I recently received an email from Daniel, a Civil Service Retirement System employee, who is getting ready to retire. He's trying to decide whether to take a full survivor annuity for his wife, or choose a partial annuity and then purchase a universal life insurance policy with the money he would save. He asked me to analyze his options. Since many people are faced with this decision, I decided to use this column to break down his message and provide my responses to the issues he raised.
Before we start, though, it's important to note that this example doesn't address the entire range of financial planning issues required to make fully informed decisions about annuities, insurance and other retirement planning options. For example, from the message, I don't know whether Daniel's wife has additional income or assets to draw from. Also, since Daniel has been exempt from Social Security during his federal career, there may not be much, if any, Social Security widow's benefits for his wife. He didn't mention how much he has saved in the Thrift Savings Plan, whether he has other investments, or if his wife has a retirement benefit or is eligible for a Social Security benefit of her own. If you're in a similar position to Daniel, be sure to take these factors into account.
With that caveat, let's look at Daniel's message and my response.
I am looking for your advice as I prepare to retire in December. I am struggling with choosing a full survivor benefit vs. a partial survivor benefit plus life insurance. Below is how I see it, and I would like to hear your thoughts. I am a GS-15/10 equivalent (under a pay-for-performance system) and under CSRS.
Full Survivor Benefit:
Cost: $8,796/year. That yields an annuity to my wife of $49,848 in today's dollars, in the event of my death. Both numbers will increase over time. That $8,796 a year grows larger each year as cost-of-living adjustments increase my retirement annuity. Over 25 years, the cumulative cost for a full survivor benefit could approach $250,000 to $300,000 or more.
Partial Survivor Benefit Plus Life Insurance:
I would keep a partial survivor benefit to keep Federal Employees Health Benefits Program coverage for my wife, and to cover the premiums. I could add a Flexible Premium Universal Life Policy with a guaranteed death benefit of $600,000 tax-free that I can pass on to my children if my wife dies first. Cost: $6,697 a year with no increases in premiums. Guaranteed death benefit until age 121. Over 25 years, the cumulative cost is $167,425.
I don't understand life insurance, nor do I particularly care for life insurance companies, but these numbers are hard to ignore. It seems to me that Option 2 puts me in a much better position financially, but my gut tells me "beware."
It looks like your unreduced retirement benefit is a little more than $90,000. Congratulations! With 3 percent average inflation, your benefit could double every 24 years. That means in 25 years, it could be worth more than $180,000 a year. Having that level of inflation-protected income is nice.
The $8,796 annual cost of the survivor annuity you mention is a little less than 10 percent of your retirement. This reduction also lowers your taxable income in retirement. If this puts you in the 25 percent marginal federal tax bracket, the real cost of this choice is cut to $6,157 per year. If you pay this for 25 years, and assuming there's 3 percent average inflation, the total cost would add up to more than $225,000.
But let's consider what you're paying for. In the worst-case scenario (your dying soon), your wife would receive a survivor annuity of $50,000 for 25 years with a 3 percent inflation adjustment. That would add up to more than $1.8 million in survivor benefits. You may not want to look at it this way, but under this scenario, taking a reduced annuity to provide full survivor benefits would be like paying for $1.8 million in insurance.
Of course, choosing a survivor annuity is not a guarantee that you will die first. But if your wife dies before you, then you will be able to restore your retirement to its full, unreduced value. You can't leave a spousal benefit to your children, but the fact that your wife would be entitled to 55 percent of your unreduced retirement benefit if you die first might mean that she won't have to live with your children.
On the other hand, if the $600,000 your wife would receive in life insurance money under Option 2 were to run out before she dies, what would she do for income? She can withdraw about 4 percent from an investment annually if she wants to be sure it won't run out in 25 to 30 years. If she wanted to take out $50,000 a year (the equivalent of the CSRS survivor annuity based on your retirement), she'd have to withdraw almost 8.5 percent a year. Assuming she was buying an annuity today at age 62 with an inflation adjustment capped at 3 percent and a cash refund feature if she were to die before getting the full amount, her payments would be only $25,380 per year. So if you're going to go the insurance route, you may have to double the amount you're considering to even come close to equaling the spousal survivor annuity.
Remember, there's no increase in the premium for the insurance because there's also no increase in the benefit. So $600,000 today could seem like $300,000 in 25 years. Also, consider that if you die 25 years from now, your retirement might have increased to more than $180,000 a year. If your wife starts to withdraw just $100,000 from the insurance money, the money will run out in six years. If she were receiving 55 percent of $180,000, she would be promised $99,000 a year for life, with inflation adjustments, no matter how long she lives.
I think the cost of both options is comparable, but the value of the survivor benefit option is much better for protecting your wife's financial security.
A few additional thoughts for those under the Federal Employees Retirement System:
- The FERS basic benefit allows only two spousal benefit options: 50 percent of the basic FERS retirement benefit to the surviving spouse, or 25 percent. If your spouse is not also a federal employee and is counting on you for health benefits, then you'll have to choose one of these two options so he or she won't lose entitlement to FEHBP coverage if you die.
- Social Security provides a widow's benefit if the amount of the deceased spouse's Social Security is more than the amount the surviving spouse was receiving in his or her own right.
- You may have more money in your Thrift Savings Plan account than a typical CSRS retiree. A surviving spouse will inherit these funds (assuming you didn't change the beneficiary designation) and can use them to provide additional income.
In last week's "Summer Assignment" column, I urged you to gather the information someone would need to access your benefits in the event you weren't around to do it yourself.
Here is a link to a very well-organized and useful guide to putting together all the necessary information, provided by Kelly, a reader who works at the Agriculture Department. And here, courtesy of Dennis Damp of Federalretirement.net, is a comprehensive guide to estate planning for federal employees.
Tammy Flanagan is the senior benefits director for the National Institute of Transition Planning Inc., which conducts federal retirement planning workshops and seminars. She has spent 25 years helping federal employees take charge of their retirement by understanding their benefits.
For more retirement planning help, tune in to "For Your Benefit," presented by the National Institute of Transition Planning Inc. live on Monday mornings at 10 a.m. ET on federalnewsradio.com or on WFED AM 1500 in the Washington metro area.