Should retirees keep their life insurance?

I recently came across a brief video on a financial planning website (meant for advisors, not our clients), and it was supposed to explain to us 5 reasons why retirees might want to keep their life insurance.  I went to watch this video very openly and honestly.  There certainly are circumstances where some small subset of retirees may want to have life insurance in place.  If there were reasons I wasn’t already aware of, this could be some very valuable knowledge for me an my clients.

It turns out that almost all of their reasons don’t make sense most of the time.  I’m not terribly surprised.  However, bear in mind that, as I said right up front, there certainly are reasons where some subset of retirees may still need to buy or keep life insurance policies, it’s an extremely complex area, everyone’s situation is unique and any generalizations – such as the 5 reasons they gave – need to be tempered by expert advice applicable to an individual’s personal circumstances.

At the end, I note a couple of reasons or types of life insurance to keep in effect (though buying them to start with once already retired is likely outrageously expensive and may not be recommended).

5 reasons a retiree may still need life insurance (from the video):

  1. still have people financially dependent (kids, spouse, especially kids with disabilities)
  2. estate taxes for illiquid assets or business
  3. leave business to one child, but want to leave fair value (in cash) to other child (and all or most wealth tied up in business)
  4. college tuition for grandkids
  5. charitable giving
Some thoughts on these 5 situations:
 
1. If you’re retired but still have people financially dependent on you, the question is more complicated — it depends on what your source of income is, mainly.  For example, if you have no assets and your entire income is Social Security, then you have a problem — when you die, your survivors may not get anything (or may not get as much).  In this case, you have a predictable problem and unless you bought the life insurance a long time ago when it was much less expensive, you need to start (a) cutting down on your spending – fast; and (b) get your dependents used to living on less!; and (c) start saving that extra money.
 
Nevertheless, what we’re looking at here is less of a need for insurance and more of a need for savings.  There are two primary kinds of life insurance:  term and permanent.  Term life insurance simply reflects the cost based on the probability of you dying.  Permanent reflects both that “probability of dying” cost and a savings component — the idea with permanent insurance is that if you keep paying it long enough, the savings (and its growth) is ultimately going to be enough to pay the policy’s payout.  That’s because eventually, the likelihood of you dying gets to be very high – and therefore, the cost of insurance based on that probability of you dying gets similarly expensive.  If the odds of you dying within a year are 100%, the cost of insurance is going to be exactly 100% of the policy’s payout.
 
The bottom line here is that there’s a predictable additional expense for which savings needs to be prepared.  The insurance part of it really only is meant to cover the chance that you die before you manage to save enough to cover that expense.  The insurance companies know this and you need to, too – if you have a predictable expense upon your death, and it’s going to happen no matter when you die – even if you live to 100  – then you need to save for that expense, whether you save for it within an insurance policy in addition to the cost of insurance, or you save for it outside of the insurance policy by building up your savings and investments otherwise.
 
To return to the issue of people financially dependent upon you – the question, as always for insurance, is what is the financial consequence of your death?  If your income is derived from assets that will continue after your death, then you probably don’t need that life insurance because your death won’t have financial consequences.  However, if your income will go away upon your death — like from a pension or single-life annuity — or Social Security — you may need to consider life insurance big enough to provide enough assets to replace that lost income.  You can do this in a variety of ways, including buying term life and building up investments such that when the term expires, you’ve accumulated enough assets; you can buy a permanent life insurance policy (likely to be prohibitively expensive if you’re over 60); or you can start cutting back on your spending now. Or some combination of those things.
 
2. Estate taxes for illiquid assets — naturally, the answer here is almost certainly, instead, again, to start planning early and building up liquid assets.  Nevertheless, this is probably the best of these targeted needs for life insurance for folks who are no longer working.  That said, if no longer working but the business is closely held, it’s time to start working out a buyout plan for it anyway.
 
#3 is the same as #2, except that the money “owed” is to the other kid rather than to the government.  Again, a buyout plan should be put into place.
 
#4 – college tuition for grandkids – is again a case of savings which should be done *earlier* not later.  Unless you were planning on paying tuition out of your retirement income which goes away upon your death (i.e., from your pension or social security), the way to do this is to start as early as possible and start saving for the goal — or to plan on paying it out of existing assets.  Buying life insurance for this is likely a very costly way to go.
 
And finally, #5 – charitable giving – makes a huge case for a lost opportunity.  If the money is simply to buy life insurance to pay for charitable giving, just use the money to make contributions to charities while alive — or to a “donor advised fund” (also known as a charitable gift fund – a fund where you make the contributions now, and get the tax deduction now, but advise the fund to actually distribute money to charities later on).  The only advantage to owning life insurance and making a charity the beneficiary is that you can change your mind – and the beneficiary – while you’re still alive.  Meanwhile, the life insurance company is making money off you.
 
There absolutely are circumstances where retirees need to get life insurance.  But it’s nowhere near as simple as these five “rules” suggest, nor does it even make sense in the majority of cases outlined here.
 
If you think you need life insurance, start with the question of “what happens, financially, if I die?”  And the sooner you ask yourself that question, the sooner you can answer it correctly — and the sooner you can start saving towards that goal.  If you’re already 65 or 70 and are only now starting to ask yourself that question, the cost of insurance is going to be an even bigger obstacle than the lack of time for assets to grow.  In other words, the time to ask yourself this question is 20 years *sooner*.
 
Almost all of these cases (with the exception of loss of annuities/SS income — effectively, part of case #1) beg for *savings* rather than life insurance, or possibly both — but if the answer is “both” — again, the question of whether it’s /term/ plus building up assets compared to permanent (cash-value) gets a lot more tricky.  If you really have a /substantial/ life insurance need – i.e., one you probably cannot save enough for (i.e., die young before a lifetime of earning and saving) – you also may well not be able to buy enough permanent life insurance to cover the needs anyway.
 
Some other issues being ignored here include (a) using an irrevocable trust to own the life insurance and making annual gifts to the trust in order to get assets out of the estate early; and (b) the tax advantage of life insurance wherein the life insurance payout is not generally subject to any income taxes (though it can be subject to estate taxes!).  Note that the life insurance payout not being subject to income taxes could potentially be a huge issue – or it can be a much smaller benefit than it may seem — because the only part of that payout which really escapes income taxes is however much that payout exceeds the sum of all the life insurance payments made over the life of the policy.  For most term policies, this is a home run, since there is no savings component.  But for a permanent policy which is held for a very long time, the sum of those payments in can be huge – and the tax benefit, therefore, a lot smaller than it seems at first.
 
In any case, the bottom line is this: examine your situation as early as possible – the younger you are, the lower the cost of insurance if you really need insurance, and the longer you have to let any savings compound and grow..  If you wait until you’re already retired, it’s probably too late to fix this.
 
And the first question to ask is always: So if I die, what’s the financial impact?  Any computation of needed life insurance should start there.
 
 
 
 
 
Disclosure: Meyers Wealth Management is a fee-only registered investment advisor, registered in the state of California.  We do not sell life insurance, we are not life insurance agents or brokers.  The above discussion is for educational purposes only and is absolutely not to be construed under any circumstances as financial planning advice.  If you think you may need life insurance — or you have life insurance and are considering canceling it — please see a professional.

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