Social Security will play an important role in most Americans’ retirement. While it is a complex system with many options that should be thoroughly considered before deciding on what’s best for you, this essay will not address those issues. Rather, it will discuss replacing the benefit upon death.
While Social Security is technically an insurance program, ostensibly it functions much like a defined benefit pension plan. The one area where they differ dramatically is with regard to survivor benefits.
Federal law mandates that a married participant in a defined benefit pension plan take a reduced pension so as to provide a minimum 50% survivor benefit to his spouse, unless the spouse agrees in writing to forego such a benefit.
The cost of such reduction is influenced by several factors, including the age difference of the participant and her spouse, but an approximation is about 10%. That is, if the participant’s monthly benefit is calculated to be $5,000/month, he/she would receive, by taking the default 50% survivor benefit, $4,500/month, with $2,250/month going to the spouse upon the death of the participant.
The cost of the reduction, in this example $500/month, is nothing more than a premium on a life insurance policy that will pay $2,250/month should the participant predecease the spouse. Question: is paying $500/month during retirement for life insurance that may not mature in a claim a wise use of resources?
The survivor benefit of Social Security doesn’t work that way and in fact is much more complicated and beyond the scope of this essay.
Your Social Security benefit will depend on your earnings record (highest 35 years, indexed) when you file for benefits. The maximum monthly payment for 2015 at Full Retirement Age (age 66 for those born between 1943 and 1954) is $2,663, but the average is only $1,328.
For our example, let’s say the worker qualifies for a $2,000/month benefit at FRA. The worker’s spouse, also at FRA, would qualify for the greater of his/her own benefit or one-half the worker’s benefit ($1,000). That is, if the spouse’s earnings record didn’t generate a benefit of at least $1,000/month, he/she would still receive $1,000/month (even if he/she never worked a day in his/her life).
Upon death, the survivor (it doesn’t matter if it’s the worker or the spouse) will receive the higher of the two benefits, and lose the lower one. Question: could the loss of a Social Security benefit impact the survivor’s lifestyle?
Replacing this lost income is yet another reason to have life insurance in retirement. It is something that affects virtually all Americans, and yet very few are prepared to deal with it effectively.
Unfortunately, those that it affects the most, that is, those whose sole retirement income is social security and who don’t have assets to replace the lost income, are the least prepared to deal with it.
The good news is it’s almost never too late to start. Cash flow is almost always better while working, so allocating a small portion of it to life insurance will serve to protect against a significant decline in cash flow during retirement.