According to a 2005 AARP Report, there is a 40% chance that an individual over 60 will experience poverty at some point. In addition, life expectancies continue to rise; someone who was 65 years old in 1950 had a life expectancy of an additional 13.9 years. By 2004, the expected life span for a 65-year old had shot up to 18.7 years, based on statistics by the U.S. Department of Health and Human services. Because these are just averages, in practical terms, a surviving spouse could live for many years - even decades - after his or her partner dies.
As a result, retirees and those close to retirement are becoming more concerned than ever about providing for their survivors. A survey conducted by LIMRA in 2001 found that 60% of retirees and 68% of pre-retirees were worried about providing for a surviving spouse.
So what can you do to make sure your loved ones have the means to get by without you? Read on as we cover some of the options available for setting up survivor benefits.
The Conventional Approach
When it comes to providing benefits for survivors, life insurance is a common solution. However, permanent life insurance can be expensive, especially for older individuals. Plus, it might not provide enough lifetime income for survivors.
Another thing to consider is whether your beneficiaries are capable of managing a large, lump sum death benefit that is supposed to last a lifetime. (For more on this topic, read Buying Life Insurance: Term Versus Permanent.)
A Practical Alternative
A reversionary annuity could be another solution. A reversionary annuity is somewhat like a three-way combination of a term life insurance policy, a permanent life insurance policy and an immediate annuity. It offers:
- Premiums competitive with those of term life insurance, but the coverage doesn't stop at some predetermined date like it does on term insurance.
- A guaranteed benefit to survivors, similar to permanent life insurance. The premiums can be lower than permanent life insurance, but instead of a lump sum benefit, it pays the beneficiaries a guaranteed, lifetime income. However, most policies dictate that once a beneficiary has been selected, it cannot be changed. Furthermore, unless specified otherwise, the policy often is terminated if the beneficiary dies before the insured individual.
- Funding for the annuity from the life insurance death benefit. This means each premium dollar is highly leveraged to maximize the amount for your beneficiaries.
|Example - When a Reversionary Annuity Pays
Here\'s a hypothetical example of a 65-year old couple, Harold and Clara, who could benefit from a reversionary annuity. When Harold retired five years ago, he was single. Therefore, he selected a life-only option from his employer\'s pension plan so he could receive the highest payout - $3,000 a month. Recently, Harold married Clara. Now the problem is that when he dies, Clara gets nothing because the pension income stops.
Harold is worried that if he dies first, Social Security alone will not provide Clara with enough steady income to pay the mortgage, taxes and other ongoing expenses. To make up for his lost pension income, Harold could buy enough life insurance to give Clara $3,000 in monthly income.
Harold\'s life insurance agent determines that Harold will need a $490,000 policy. If Harold predeceased Clara, she could put that money into an immediate annuity to generate a guaranteed $3,000 monthly income for the rest of her life. The premium, however, is more than Harold can afford.
However, a reversionary annuity could accomplish the same thing for a lower premium. The monthly premium would guarantee Clara $3,000 in lifetime income should Harold die first. After she dies, the insurance company\'s payments stop.
In this case, a reversionary annuity would allow Harold to take comfort in knowing that for pennies on the dollar, Clara will able to maintain her standard of living should he die first.
Taxability of Income
A reversionary annuity's beneficiary will not owe income tax at the time of the insured's death. Once payments to the beneficiary begin, the tax will be pro-rated based on how long the payments are expected to last. This means that part of the income will be taxable and part will be a tax-free return of the annuity's value at the time of the insured's death.
What's more, annuity income is not included when calculating the taxability of Social Security benefits.
This could result in a higher net income for your beneficiaries than they would get from other investments. Consequently, they might be able to preserve the tax-deferral of their IRAs longer and not begin taking taxable distributions until required by law.
The reversionary annuity offers a simple and affordable way to provide a guaranteed income to protect your beneficiaries' standard of living, but not all reversionary annuities are alike. Some offer inflation protection. Some have a return of premium benefit in case the insured outlives the beneficiary. And others allow the beneficiary to bypass medical exams.
Be sure to read the fine print. Even though the amount of income for your beneficiary is guaranteed, your premiums are not and can go up each year. In addition, look for a reversionary annuity issued by a top-rated carrier.