Spousal Provision

In a recent column, I took on the subject of federal spousal survivor benefits. That prompted more questions from readers about the value of survivor benefits vs. life insurance -- including this one, which I thought I'd address this week:

Has anyone looked into using a universal life insurance policy versus staying with the federal spousal survivor benefit? Of course, I would maintain the minimum amount of survivor benefit to maintain health coverage for my spouse. There look to be considerable savings with the universal life over the long term, although I sense there are risks that a spouse could outlive the benefits. Any thoughts or references I could look into?

Courtesy of Wikipedia, here's a definition of universal life insurance:

Universal life is a type of permanent life insurance based on a cash value. That is, the policy is established with the insurer where premium payments above the cost of insurance are credited to the cash value. The cash value is credited each month with interest, and the policy is debited each month by a cost of insurance charge, and any other policy charges and fees which are drawn from the cash value if no premium payment is made that month.

I don't pretend to be an insurance expert, but here are some things to consider before deciding to substitute life insurance for the government survivor annuity benefit:

• I can leave my heirs my house, my investments and anything else they can find after I'm gone. Life insurance is not designed for this purpose. I really don't want my adult kids to have any incentive for me and my husband not to be around. With the federal survivor benefit, you pay for it as long as you need it and you can stop paying for it your spouse dies before you.
• What would happen if you didn't live out your normal life expectancy and your spouse outlived you by 20-30 years? Would the insurance provided be able to sustain your spouse for that long? How would they need to invest the proceeds to allow for a long life expectancy and inflation? What if your spouse who receives life insurance benefits can't find a return better than 3 percent? How much income will he or she be able to withdraw from their investments and still protect the principal?
• What if there is a period of high inflation? (Think 1970s and early 1980s.) The federal survivor annuity is adjusted annually for inflation. The amount of insurance you purchase may not be enough to offset future inflation.
• Is it really cheaper? The cost of the survivor benefit under both the Civil Service Retirement System and the Federal Employees Retirement System reduces your taxable retirement income, and there are no underwriting requirements. Life insurance premiums are paid with after-tax dollars, and you must pass underwriting requirements to get the best rates. The reduction to your retirement to provide the maximum survivor annuity benefit is around 10 percent of your unreduced CSRS or FERS benefit. Let's say that your retirement benefit is $40,000 per year, so the reduction is $4,000. If you are paying around 25 percent in taxes, you've lowered the "cost" of this option to $3,000 per year, since you'll pay $1,000 less in income tax. This would provide a benefit that is worth $20,000-$22,000 per year to your surviving spouse. How much life insurance you will be able to purchase depends on your age and health. How much life insurance you need will be based on the age and health of your spouse and future inflation rates.
• Your spouse is entitled to your survivor benefit by law, and once selected, it cannot be changed other than by death or divorce. If you and your spouse fall on hard times, the survivor benefit cannot be cashed out. If there is friction between you and your spouse, the survivor benefit cannot be canceled and it can become part of a divorce settlement.
• The income of the spousal survivor benefit is for life. It is not subject to investment fluctuations and poor investment decisions. It is adjusted annually for inflation. These are all characteristics that are hard to duplicate using a fixed amount of life insurance.

I think the fundamental question in this debate is how much risk your spouse is willing to tolerate. Ultimately it should be up to them to decide whether to accept an alternative to the spousal survivor benefit to which they are entitled.

I suppose I sound a little biased, but I wanted to balance the bias that an insurance agent may have when their commission is on the line. After all, I don't receive any money if you provide your spouse with a government survivor annuity.

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.