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There are many, many ways that life insurance can be used. Sometimes it is to replace lost income, when a wage earner dies during his or her working years. Other times it may be to help pay taxes on a large estate upon the passing of the second spouse in a couple, so that your heirs can receive the full fruits of your labors and won’t have to worry about a tax haircut.
Another use for life insurance is to help you to maximize a pension. I know, everyone believes that pensions have gone the way of the buggy-whip. That may be the case for many folks, but I still find a lot of people retiring these days who have a traditional pension.
For those of you who are familiar with pensions, you’ve probably seen the payout options that are typically available: lump sum, single life annuity, joint and 100% survivor annuity, joint and 50% survivor annuity, and so forth. We’ll focus on just two of these options: a single life annuity, versus a joint and 100% survivor annuity.
For an illustrative example, we’ll say that the single life annuity would pay out at a rate of $40,000 per year, while the joint and 100% survivor annuity would pay at a rate of $33,000 per year. The retiree is 62. (Note to the insurance professionals out there: I pulled those numbers out of the air, they may or may not represent realistic annuity payout rates!)
Naturally, you’d like to receive the higher amount from the pension – but the risk that you take is that your survivors would have to get by without that pension income. And if you happened to die relatively soon after leaving the job, this could turn out to be catastrophic for your surviving spouse (and family, if you have other dependents).
You might actually be able to get by on the lower amount, and that would provide your surviving spouse with the same benefit over his or her lifetime as well – but it would be nice to have a leetle bit extra. One way to do this would be to use term life insurance.
If you took out tiered (or laddered) term life insurance policies to cover an approximately 20 years, this could cover any shortfall if you happened to die during that 20-year period. During that time, receiving an extra $7,000 per year from your pension, you could use $2,000 (and gradually less, as your tiered policies expire) to pay the premium on the policy, and then you’d have an additional $5,000. If you saved the difference at an average of 5% return, this would equate to a $165,000 savings by that time. Even if you didn’t save the extra, your portfolio should have grown by that much, assuming that you’re maintaining some willpower over your spending.
At any rate, if you happen to outlive the averages and live beyond age 82, every year that you receive the pension is extra money. If you die earlier, your term policies will pay out to your surviving spouse, providing him or her with the funds to continue with the same or a similar standard of living afterwards.
A pension-maximization strategy isn’t for everyone! Several factors need to be in your favor:
- The increase in pension is more than enough to pay the insurance premiums
- Your health must be good enough to qualify you for the additional insurance policy(s)
- Your spouse must know how to handle the insurance proceeds if you die first
- Keep in mind that if the pension is increased, taxes on that retirement income will also increase – to the amount you receive may be less than you think
