Archives for April 2024

A general principle in financial planning is that if nobody would be financially in trouble if you were to die tomorrow, you don’t need life insurance. The most common example of this principle is that an unmarried person with no children probably does not need life insurance.

A less discussed but still very common application of this principle is that, after you have retired (or reached financial independence), you probably do not need life insurance anymore. (I say “probably” because one noteworthy exception is that if you have a pension/annuity with a small (or no) survivor benefit, you might still need life insurance to support your spouse after your death.)

But once nobody other than you is dependent upon your income, you no longer need life insurance.

But that doesn’t necessarily mean you should let an existing life insurance policy lapse.

If your own retirement security would be meaningfully improved by no longer paying the premium, then you should probably let it lapse. Why put your own well-being at risk, simply to pay for a policy that’s no longer needed?

But if your own retirement security is not really at risk at all (i.e., your assets and other sources of income, relative to your desired level of spending, are such that you’re extremely unlikely to run out of money during retirement), it often makes sense to keep paying the premiums.

In general, if you reach a point where your own retirement security isn’t at risk, then the impacts of the various financial decisions you make will primarily be felt by your heirs rather than yourself. The metric of interest is no longer “probability of portfolio depletion” (or other similar metrics) but rather “after-tax expected bequest” (or other giving/bequest-related metrics).

And when measured in that way, continuing to pay the premium on an unneeded life insurance policy can still look pretty good, in many cases.

Let’s Look at an Example

Bob is a 50 year old male who has never smoked. He’s in good health. Based on a quote from term4sale.com, Bob could buy a $1 million 15-year level premium term policy for a premium of $1,175 per year.

If we use the most recent (2017) CSO non-smoker super preferred mortality table, Bob has just a 0.18% chance of dying this year. This tells us that the probability-weighted payout for the policy this year (i.e., the “expected value”) is $1,000,000 x 0.0018 = $1,800. Right from the start, that’s more than the $1,175 annual premium.

Granted, Bob’s chance of dying in a given year is probably not exactly the same as the probability shown in any given mortality table. But we’re already looking at a table that reflects longer than average life expectancies. And with an $1,800 expected value for this year and a $1,175 annual premium, Bob’s chance of dying would have to be much lower (about 35% lower) than that shown in the table in order for the policy to be a “bad” deal.

And the policy only becomes a better deal each year, because the premium stays the same while Bob’s chance of dying grows as he ages.

For instance, let’s imagine that by age 60, Bob is financially independent and no longer needs the insurance. His premium will still be $1,175 each year for the last 5 years of the policy, if he chooses to pay it. If we again use the same mortality table:

• Bob’s chance of dying between age 60 and 61 is ~0.36%. (Expected value of $3,610.)
• From age 61 to 62 it’s ~0.40%. (Expected value of $4,010.)
• From 62 to 63 it’s ~0.45%. (Expected value of $4,470.)
• From 63-64 it’s ~0.50%. (Expected value of $4,980.)
• And in the last year of the policy, from 64-64, it’s ~0.55%. (Expected value of $5,540.)

Those values are way above the $1,175 annual premium.

If paying the $1,175 premium would put Bob’s financial well-being at risk in any way, he should let the policy lapse. But if 1) he can comfortably afford to pay the premium and 2) he has even a modest degree of bequest motive, he should keep paying that premium.

A level premium term policy that you have already held for some years is kind of like a lottery ticket in that it offers a high probability of no payout, with a low probability of a high payout — but the critical difference is that in this case the odds are often weighted in your favor. The expected value each year can be quite a bit more than the premium being paid, whereas with a lottery ticket the expected value is generally considerably less than the cost of the ticket.

Another point in favor of continuing to pay the premium is that the death benefit is not taxable as income to the beneficiary. And, if estate taxes are a concern at all, if the policy is owned by an irrevocable trust, it may be excluded from your gross estate as well.

Among people who read personal finance books, many save a high percentage of their income through most of their careers. One thing that eventually happens for some such people is that they reach a point at which they realize they have not only saved "enough," they have saved "more than enough." Their desired standard of living in retirement is well secured, and it’s likely that a major part of the portfolio is eventually going to be left to loved ones and/or charity. And that realization raises a whole list of new questions and concerns.

This book’s goal is to help you answer those questions.

Today I want to share with you a brief “estate planning gone wrong” story. The story is real, but of course the names have been changed. If you are not up-to-speed on basic trust terminology, please read “What’s the Point of a Trust?” first.

Here’s the basic sequence of events:

• Hank and Wanda (a married couple) had their attorney, Adam, create a trust for them.
• Hank was named as trustee of the trust.
• Adam was named as successor trustee.
• Hank and Wanda were co-beneficiaries of the trust, with their adult children named as secondary beneficiaries.
• Hank and Wanda moved essentially all of their assets into the trust. (Retirement accounts, which cannot go into the trust, made up only a very small portion of their assets.)
• Adam died before Hank or Wanda. The trust was not modified to add a new successor trustee.
• Hank died.

The result: the trust had no trustee — nobody who was authorized to make decisions about how to use the assets. Wanda was beneficiary of the trust, but because she was not the trustee, she had no control over the assets. This resulted in two problems:

1. Wanda could not spend from the money that she naturally thought of as “her” money.
2. There was nobody who could make any portfolio management decisions.

Wanda petitioned the applicable court to appoint a new trustee for the trust, and the court eventually did so. But the process took several months. And in the meantime, there was very little other than her monthly Social Security check that she had access to.

Fortunately, her adult children were able to step in and provide some needed funds. And, fortunately, the portfolio being left on autopilot did not result in any bad outcome. But you can easily imagine situations where either of those two problems could have resulted in very real damage to Wanda’s well-being.

Why wasn’t Wanda named as co-trustee along with Hank? Frankly, I don’t know. There are various cases in which it would make sense for only one of two spouses to be named as a trustee (e.g., the other spouse has a gambling problem or cannot be trusted to make sound financial decisions for some reason). I could not see any obvious reason in this case, but maybe the husband and the attorney really did have a good reason.

Regardless, this is an easily avoided situation. Make sure your trust has multiple successor trustees. Even if you like the idea of naming a family member or a trusted individual professional as the trustee, naming a business entity, such as a well-established law firm that’s likely to outlive any one person, as a final successor trustee can prevent the situation described here.

In addition, estate plans should be updated periodically. In the example above, the situation would have been avoided if the couple had reviewed their estate plan after the first attorney’s death, as they (or the attorney doing the review) would have realized that the trust no longer had a successor trustee.

Among people who read personal finance books, many save a high percentage of their income through most of their careers. One thing that eventually happens for some such people is that they reach a point at which they realize they have not only saved "enough," they have saved "more than enough." Their desired standard of living in retirement is well secured, and it’s likely that a major part of the portfolio is eventually going to be left to loved ones and/or charity. And that realization raises a whole list of new questions and concerns.

This book’s goal is to help you answer those questions.