First, I have to admit, I have a bias. I hate life insurance. Whole life, universal life, annuities, you name it, I’m not a fan. So, maybe I’m not the person you should be getting insurance advice. Or, maybe I’m the best person because unlike your insurance agent, I’m not trying to sell you anything. Sure, I’m fine with a good boring term insurance policy which ends at retirement. Your insurance agent probably isn’t though, as a term policy is probably the lowest commission product they can sell you. It probably comes as no surprise that I suggest for most people, the first expense they should get rid of in retirement is their life insurance monthly premium. Still, there are situations in which life insurance does make sense in retirement. This article will address your life insurance need in retirement.
First, we need to discuss the main purpose of life insurance. Life insurance is meant to replace lost income in the case of a person dying. The more earned income potential a person has, the higher the need for life insurance. For example, I’m still fairly early in my career, have a 4 year old son and a wife that takes care of my son full time. My life insurance need will probably never be higher than it is today. If something happens to me, my son and wife need to be taken care of for a long time. That being said, I don’t need life insurance forever. I’ve only purchased insurance long enough for my son to be out of school and my savings high enough that my wife would be taken care of if something happens to me.
Now, let’s fast forward to retirement. Typically, there is no more earned income. The main sources of income in retirement will include Social Security, maybe a pension, and retirement savings. If the primary breadwinner passes away, the spouse will still receive Social Security, the pension, and all of the retirement savings that the couple has accrued. Yes, the remaining spouse may receive less from Social Security and pension but the expenses should also decrease when someone passes away. The truth is that life insurance is just not as important in retirement because your financial standard of living is not impacted as much when a spouse passes away. Also, don’t forget that life insurance is really expensive when you get older (life insurance companies aren’t dumb). Put it all together and life insurance in retirement is an expense that you can typically do without.
Now, of course, telling everyone to get rid of life insurance as soon as you retire isn’t exactly always the best advice. There are situations in which you may still need life insurance after you retire. Here are a few situations in which life insurance may be necessary in retirement:
- Ownership in a small business
- Significant taxable estate and facing a high estate tax
- Special needs child that you want to provide financial support after your death
Ownership in a small business
If you are a small business owner, there is a good chance that you will need to carry life insurance in retirement. Many business owners will keep an ownership interest even in ‘retirement’, and for many families this is a significant part of their net worth. Typically, these type of businesses might take time to sell and are not considered liquid. If this is the case, the spouse or the other family members may need an influx in cash to help bridge the gap until the business is sold. Many times when a business has multiple partners, the partners will have life insurance on each other. This allows the remaining partners to buy out the deceased family’s share of the business. Life insurance can be an important planning tool for small businesses, and typically whole (permanent) life is appropriate in this situation.
Subject to the estate tax
Very few families are now subject to an estate tax. In 2018, an individual would need to have more than an $11 million estate, and a family over $22 million, before they are subject to the estate tax. If you are fortunate enough to have a large taxable estate, life insurance can be helpful. If you believe you will be subject to the estate tax, you can purchase life insurance in a trust called an ILIT (Irrevocable Life Insurance Trust), and the proceeds will not be subject to estate tax. This allows a family to reduce their taxable estate (the initial purchase of the insurance costs money) and then the heirs receive the proceeds tax free. ILITs were very important when the estate tax kicked in at $600,000, but the higher estate tax exemption has made estate tax planning very rare.
Special needs child
The hope of any parent is that their kids are financially independent by the time that the you retire. It is hard enough to support yourself in retirement, yet alone your kids too. Yet, for parents with special needs children, a child may need financial support in retirement and even after your passing. The purchase of life insurance, and specifically an annuity, could provide a child a lifetime of income upon your passing. You will almost never hear myself recommend an annuity for most people, but in this scenario they can be an important planning tool.
Like I mentioned previously, for most of my clients I suggest that they get rid of life insurance as soon as they retire or close to it. If you have a whole life policy, this is an opportunity to cash it in and use the (probably very disappointing) proceeds to help fund retirement. If you have a life insurance policy through work, don’t renew it in retirement. If you have a term policy, you will probably need to continue until the term ends, but at that point, don’t renew it. Like many things, life insurance planning happens far before retirement. If you feel like you need insurance in retirement, you should consider a whole life policy well before you are in your 60s. After age 60, the insurance will be expensive, if you qualify for it at all. If you are purchasing a term policy, don’t purchase anything that covers you past the age of 65. The good news for most of us is that we don’t need life insurance in retirement, and that money can be much better spent on the golf course or travelling.