org