Do You Still Need Life Insurance in Retirement?

Key takeaways

The reason to own life insurance, replacing earned income for dependents, usually ends at retirement; a paid-up portfolio is its own death benefit.
The exceptions are a pension without a survivor option, a large drop in Social Security at the first death, an estate tax liability, and an illiquid estate such as a business or real estate.
Existing term policies should usually be allowed to lapse at retirement; existing permanent policies need a separate analysis of cash value, cost, and the tax on surrender.
Long-term care and the survivor's income are the retirement risks that deserve the premium dollars, not death.

Retirees often carry life insurance out of habit, or because an agent suggested a policy is a "legacy" or a "tax-free asset." We ask a simpler question. If one spouse died tomorrow, what would the survivor lose financially, and is a life insurance premium the cheapest way to cover it? For most retired households with an adequate portfolio, the survivor loses less than they expect and the policy isn't worth its cost. For a few, the policy is essential. Sorting out which household you are takes about a page.

What the survivor loses

Social Security. At the first death, the household keeps the larger of the two benefits and loses the smaller. A couple receiving $5,500 a month combined may drop to $3,500. That's a real loss, and it's permanent.

A pension without a survivor benefit. If one spouse elected a single-life pension, it stops at death. This is the largest survivor risk in many retirements, and it's created by the election, which is why the pension decision should be made with the survivor in view.

The survivor's tax position. A widow or widower files single from the second year after death, with half the bracket width and half the standard deduction. Same income, more tax. And RMDs from an inherited IRA keep coming.

Very little else. The portfolio doesn't shrink at death; it passes to the survivor with a step-up in basis on the deceased's half (or all of it, for community property). Expenses fall, often by 20% to 30%. A household that could support two people on the portfolio can usually support one.

The retirement income plan should show the survivor's income and spending after each spouse's death. If the plan works for the survivor without insurance, you don't need a policy. If it doesn't, the shortfall is the amount to insure, and it can usually be covered with a term policy running until the portfolio grows enough to close the gap, or with a change to the pension election or the Social Security claiming plan.

The four real reasons

Estate tax. A household above the $15 million per person exemption ($30 million per couple) faces a 40% tax on the excess, due nine months after death. A permanent policy owned by an irrevocable life insurance trust provides liquidity for the tax without adding to the estate. For families whose wealth is in a business or real estate, this is often the cleanest solution. For families below the exemption, it's a solution to a problem they don't have.

An illiquid estate. A retiree whose net worth is a business, a farm, or several properties may need cash at death to pay debts, equalize among children (one child takes the business, the others take insurance proceeds), or avoid a forced sale. Insurance provides the cash.

A dependent who will outlive you. A child with a disability, or a much younger spouse with a long life ahead and limited assets, can need support beyond what the estate provides. A policy funding a special needs trust is a standard tool here.

A pension already elected single-life. If the election was made and can't be changed, insurance on the pensioner's life, sized to replace the pension for the survivor's expected life, is the repair.

The reasons that aren't reasons

"Leaving a legacy." A permanent policy bought in retirement to leave money to children is a savings vehicle with a mortality cost attached. Over a normal life expectancy, the premiums invested in the portfolio usually leave more, with liquidity along the way. The policy only wins if the insured dies early. Which isn't a strategy.

"Tax-free income" from cash value. Loans against a permanent policy are tax-free because they're loans. They reduce the death benefit, and if the loans outgrow the cash value the policy can lapse with a large taxable gain. Our review of indexed universal life covers the pattern.

Final expenses. A funeral costs $10,000 to $15,000. A household with a retirement portfolio doesn't need an insurance policy to pay for it.

What to do with policies you already own

Term. Let it expire at the end of the level term, or cancel it at retirement if the survivor analysis shows no gap. Some term policies allow conversion to permanent coverage without underwriting. That's worth considering only if one of the four reasons applies and health has declined.

Permanent (whole life, universal life, variable life). The options: keep paying, stop paying and let the cash value carry the policy (reduced paid-up), take the cash value and surrender (taxable to the extent it exceeds premiums paid), exchange it tax-free under Section 1035 into a low-cost annuity or a hybrid long-term care policy, or sell it in a life settlement if the insured is old or ill. The right answer depends on the policy's internal cost, the cash value, the gain, and whether the death benefit still does anything. We request an in-force illustration and run the numbers. The answer is rarely the one the agent who sold it suggests.

The risk that actually deserves the money

In retirement, the insurable risk isn't death. It's living a long time with expensive needs. The premium dollars that would have gone to a policy nobody needs are better spent on long-term care coverage for the households that need it, or simply saved. Death, financially, is the risk a retirement portfolio already covers.

Where we come in

The insurance review for a retired client starts with the survivor projection for each spouse, not with the policies. Where a gap exists, we size it and find the cheapest way to close it, which is sometimes a policy and more often a pension or claiming change. Where no gap exists, we help the client stop paying for coverage they don't need. We sell no insurance and receive nothing from any policy, so the recommendation to keep, cancel, or exchange is about the household's numbers and nothing else.

Frequently asked questions

My agent says I should keep the whole life policy for the cash value growth.

Ask for an in-force illustration showing the guaranteed and current cash value each year, and compare the internal return to a bond fund. Most mature whole life policies earn a bond-like return on cash value, which may be worth keeping if the policy is paid up and the death benefit serves a purpose. It's rarely worth new premiums.

Is life insurance taxable to my beneficiaries?

The death benefit is income-tax-free. It's included in the taxable estate if the insured owned the policy, which only matters above the exemption.

Should I name my trust as beneficiary?

If the estate plan uses a revocable trust to manage assets for a spouse or children, naming the trust keeps the proceeds inside the plan. For a spouse who'll manage the money directly, naming the spouse is simpler.

What about a policy on my adult child?

Almost never. Life insurance on someone who doesn't support you financially insures nothing you'd lose.

Joseph G. Valerio, CFP®, EAFounder and Lead Advisor at Valerio Wealth Management, a fee-only, fiduciary virtual family office in Miami, Florida. One advisor, credentialed in both financial planning and federal tax. About Joseph

This article is general education, not individualized advice, and it is not tax, legal, or accounting advice. Figures reflect federal law for the year stated and can change. Valerio Wealth Management does not prepare or file tax returns. Speak with a qualified professional about your own situation before acting.