Retirement Life Insurance

How Much is Needed to Optimize Retirement Spending

Steve Heller

• Publisher: De Gruyter
• Year: 2017
• eBook ISBN: 9781501506307
• Edition: 1
• Topic: Business
• Subtopic: Corporate Finance
• Index: Business

Do your clients have any idea of what they can/should spend in retirement? Do they know what they need to do to optimize their retirement spending? How can you protect a spouse from the drop in social security if a client dies early? Why is it likely that buying insurance or buying a fixed annuity can dramatically increase the level of your client's spending—even if your customer is already retired? What if you could show your client exactly what the impact would be and at what level they would need to buy to achieve a certain level of spending? How can buying a fixed annuity be a hedge against term life expiration and what level is required? When should your client start taking social security? What can your client spend now and how much can that improve if they purchase insurance or an annuity from you?

All these questions and more are answered in this book and in the free software that accompanies this book. The software, though more complex than most end users would care to learn, offers you the opportunity to load in customer financial data and give them results that will calculate various options. The amazing and counter-intuitive part is that it is highly likely that most individuals can see their monthly spending capability go up dramatically by buying insurance and/or buying a fixed annuity and the software enables you to zero in on the desired level.

Even though life insurance is an old, established financial product, and annuities are even older, there is one enormous market that has been overlooked: the market for additional retirement funds for a surviving spouse and replacement of Social Security payments that are lost after the death of a spouse. This book explains how to address this market, and includes instructions and a license for software that illustrates how insurance and annuities can increase sustainable spending in retirement.

Most people have no idea how much they can really spend in retirement. Many are living frugal lives spending their social security while "saving for a rainy day". They buy life insurance in batches of tens thousands of dollars because it sounds good or what they think they can afford. Almost no one would believe that buying "expensive" life insurance after age 60 actually can free them to spend MUCH more on a monthly basis. Furthermore, no one is looking at an optimum return on the investment based on a certain level of potential spending. Until now. This book, and the accompanying software enable you, the life agent, to input the customer data and come up with a plan for your customer and provide proof that the plan will work for them.

The book explains what goes into making these calculations, why they work the way they do and gives various case studies that quite often show that buying term insurance or buying an annuity after retirement can be great investments for them. We think your customers will be convinced. There are detailed instructions as to use of the software (at www.steveheller.org/rhino ) that accompanies the book with built in case studies that you can use. But even more importantly, you can input a customer's data and provide them with options and actually show them the benefits or give them the solutions that they would otherwise not know exist. These solutions will be invaluable to your business and offer you a distinct advantage over competition that are not selling in this manner.

Chapter 1
The Retirement Crisis in Brief

A Tale of Two Widows

Jane and June Smith are sisters, Jane turning 58 years old in 2017, while June turns 60 in that same year. They are married to two brothers, Jim and John Smith, who turn 61 and 63, respectively, in 2017. Jim and John work for the same company.

Each Smith family has the following financial profile:

1. $200K in investible assets, comprising $30K cash, $100K in traditional retirement accounts, and $70K in a taxable brokerage account with a tax basis of $50K. All the assets but the cash are in index funds that are expected to provide a 7% pretax return before expected inflation of 2%, whereas the cash is expected to return 2% pretax before inflation.
2. The husband works as a contractor, with no benefits other than his salary of $50,000 and plans to retire at age 65 (2021 and 2019 for Jim and John, respectively); the wife has already retired from her corporate job.
3. Projected Social Security benefits, starting when the husband retires: $2,300 for the husband, $1,800 for the wife.
4. No pensions for either spouse.
5. They have no children at home and don’t need to leave a legacy to anyone.
6. Both spouses are in excellent health.

One day the call comes in to both Mrs. Smiths telling them that their husbands have been killed in a freak accident at work.

After Jane recovers a bit from the shock of the news, she asks June to come over so they can discuss their new financial situation. When she arrives, Jane says, “What will I do now? I don’t have any idea how I will pay my bills or how much I can spend!” June says, “Didn’t you get that retirement analysis that Bob, our new financial planner, wanted to do for us?” Jane replies, “No, what are you talking about? We never talked with him because we got too busy.”

June says, “Bob showed us how, with one small change in how we handle our money, we would be able to increase our sustainable retirement spending by about $14,000 a year, after federal income taxes, even in the event of a tragedy like this. So, we did it.”

“I wish I had made time to see him.”

“You can fix that.”

“How? It’s too late now!”

“No, it isn’t. Wake up. WAKE UP!!!”

Jane bolts upright in bed. “What a terrible nightmare!” She looks across the room to the bathroom door and sees light under the door, along with the sound of the shower that Jim is taking before work. So much for her plan of sleeping in today.…

After kissing Jim goodbye and sitting down to a raisin muffin for breakfast, she texts June:

Jane: “Hi, got an hour to talk this morning?”

June: “Sure, your place or mine?”

Jane: “Mine.”

June: “I’ll be over at 9.”

When June arrives, Jane says, “Remember when you explained what that new financial planner did for you? Well, I just had a nightmare about our husbands being killed in a freak accident and my not having done whatever it was that he told you to do. The only detail I remember is that you were able to increase your projected sustainable retirement spending by about $15,000 a year (after federal income taxes) by following his suggestions. Obviously, my unconscious was trying to tell me I should have paid more attention to what you were telling me. Please explain it to me again, and this time I promise I’ll listen carefully.”

“Sure, glad to. He has a new kind of financial planning software that takes assets, salary, pensions, age, sex, any existing life insurance, and health into consideration when making a conservative projection of how much after-tax spending you can afford to do per year in retirement, even if one spouse dies at the worst possible time. It takes about 15 minutes to gather the data, then he runs some ‘optimizers’ to see if there’s a way to improve the results by making some changes in your insurance and/or annuities. In our case, with the assumptions he put in for expected returns on our investment portfolio and our cash holdings, it turned out that we had to make only one change to the way we were handling our money to get a big improvement in the worst-case scenario, as you correctly remembered.”

“Ok, I’ll call him today to make an appointment for him to show me exactly how it works.”

…

We’ll pick up this conversation a bit later. But first we need to look at one of the most important sources of retirement income for many Americans. Social Security as a Mainstay of Retirement Income

As with current retirees, one of the largest sources of retirement income for the Baby Boomer generation will be from Social Security payments, as explained in an article in the “Social Security Bulletin”:

“Similar to current retirees, Social Security will account for about two-fifths of the projected family income at age 67 and will be received by almost all baby-boomer retirees. Supplemental Security Income will be received by 5 percent of current retirees and only 2 percent of baby-boomer retirees. The projections also suggest that baby boomers are less likely than current retirees to have enough postretirement income to maintain their preretirement living standards. The financial planning literature often recommends having enough postretirement income to replace 70 percent to 80 percent of preretirement income; however, over two-fifths of baby-boomer retirees will replace less than three-quarters of their preretirement earnings and almost a fifth will replace less than half of their preretirement earnings.”

(From https://www.ssa.gov/policy/docs/ssb/v65n3/v65n3p1.html,
emphasis added by author)

However, even this insufficient income is subject to a risk of loss that is currently uninsured in most cases. This is the risk of premature death of one spouse of a married couple; when one spouse dies, the remaining spouse’s income is reduced by the loss of one payment. The exact proportion of income lost by this event varies but is generally in the range of one-third to one-half of the original income.

This problem is widely recognized by personal financial advisers, and was discussed in detail in a 2012 GAO publication entitled “RETIREMENT SECURITY: Women Still Face Challenges” (http://www.gao.gov/assets/600/592726.pdf). Here is a passage entitled “Widowed After Age 50” (pp. 30–31):

“Not only did women’s total household assets and income decline substantially with widowhood, but the effects were more pronounced for women than for men. For example, while men’s income fell 22 percent after widowerhood, women’s income fell by an even greater amount — 37 percent. The effects were larger for women living in younger households than women living in older households. Specifically, women in households where all members were age 64 or younger experienced a 31 percent decrease in assets and a 47 percent decrease in income. Adding to these effects, widowhood was a much more common experience for women than men in our sample. In fact, women were at least twice as likely as men to become widowed between any two survey periods. Consequently, 70 percent of women age 85 and over were widowed compared to only 24 percent of men age 85 and over.”

However, just realizing that the problem exists, while necessary, is not sufficient. What we need is a solution to the problem of the “significant financial decline” at widowhood. Fortunately, there is a method to prevent this disaster in many cases. Let’s see what it is and how it works.

Chapter 2
A New Use for Life Insurance

In this chapter, we are going to use a slightly oversimplified example to give you an understanding of how Social Security and life insurance can impact retirement spending. In particular, we will see how the correct amount of life insurance may enable people to safely spend more than they could without that insurance. It is important for you to understand the dynamics of the impact of life events on the retiree’s level of spending and, hopefully, at the end, you will get a sense of why the variables involved work the way they do. In succeeding chapters, we will go into more detail about the exact impact of changes to life insurance and other variables.

Retirement Income Security and Life Insurance

We will start with a new example and return to the Smiths later in the chapter.

Richard and Mary Doe are a married couple, both aged 66 in 2017. Each of them qualifies for a $2,000-a-month Social Security payment at full retirement age (FRA), which is 66 in their cases because they were born in 1951. Of course, this means that when one of them dies, the survivor will be able to collect only one Social Security payment, which means a severe reduction in family income of 50% compared with the situation where both are still alive and collecting their Social Security payments.

In such a situation, it shouldn’t be too surprising that the worst-case scenario is that one of the spouses (the one with the shorter life expectancy) dies immediately, whereas the other spouse lives to the end of their reasonable life expectancy. This cuts off the second Social Security payment as early as possible while the survivor requires retirement income to continue for the longest possible time.

In this particular case, the worst-case scenario is that Richard dies in 2017, whereas Mary lives a long time on just one Social Security payment that amounts to $24,000 a year. Thus, it is possible that Mary will have to live on about $24,000 a year for the rest of her life.1

That is a severe drop in income. Is there any way that she can mitigate this without going back to work?

Yes, there is; and the answer is surprising—life insurance. The truth is that most people, at best, look at what they have and how long they might live, divide the first number by the second number, add their Social Security or other retirement income sources, and decide that is the amount they can spend. Sadly, they do not take advantage of the opportunity afforded by life insurance to enable what in many cases is a significantly higher level of spending; or to realize that in already having insurance, they have more spending power than they know. Even worse, many people assume that they can spend all their current Social Security income without considering the significant drop in income if one of them dies early.

Furthermore, until now, there has been no way to calculate the amount they can safely spend. Without that knowledge, it does little good to know that you can spend a bit more. The remainder of this chapter will explain why life insurance can increase the level that can be safely spent and make it clear that the level of insurance required to fit a given situation can be determined.

Let’s go back to Richard and Mary and see what an optimal amount of life insurance could do for them. If we were to add $250K of 15-year term life insurance on each of them, at an estimated yearly premium of $1,763 for Richard and $1,127 for Mary,2 the worst-case scenario is still that Richard dies in 2017. But with the life insurance in force, Mary can spend about $31,000 a year for the rest of her life, an improvement of about $6,500 a year, after paying the insurance premiums, even if Richard dies in the worst year (2017)!3 How is this possible?

The answer is that the life insurance payout of $250K after Richard dies in 2017 allows Mary to fund her retirement at a higher level of spending. We are assuming that she lives to her 90th percentile life expectancy, which is the year 2052, so that extra $250K has to be spread out over all of those remaining years. Since Richard’s dying in 2017 is the worst case, assuming no other factors change significantly, she can expect to be able to spend at that $31,000 level.

But I’m sure some of you are already saying “What good does term life insurance do if they both live beyond the term of the insurance?” The answer is that if they both live that long, then they have had a long time to collect both Social Security payments and should have been saving some of that Social Security money to sustain the survivor after one of them dies; this is why the maximum safe spending level with the recommended insurance is only about $31,000 even though their two Social Security payments total $48,000. We’ll get into that in more detail later.

Of course, this analysis is a gross oversimplification of the nature of Social Security, especially as it applies to married couples. It is no exaggeration to say that Social Security is complicated. The ages of both spouses, both when starting to take payments and at the death of the first spouse, the tax implications of Social Security payments and how they interact with other sources of income, the special rules for widow’s benefits, and a number of other factors make calculations regarding Social Security payment...

Table of contents

• Cover
• Title Page
• Copyright
• Acknowledgments
• Contents
• Preface
• Chapter 1: The Retirement Crisis in Brief
• Chapter 2: A New Use for Life Insurance
• Chapter 3: A Visit with the Financial Planner
• Chapter 4: Another Visit with the Financial Planner
• Chapter 5: The Withdrawal Source Section of the Spreadsheet
• Chapter 6: Cash, Taxes, and Insurance Premiums The Next Day…
• Chapter 7: Calculating Sustainable Retirement Spending
• Chapter 8: Adding an Annuity
• Chapter 9: Can an Annuity Improve Sustainable Retirement Spending?
• Appendix A: Reference Manual for the Gui Interface of the Rhino Retirement Analyzer V1.0, Basic Mode
• Appendix B: Reference Manual for the GUI for the Rhino Retirement Analyzer v1.0, Expert Mode
• Appendix C: Tutorial for the Scripting Language and Command-Line Interface of the Rhino Retirement Analyzer v1.0
• Appendix D: The Market for Retirement Spending Optimization
• Appendix E: The Genesis of the Rhino Retirement Analyzer (and this Book)
• Appendix F: What is Included, What is Excluded, and Known Limitations of the Program
• Index