Life Insurance For Pension Protection

Families utilize life insurance for many different reasons – for family protection while kids are still young, to pay off a mortgage, to create a legacy for children, etc.  Several different types of life insurance are available in the marketplace to achieve these various objectives.  Life insurance is essentially characterized by two different types – temporary (term) and permanent.  Temporary or term life insurance is designed to protect your family for a defined amount of years (10, 20, and 30 year term contracts are the most common).  Permanent coverage can come in many different varieties but all of them are designed to cover yourself for your entire life and one day have the death benefit be paid out to your beneficiaries.  Whatever goals a family is looking to achieve will dictate which type of life insurance is appropriate.

FDNY families face a unique situation in which life insurance can play a very important role.  At retirement, FDNY members are presented with various pension options.  Most notably, these options can be boiled down to two main choices – “life-only” and “joint and survivor”.  The life-only option, often called the max pension option, provides a higher monthly income, but this benefit ends when the individual passes away.  Conversely, the joint and survivor option ensures that a spouse will receive the full pension or a portion of the pension should the individual pass away, but the monthly income is reduced compared to the max pension option.

Max Pension Option and Life Insurance

Historically, when faced with these two choices, FDNY families will choose the life-only option and use life insurance for pension protection to offset the risk of the individual passing away. Here, we’d like to discuss which type of life insurance would be most suitable for this strategy – term life insurance or permanent life insurance.

With term insurance, an insurance company will cover the life of an individual for a certain number of years (10, 15, 20, 30 years) – and when those years are up – the coverage is gone.  Permanent life insurance (“whole life” is the most common of this type) is structured to pay a death benefit to the beneficiary at any age the individual passes away – the coverage is not structured to end at any point prior to the person’s death.

In addition to the permanent death benefit coverage, this type of life insurance also builds cash value over the life of the contract.  At a certain point, the owner is allowed to access this cash value in the form of a withdrawal or a loan depending on the specific contract.  This cash value aspect is a significant benefit to owning permanent life insurance.

Considering the main characteristics of term and permanent, you’d be right in guessing that permanent life insurance would cost much more than term insurance.  In a perfect world, everyone would own the permanent life insurance coverage.  But, due to the significant difference in cost, often times the buyer will find it too financially challenging to purchase the right amount of the permanent kind to adequately achieve their life insurance goal.  Therefore, making it very difficult to use only permanent life insurance for pension protection.

Term Life Insurance for Pension Protection

While there is never a one-size-fits-all, the characteristics of term life insurance make it a suitable option for families that choose to use life insurance for pension protection.  Since term life insurance can be 9-10 times LESS in cost than permanent life insurance, the buyer can afford to get the right amount of life insurance coverage that could then be utilized to create an adequate income for a surviving spouse – which, after all, is the strategy of life-only plus life insurance.  A $1 million death benefit that could generate approximately $50,000 a year in income for a surviving spouse can be 10 times cheaper via term insurance.  Recently, many companies now offer term periods exceeding 30 years – 35 and 40 year term depending on the age of the proposed insured.  This can allow a 40-50 year old to have the right amount of life insurance in place to protect a pension into his or her 80’s.

Why is Permanent Life Insurance Expensive?

Two characteristics lend permanent to being more expensive – the death benefit never expiring and the cash value component.  While the cash value is a great perk, it often is not a defining need for someone collecting a pension.  Why spend significant extra dollars for a benefit you don’t need?  FDNY members retire with a pension income, significant retirement assets, and eventually social security income.  The need for accessible cash value inside life insurance is usually not the priority for retired FDNY members.  The goal is usually the right amount of coverage for a long period of time at an affordable price.  This can allow an FDNY member to take the maximum pension income and, at the same time, protect his or her family should an early demise occur.

Again, ideally – everyone would own permanent life insurance with a large death benefit.  But, in today’s world, a large amount of 30-40 year term insurance can provide a family with peace of mind while they collect the maximum pension income that they earned during their working years.

A Mix of Both?

Some retired members like the idea having permanent coverage so that one day their loved ones will get a tax-free sum of money regardless of if they have outlived their term coverage.  A strategy that some people employ is getting a combination of both term and permanent insurance.  For example, in the years before they retire with a pension they set up a ladder of term insurance on top of permanent life insurance.  This is a good strategy to use because the first 10 years of the pension is more important to protect than the next ten and that following ten.  This allows the member to bring their cost down while simultaneously protecting their pension and loved ones financially.  Again, this is a strategy that some employ to use life insurance for pension protection, but it is not for everyone.  

Don’t Wait Until You Retire

Whether term or permanent or a blend of both types of life insurance may be best for you, it’s important to remember that not everyone can qualify for life insurance.  One needs to be healthy to implement the “life-only plus life insurance” strategy.  Too often, one will wait until they are ready to retire before they consider life insurance.  By then, the person may not qualify due to health issues.  The cost of life insurance is directly related to your age and your health – the older and less healthy a person is – the higher the cost of life insurance.  With 40-year term now available in the marketplace, it may be very beneficial to consider “life-only plus life insurance” in your low to mid-40’s.