As your retirement horizon draws closer, you may be wondering about the role life insurance plays in retirement.
Is it necessary? In what ways? How do you decide whether to extend your coverage of drop it completely? Is life insurance worth carrying into your later years?
In this post I’d like to explore the role life insurance may or may not play in your retirement.
Why Life Insurance is so Important
First and foremost, remember that nearly every pre-retiree needs sufficient life insurance during their earning years. Life insurance is (among other things) an income replacement tool should the primary breadwinner of your family pass away.
How will your family keep the roof over their heads and bread on the table?
How will childrens’ education expenses be funded in the event of an earner’s untimely death?
How will your widow or widower have enough income to re-enter the workforce following your death?
These questions and many others are answered with life insurance.
Making sure you have some sort of life insurance policy with sufficient coverage in place is 90% of the battle. For a quick primer on how much life insurance to purchase, see my article here.
Does Life Insurance in Retirement Matter?
But if life insurance is primarily an income replacement tool, is it necessary in retirement? Consider the following example.
A Quick Case Study
Tom and Peggy are anticipating retirement in the next five years. Tom has a $100,000 term life insurance benefit through his employer, and an additional $500,000 term life insurance purchased through an insurance broker in his community, with a term extending 10 more years. Tom and Peggy’s anticipated monthly expenses in retirement are $4,000, their home is paid off, and they expect to easily cover their monthly expenses between their combined $5,000 per month Social Security benefits and withdrawals from Tom’s Traditional IRA, valued at $500,000.
In this scenario, there’s not much reason for Tom to keep his life insurance in place upon retirement. Their expenses will be easily covered with a guaranteed income stream from their Social Security, and they’ll have additional funding through optional (and later required) IRA withdrawals.
Term Life Insurance in Retirement
It’s important to remember the nature of term life insurance when deciding whether to keep life insurance in place during retirement.
As opposed to permanent life insurance, term builds no cash value over time. Instead, it is coverage for a set period of time. If the policy needs to be used (i.e. the covered person dies) then payout occurs; if not then the policy lapses after the term. Since there’s no cash value built up, term insurance is typically much cheaper than permanent insurance. (Here’s an article I wrote comparing the two in more detail.)
If debts are paid off and you’re confident of your sources of retirement income, carrying term life insurance into retirement isn’t necessary.
Permanent Life Insurance in Retirement
Permanent life insurance is designed to stay with you until you die, hence the name.
It comes in a wide variety of options including whole life, universal life, and variable policies to name only a few. The cash value grows over time, but fees are also higher in these policies compared to term.
Does this type of insurance have broader implications into retirement, compared to term life insurance?
Assuming the same scenario as outlined in the case study above where income is relatively secure and debts are paid off, there is an argument that permanent life insurance could still play a part in your retirement planning.
For example, permanent life insurance could be used as an alternate source of cash (tax-free, by the way) to cover funeral costs, or to handle the attorney fees, taxes due, and other expenses of settling one’s estate.
While permanent life insurance could help fund some specific retirement expenses, I do not personally believe that permanent insurance is an ideal way to primarily fund one’s retirement living expenses. I feel these policies are too expensive compared to more traditional funding methods, namely utilizing diversified, low-cost investments in tax-advantaged accounts, like IRAs and 401k plans.
Final Thoughts
Assuming you have a clear understanding of your income needs throughout retirement, your major debts are paid off, and relatively stable sources for that income have been identified, I don’t see a huge need for life insurance in retirement. If it is primarily an income replacement tool and your income is reasonably reliable, then have your term policy terminate upon retirement and save yourself the extra premium cost.
While there are some arguments for carrying permanent life insurance into retirement, be mindful of the costs associated with these policies and the potential drain the extra expense may be on your fixed income throughout retirement.