Life insurance in retirement: Who needs it?

The KISS principle–invented by the U.S. Navy in the 1960s–holds that most systems work best when they are kept simple.

And KISS is a great principle to apply to this question: When, if ever, does it make sense to own life insurance in retirement?

Keeping things simple, here’s the answer: In most cases, never. The basic purpose of life insurance is to protect dependents against the loss of income–yours–in the event of premature death. But by the time retirement rolls around, that risk usually declines sharply. Children are out on their own, we hope. And life insurance is hardly the only way to provide for your surviving spouse; smart options include Social Security optimization, retirement savings, joint and survivor defined benefit pension features, and income annuities.

“The purpose of term insurance is to cover the loss of human capital, and you don’t have much of that at retirement age,” says Michael Finke, dean and chief academic officer at The American College of Financial Services.
Term life insurance is an easy target to eliminate in retirement–especially older policies with built-in large premium spikes for older policyholders. An exception to that rule: If you’re in poor health at retirement age, that’s a good reason to think twice about dropping an existing life insurance policy.

“If there’s a health issue, the term policy may be a valuable asset for the beneficiaries, or you might be able to sell it to a third party in a life settlement,” says Glenn Daily, a fee-only life insurance advisor. “So I always ask about health early on in discussions with clients.”

But Finke and other researchers have been developing a theory of retirement income planning that suggests including insurance–annuities and cash value life insurance–in the mix alongside equities and bonds. They argue that insurance can play a role in mitigating longevity risk.

The risk of outliving your assets is a key consideration in any retirement plan. In fact, longevity may be a more important component in retirement planning than any other, as Morningstar’s David Blanchett has noted.
Expected longevity for men and women at age 65 has jumped more than 10% since 2000, according to the Society of Actuaries. Men who reach age 65 can be expected to live to an average age of 86.6, and women to 88.8.

But those figures are only averages. A 65-year-old man in good health has a 13% chance to live to 95, as do 21% of women, according to research by Vickie Bajtelsmit, a professor of finance at Colorado State University whose research focuses on retirement and financial planning. And there’s a 31% chance that a surviving spouse will make it to 100, she calculates.

Those eye-popping numbers bolster the case for strategies such as working longer and saving more, optimizing Social Security and perhaps adding an income annuity to the mix to bolster lifetime guaranteed income.

How about life insurance?

Plenty of experts are skeptical about cash value insurance as an investment, due to its complexity and high costs. But Finke has made the case for holding cash value insurance, if purchased at an earlier age, as a bond-like portion of a broader portfolio that also includes equities and income annuities. (For the record, the research was sponsored by an insurance company, but the numbers are worth considering.) Finke’s longevity-related whole life argument is that the tax-sheltered status of these policies can provide liquidity in later years, offer guaranteed and stable cash value, and provide tax-deferred growth.

Daily says holding an older permanent policy sometimes makes sense–compared with other fixed-income holdings–if it is being held for beneficiaries, considering only the growth of cash value.

“I’ve seen many whole life policies with an expected present value of death benefits that is 10% to 30% higher than the expected present value of premiums.”

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