THE RETIREMENT PENSION TRAP: What is it and how to avoid it?

By Eugene A. Luciw, J.D.

There are many reasons to carry life insurance through retirement years: paying final expenses; protection of a financially dependent spouse – the one that will suffer without the decedent’s work pension (see below); the cash value that can be used instead of retirement savings for emergencies; a tax free inheritance for future generations; liquidity to cover estate taxes and expenses.

Financial dangers never disappear and can be particularly devastating in retirement years; therefore, life insurance is an important element of planning for retirement. For example, it helps retirees avoid “the pension trap.”

What is the pension trap? “Breadwinner” spouses often rely too heavily upon their employer sponsored pension plan. They often discovers too late that the plan’s settlement options are limited: (1) a pension check for the breadwinner’s lifetime; or (2) a smaller pension check for his lifetime and only half of that monthly check for his spouse, if he should predecease her.

In either scenario, especially if the breadwinner dies an early death, the dependent spouse is asked to live with no or dramatically reduced lifetime benefits. Social Security and savings almost invariably cannot cover the gap. The surviving spouse unexpectedly has to reduce her standard of living and exists in constant fear of living longer than available savings permit.

Adequate cash value life insurance can cover the gap? Needless to say, a responsible measure of life insurance is the best available way to avoid the pension trap. Proper retirement planning dictates that each spouse has that amount of life insurance that would cover the loss of pension and other income and services his or her premature death would precipitate for the other spouse.

In fact – although we would generally recommend against this because of the amount of money that would be “left on the table” in the event of an untimely death – proper insurance planning could justify the pensioner spouse taking the higher lifetime benefit that is offered to him. If he dies prematurely, adequate life insurance can replace the gap in income.

Why do many retirees overlook having adequate life insurance for retirement years? The excuses are as many as there are days in the week. Many Baby Boomers simply rely too heavily or too long upon term life insurance, in general, or employer subsidized term life insurance in particular. Shortly before retirement, they discover that in most cases term life insurance – especially employer life insurance – is prohibitively costly in later years and expires at a relatively early attained age (usually 70-74)..

            Nor are the Baby Boomers willing to purchase adequate permanent cash value insurance when they near retirement, because they mistakenly think that it is “too expensive” and unjustified. Instead they rely upon their pensions and savings to provide for the family. They are, of course, seriously mistaken They walk right into the pension trap, exposing their spouses to potential disaster.

What is the best answer? Every responsible adult should purchase adequate cash value life insurance in his or her early years (even at a time when they might not be married). The premiums are exceptionally low while the benefits of a lifetime of solid guaranteed and immutable protection are self-evident. What is more, delaying the purchase of life insurance runs the risk of deterioration in health that can lead an insurance company to refuse coverage due to lack of insurability.

            For those pensioners that might not have purchased adequate life insurance in earlier years, it is very advisable for them (assuming their health is still reasonably good) to do so even at the more costly rates that exist in the years approaching retirement. Term life insurance will never carry the load and should never be viewed as anything other than a temporary supplement to a good solid permanent policy.

Demonstration: Ivan retired at age 65 from a nice career as a college professor. He was in great health, active and robust. His employer's annuity pension plan offered him a typical selection from only two imperfect options. Option one offered Ivan a $2,500 monthly lifetime income for himself; option two offered Ivan a $2,040 monthly pension for his life and, upon his death, a reduced $1,080 monthly stipend for his surviving then aged 60 wife, Marrussia's, lifetime. Ivan selected the larger monthly pension. Marrussia would continue working until her retirement at age 65. She worked part-time as a paralegal for a small law office that offered her no pension plan. The couple had lived well, saw two children through graduate school and had only marginal personal retirement savings. They were relying on social security and Ivan's pension.

    At that time, Ivan rejected the option to continue a very expensive term policy previously supplied by his employer that offered coverage to age 70.He learned that the rates were set based upon a very high risk pool of people who had to keep the policy in place, because no other company would insure them. He also rejected a comparatively economical cash value policy plan that a Providence agent had meticulously designed for him. Life insurance simply was never "in Ivan's budget", especially now that he was about to retire in an "empty nest". In fact, many years earlier he had rejected a number of offers for cash value life insurance, relying upon his employer’s low cost group term policy.

    Five years later, Ivan died in a tragic motor vehicle accident. Marrussia was left with nothing other than Ivan's devastating final expenses -- funeral and burial bills, medical expenses, a credit card bill for a recent vacation at the shore, property and income tax bills, estate administration expenses -- and an old furnace and roof that needed to be replaced. She had no pension income and her meager saving were about to be depleted. The $180,000.00 life insurance plan that the Providence agent had designed for the couple many years ago and at Ivan's retirement would have been the answer: Marrussia could have taken some of the the tax free death benefit monies to fix her house and to cover final expenses and invested the rest into an immediate annuity that would have given her a guaranteed monthly pension nearly identical to Ivan's full benefits.

Demonstration 2: If Ivan had selected the survivor benefits option for Marrussia, she would have fared much better. However, she would still have had to pay final expenses and would also have to weather the loss of Ivan's nearly $1,000.00 per month, his Social Security pension, and his services to the household. The perfect solution to the problem would have been for Ivan to have insured his life for somewhere in the range of $100,000.00.

For further retirement and life insurance planning advice: Look to succeeding issues, visit our website, call (1.877.857.2284 or email (eluciw@provassn.com).