Should your retirement savings plan include life insurance? Here are some pros and cons
Dear Liz: Are indexed universal life insurance products worthwhile, and how do they compare to a Roth IRA?
Answer: Both offer the potential for tax-free distributions in retirement, but indexed universal life insurance is a complex product with high expenses that’s not a good fit for most investors.
With a Roth IRA, virtually all of your money can go toward your retirement investment. (Most investments have fees of some kind, but you can minimize those by using exchange traded funds or low-cost index funds.) With permanent life insurance, some of your money goes toward paying premiums for the death benefit and other administrative expenses, including commissions for the person who sells you the policy. The remaining cash can be invested in accounts that are tied to the performance of a stock market index. Your principal is guaranteed, but the amount you earn is subject to caps.
Financial planners generally recommend that you first max out other retirement savings options, such as 401(k)s and IRAs, before considering investing through a life insurance policy. Also, you should be someone who needs permanent life insurance — the kind that is meant to cover you for the rest of your life. (Term insurance, by contrast, is a much less expensive option meant to cover you for a set term, such as 20 years.)
Some people do need permanent coverage. Their estates may be large enough to incur estate taxes that they want to pay with insurance, for example. Or they may have a special needs child who will require ongoing support. If you need permanent coverage, consider hiring a fee-only financial planner to help you sort through your options.
The 50/30/20 budget was popularized by Sen. Elizabeth Warren and her daughter Amelia Warren Tyagi in their book, “All Your Worth: The Ultimate Lifetime Money Plan.”
Social Security and government pensions
Dear Liz: When is the “sweet spot” for me to start receiving Social Security benefits? I am retired and collecting two government pensions — mine and my ex-husband’s. I paid into Social Security for 26 years of substantial earnings when I was in the private sector. I do not want to return to work to get to 30 years of substantial earnings in order to avoid the windfall elimination provision reduction. I will reach full retirement age early next year and have a family history of longevity (my parents lived into their 90s). I am paying all of my bills currently but will do more traveling once I am collecting Social Security. Should I wait until 70 to collect? I think I need to live until about 84 to make waiting a good choice. I tried to get this answer from a financial planner at a free seminar and he would not tell me without hiring him for further consultations.
Answer: That’s not surprising. Social Security claiming strategies can be a complex topic, and your situation is more complex than most.
As you know, the windfall elimination provision can reduce Social Security benefits for people receiving pensions from government jobs that didn’t pay into Social Security. The provision doesn’t apply to people who have 30 or more years of “substantial earnings” from jobs that did pay into Social Security. (The amount considered substantial varies by year, but in 2023 it’s $29,700.) Your 26 years of substantial earnings will mitigate, but not eliminate, the provision’s effects.
Social Security has tools that can help you estimate the impact. Start by opening an account with Social Security, if you haven’t already, and getting your earnings record from those 26 years. You’ll then enter each year’s worth of “substantial earnings” into Social Security’s windfall elimination provision calculator to determine what your benefit is likely to be at various ages.
Next, consider using a paid Social Security claiming site, such as Maximize My Social Security or Social Security Solutions, to get recommendations on when to claim rather than using calculators that purport to show a “break even age” for delaying Social Security.
These calculators typically don’t include important factors such as tax rates, rates of return and, for married couples, future survivor benefits. They also don’t really address “longevity risk” — the substantial danger that the longer you live, the more likely you are to run through your savings and wind up short of money.
On the other hand, you have not one but two government pensions that will provide guaranteed income for the rest of your life. If your Social Security benefit is truly “fun money,” rather than the lifeline it serves as for most people, maximizing your benefit may not be your top priority. But get all the information you can about the cost and benefits of claiming at different ages before making your decision.
Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions may be sent to her at 3940 Laurel Canyon Blvd., No. 238, Studio City, CA 91604, or by using the “Contact” form at asklizweston.com.
