When most people think of life insurance, they think of the death benefit, which is normal. After all, its primary purpose is to provide financial protection against a premature death. However, as long time readers know, that is just one of life insurance’s many uses. Today we will discuss another.
A 72 year old widow had $100,000 in a CD that she had earmarked for her granddaughters, 8 and 11. Her husband had left her in very good financial shape. Her house was debt free, she had his pension and social security, and an investment account of a little over a half a million dollars. Additionally, she was talking about downsizing, which would free up another couple of hundred thousand. So she could well afford to be benevolent with her granddaughters.
The problem was that the CD was earning .7%. Using the Rule of 72, it would take over 100 years for it to double. Life insurance (and an annuity) to the rescue!
Now obviously for this strategy to work, the person must be insurable. This widow was in excellent shape (for a 72 year old), so the first hurdle was met. A survey of guaranteed universal life products indicated a $250,000 policy was available for an annual premium of $6,004. Since the CD was only earning $700/year, that wouldn’t work as a funding mechanism.
But she could transfer the proceeds from the CD to a single premium immediate annuity (SPIA) that would generate $6,788 for as long as she lived, with only $164 of that amount subject to income taxes.
Alternatively, she could choose a refund option on the payout, so that in the event she died before the entire $100k was distributed, the beneficiary would receive the balance of the undistributed amount. There is a cost to that option though, so instead of receiving the $6,788 for her life, she would receive $5,954/year for as long as she lived. But if she died before the entire $100k was distributed, her beneficiary would receive the balance.
To illustrate, if she lived to age 86 (her life expectancy), she would receive $95,032 under the first scenario (14 x $6,788) and her beneficiary would receive nothing upon her demise. Under the refund option, she would receive $83,356 (14 x $5,954), but her beneficiary would receive $16,644 ($100,000 – 83,356) at her death.
The break-even is about 16 years. That is, if she lived more that 16 years, the first option would be better, but if she didn’t, the refund option would be better. But what is undisputable is that her granddaughters would be significantly better off under either scenario. Just another efficient use for that very flexible product known as life insurance.