The Bogleheads' Guide to Retirement Planning (37 page)

If your family includes or will include minor children, your next step is to see how much annual income Social Security survivor benefits will pay after the death of either spouse. The personal statement the Social Security Administration sends you annually shows the estimated amounts that would be payable. Detailed information about eligibility and other factors is in the Social Security Handbook at
www.ssa.gov
. Income from Social Security can be very helpful to the surviving family, although it’s likely to leave a significant gap to be filled by life insurance.

There are numerous formulas to arrive at the amount of insurance you need for your family. Probably the simplest way is to multiply the amount of annual income you want to provide by the number of years desired. Add to this an amount for final expenses, children’s education, and an emergency fund, and you’ll have a good estimate of the amount of insurance you’ll need.

Stay-at-home parents should also be covered. Hiring someone to look after children and to perform the duties of the deceased spouse can be very expensive for the surviving parent. Paying for those expenses on one income adds a load of extra stress at a time when children most need the support of their remaining parent.

If you have no dependents, your only life insurance needs would be for last expenses such as a funeral, any probate costs or legal fees, and any debt repayment. If you are financially independent, you may not need any life insurance at all.

For a more thorough needs analysis, you can seek the help of a professional insurance agent. Most will provide the service at no cost. You can contact an attorney or financial planner for this service, but expect to pay a fee.

Commercial software and insurance web sites are readily available to help you calculate insurance needs. These web sites are for-profit, so we don’t make specific recommendations. A simple Google search will provide you with many to choose from.

Regardless of which approach you decide to use, remember to err on the side of a little extra coverage. Inflation is sure to take its toll, and a little extra term insurance is inexpensive for those in good health.

We believe that permanent life insurance should not be used as an investment vehicle. Buying the appropriate term policy and investing the difference will almost always result in more wealth accumulation and better insurance protection. We need to emphasize this because the life insurance industry historically has promoted permanent insurance as a good investment for future retirement and other cash needs. Policy illustrations often project unrealistically high earnings and cash value growth up to 40 years down the road. These cash values are touted as providing a tax-free stream of income to educate children, pay for emergencies, and provide for retirement income.

Why is permanent insurance a bad investment alternative? Here are a few disadvantages of going this route:

Those who benefit most from the sale of permanent policies, sold as an investment, are often insurance agents and the company they work for. Billions in assets held by many life insurers were accumulated during the latter half of the twentieth century, when sales of highly profitable permanent insurance were much higher than they are today. With the rise in prominence of low-profit term insurance, life insurers have increasingly turned to other products to boost their income, such as long-term care and deferred annuities. Our recommendation is to buy term insurance and do your own investing elsewhere. This will improve your own bottom line—not the bottom line of the insurance agent and company.

Defined benefit pension plans (see Chapter 5) are subject to the automatic survivor benefit requirements. This law requires that retirement benefits be paid in the form of a qualified joint and survivor annuity unless the employee waives the right and it is agreed to by the spouse. If waived, the employee can opt for other choices, such as a straight life annuity on the retiree only. The joint annuity provides a lower monthly payment than the straight annuity, but all or part of the income continues to the surviving spouse. The straight life annuity provides a higher monthly benefit, although the death of the retiree leaves the surviving spouse with no income.

To address this predicament, the insurance industry developed a marketing concept called pension maximization. This idea suggests that the retiree take the higher payout of the straight life annuity and use the difference in retirement benefits to help pay for a permanent life insurance policy. This arrangement offers the advantages of flexibility to select a new beneficiary at any time or to cash in the policy if your situation changes in the future. The cash value in the policy can be tapped if needed, and the death benefit of the insurance is income tax-free, unlike the joint annuity payments, which are taxable.

Disadvantages include that the premium to buy enough life insurance to match the benefits of the joint and survivor annuity may not be available when the policy is purchased. You also have to qualify for the coverage, and you have to deal with the knowledge that should you die first, your spouse will never receive one dollar of the pension benefits you earned over your working career. Still, there are situations where life insurance might be a good choice. For example, if your spouse has a reduced life expectancy or is older than you, life insurance may make sense. Each situation is different. It would behoove you to evaluate your pension options several years before retirement. You want to have a plan in place before you sign off on the joint annuity.

Estate transfer of your property at death may involve shrinkage due to federal estate taxes, state estate taxes, administrative expenses, probate expenses, and payment of debts. If you foresee a need for estate liquidity, you should consider life insurance as a way to help solve this problem. Illiquid estates that include small businesses or closely held corporations are particularly vulnerable to estate shrinkage. These estates often are composed largely of property, machinery, or other assets that cannot easily be converted into cash in a timely manner or at full value. A forced fire sale of a business and other illiquid assets can result in a substantially lower value, thereby reducing the amount available to pay estate settlement costs and the heirs. Federal estate taxes are due nine months from the date of death. They can be paid from liquid assets, from loans if available, or from life insurance earmarked for this purpose.

Advantages of life insurance to pay estate expenses include:

Disadvantages of using life insurance to pay estate expenses include:

A good way to find a qualified insurance agent who specializes in estate planning is asking for recommendations from trusted friends, estate planning attorneys, and trust officers. You might want to obtain several referrals from each source, interview those who interest you, and select the agent you believe will do the best job for you. These agents are often Chartered Life Underwriters (CLUs), who are trained in estate planning concepts. They can perform estimates of projected estate settlement costs and provide education on the use of insurance trusts and other options that are available to solve these problems. If the agent recommends insurance for your estate needs, we suggest you confirm the recommendation with solid research on your own and by consulting an estate planning attorney, who will write any legal instruments needed. Please note that insurance agents are not attorneys, and they do not provide legal advice. Other professionals, such as fee-only insurance agents, CPAs, or financial planners can perform this work, but you will be charged a fee for their services.

Small business owners commonly use life insurance for business needs to replace potential lost revenue and to resolve ownership interests in the case of death. This is done through buy-sell agreements, key-person insurance, and arrangements for debt coverage in case an owner dies. Buy-sell insurance provides surviving business owners with the cash needed to buy out the share of the deceased partner from his or her heirs. Key-person insurance provides a cash cushion to the company while the business seeks a replacement for the loss of a productive employee. Likewise, insurance to cover business debt provides liquidity when an owner dies. Term insurance is often used for temporary needs, such as debt coverage. Permanent insurance is often recommended by professionals for permanent needs. It is recommended that business owners seek qualified help in the same manner as you would for estate planning.

Disability income insurance protects your income against the risks of serious illness or accident. According to the Social Security Administration, 3 in 10 workers entering the workforce today will become disabled before reaching full retirement age. The U.S. Census Bureau says that an illness or accident will keep one in five workers out of work for at least one year. Yet, according to the Social Security Administration, 70 percent of the private-sector workforce has no private long-term disability insurance.

You should consider protecting your earnings with a good disability insurance program above and beyond the meager Social Security benefits for the disabled. Even though you may have some disability income (DI) coverage at work, it may only be short-term disability (STD), or it may be long-term disability (LTD) that does not cover enough of your income. Just ask yourself how long you could go without a paycheck before spending your savings and investments.

In order to ascertain your DI needs, you will need to take into account government programs, employer programs, and individual coverage. No company will insure 100 percent of your earnings, as there would be no incentive to return to work. Sixty to 70 percent of your earnings is typically the maximum amount you can insure. A good rule of thumb is to insure for the maximum amount available because few of us would feel comfortable taking a pay cut. In addition, disability tends to increase your living expenses with medical and related costs.

Most of us are covered by some combination of disability insurance provided by the government, our employers, or individually purchased plans. A basic understanding of insurance that is available from these three providers will help you implement a program that meets your needs and fits within your budget.

Social Security covers most American workers. The Social Security disability insurance (DI) program pays monthly income to disabled workers and their families. Benefits are based on your earnings record and number of dependents, with annual cost-of-living increases. The personal statement Social Security Administration (SSA) sends you annually shows the estimated DI benefit that would be payable.

You must be unable to perform any substantial gainful work to qualify for Social Security disability benefits. The impairment must be expected to last at least 12 months or potentially result in death. You also must have a history of fairly steady covered employment, especially in the last years leading up to disability. SSA often takes years to resolve a DI claim because the rules for evaluating a disability are complex. A disapproved claim can be appealed several times, and a large backlog of unsettled claims is in the pipeline. Legal representation helps. There are attorneys who specialize in only this area of law.

Benefits begin after a waiting period of five full calendar months and continue for life if your disability doesn’t end before full retirement age. You also become eligible for Medicare benefits two years after your DI benefit begins. Detailed benefit information is available in the Social Security Handbook on the Web at
www.ssa.gov
.