By Henry K. (Bud) Hebeler

12/6/04

There are only a few times in our lives that, when planning ahead, we consider the need for a surviving spouse after the primary wage earner dies. The first of these is usually early in our life when we have children and consider how much life insurance we should buy. Another time is when we determine the age we will start Social Security payments and select a survivor pension benefit option. At some time, we may also look into annuities, long-term-care insurance, and reverse mortgages—all as ways to make life more comfortable for the surviving spouse. Once we have selected survivor benefits, determining how much to save before retiring or how much to spend in retirement is relatively simple with comprehensive planning programs.

Few people have the tools to do an analysis to determine the best choice for survivor alternatives. Even when they seek the help of a professional, clients should be alert to recommendations that may be biased toward products that give the professional the greatest personal income. Anyone who has the full version of Microsoft Excel can do their own analysis using any of the retirement programs on www.analyzenow.com. This is particularly easy with the Simplified Financial Planner which has controls that let you vary the age of each spouse to die to test your alternatives. This program was designed specifically to help with long term planning and related survivor benefit decisions.

The Simplified Financial Planning program asks for the percentage the survivor needs compared to the needs of the couple. The decisions that you make below are not terribly sensitive to a reasonable range of percentages, so I like to enter 67% meaning that the survivor can live on about 2/3 of the amount needed for two people. Of course there are instances where the survivor can live on a lot less or requires a lot more. In such cases, the results may well drive you to different conclusions. That’s one of the reasons why there are no pat answers to survivor benefit alternatives. Answers may be highly customized.

Let’s consider how you might plan for your survivor’s future by considering several of the alternatives.

I’ve already written a number of papers about when to start taking Social Security. I believe that, if you have sufficient investments to tide you over until Social Security begins, both spouses should take Social Security at their "full retirement ages," that is, 65 to 67 depending on their birth years. Of course you can test this hypothesis for your own particular situation with the retirement programs from www.analyzenow.com.

From the standpoint of the surviving spouse’s Social Security, it’s important that the spouse with the larger Social Security benefit delays initiating benefits as long as practical. That’s because the surviving spouse will get whichever is larger: 100% of the deceased spouse’s benefits or the surviving spouse’s own benefits. The principal determinant for the spouse with the smaller benefit is the likely age to die of each spouse. You can only develop a perspective of this by trying a number of possible ages to die for each spouse. The age-to-die controls on the Simplified Financial Planner make this a snap. For modest to medium income people, this may be the most important consideration for their retirement future, so it pays to take the time to do a conscientious analysis.

Before you start cycling ages-to-die, you will have to remember to enter a different Social Security value for each age to start getting payments. The report you get annually from the Social Security Administration will provide sufficient information for the major alternatives, that is, retire at 62, retire at the "full retirement age", or retire at 70. For intermediate ages, you can estimate values or contact the Social Security Administration at (800) 772-1213 or www.ssa.gov. The Simplified Financial Planner automatically makes an estimate of the non working spouse’s actual payments based on these inputs as well as the rules for the non working spouse’s Social Security when based on the working spouse’s benefit. For example, if the non working spouse starts Social Security before her/his full retirement age, the non working spouse will not get the full 50% of the working spouse’s benefit but will get 100% of the working spouse’s benefit after the working spouse dies.

The results are somewhat dependent on the returns from investments. Most often, forecasters make overly optimistic assumptions when compared to actual historical results considering investment costs and reverse dollar-cost-averaging. The Simplified Financial Planner gives you some perspective of this because, with the click of a button, you can also select both an historical scenario for one of the best years to retire in past history as well as one of the worst years to retire. If your own return assumptions put your projections close to the scenario with the best historical results, it’s very likely that you are being optimistic by historical standards.

Those who have the opportunity to get a pension from a traditional defined benefit plan will be asked what percentage they want to leave to the surviving spouse. Often these choices are specific percentages such as 0%, 50%, 75%, and 100%. Obviously, the size of both the before and after death payments are dependent on this choice. The smallest payment before death would be for 100% survivor benefit. With this alternative there would be no reduction in pension payments no matter who died first. The largest payment while the pension owner is alive is for zero percent survivor benefit, but few couples would select this alternative. Insurance sales people believe this is the best alternative if you would spend the difference in payments on an insurance policy. There are a few cases where this is true. If you want to investigate the 0% survivor benefit alternative, you can use any retirement program from www.analyzenow.com to make this comparison.

Most people select 50% for the surviving spouse as being a satisfactory compromise. Actually, it’s hard for a single person to live on 50% of the income of a couple, but if a significant portion of retirement income will come from investments, then 50% or even lower may well be a good choice. The Simplified Financial Planner makes it easy to help with this decision both for fixed income and COLA pensions. Write down the amount the program shows you can afford to spend for each case you try. It’s likely that you will select the alternative that gives you the largest capability to spend in retirement considering some practical range of ages-to-die.

Some retirement savings plans permit employees to convert their savings to a series of guaranteed monthly payments for life. A computer program like the Simplified Financial Planner copes with this easily, but there is not much point in considering an annuity when the actual decision is a number of years in the future because both the amount that you would annuitize as well as the rates used to determine the payments may be significantly different than your current assumptions. Further, conversion to an annuity is a one-way process that takes away your flexibility to invest in other alternatives that may look better to you at a later point in time.

When you are at the point of making an annuity decision, all you have to do is (1) make an analysis of the amount you can afford to spend in retirement if you do not make the conversion, and (2) compare that result with the amount you can afford to spend if you annuitize the savings, that is, convert the savings to a lifetime pension.

To simulate the conversion, you reduce your investments by the amount that you will put into the annuity and enter the annuity payments as a monthly pension. Like in the other pension instances, you will be asked about survivor benefits. So again, you do the analysis with the annuity payments for the survivor at some different survivor percentage alternatives, each of which will have a different value for monthly payments. Compare the results with the case without the annuity and see what is best for your particular situation. In each case, cycle through a number of ages-to-die to improve your perspective for this decision.

In a few cases, you may have the alternative of selecting a pension that has some escalation to help compensate for inflation. The Simplified Financial Planner can cope with this if you make your pension entries in the COLA pension area. You can choose something other than a full cost-of-living adjustment because many of such alternatives have restrictions on the potential annual increases.

There are two kinds of people who don’t need long-term-care insurance: (1) those who will be on Medicaid, and (2) those whose affordable retirement expenses are likely to be significantly higher than long-term-care costs.

Determining whether long-term-care insurance is in your best interest is relatively easy with the Simplified Financial Planner if you can fairly estimate the time you will need such care. The truth is that the best we can do is guess how long we will be exposed to long-term-care costs. For example, if you could get long-term-care at $70,000 a year (in today’s dollar values) and might need it for two years, you would enter $140,000 in the special expense section. This will help you estimate an amount you will be able to spend in retirement if you didn’t have long-term-care insurance and wouldn’t have to rely on Medicaid to pick up your long-term-care costs.

If you do get the full coverage insurance, you would not enter the $140,000 as an expense because your insurance is going to cover that amount. If you were buying partial coverage (not a bad compromise), then you would enter only part of the $140,000 cost. Next, you have to enter the annual cost of the insurance. If you are getting this insurance before retiring, you would reduce the annual savings entry by the cost of the insurance. After retiring, the costs will be part of your calculated normal expenses. If you are using the Simplified Financial Planner, you can enter the post-retirement costs in the special expense section which both accommodates different cost escalation rates as well as makes it easier to compare the amount you can otherwise afford to spend for everything except the long-term-care insurance.

In the case of long-term-care insurance, it’s important to test different lengths of time for the need for such care as well as different ages-to-die. This is a tough decision for middle-income people because it becomes a trade between being insurance-poor and a gamble on whether you’ll need welfare to sustain the remaining retirement life.

Life insurance is the most difficult decision because there are so many different products that are sold by life insurance companies that go beyond pure insurance and get into investments. Once you get over the hurdle of understanding that most of the time the best thing to do is to separate investments from insurance and buy only term insurance, then the analysis is much easier. It’s also much easier to get competitive rates. (Caution, you want to use quotes only from highly rated insurance companies. You don’t want to outlive the solvency of your insurer.)

First you have to enter the costs. If it’s a lump sum, either reduce investments by the lump sum or make a specific entry for the cost in the special expenses part of the program. If it will be an annual cost that continues till retirement, reduce your annual savings by the annual costs of the insurance if you have not yet retired. The costs after retirement will be part of your normal expenses. However, if you are using the Simplified Financial Planner, you can choose to use the special expense entries and then not have to worry about subtracting the life insurance costs to determine what you otherwise could afford to spend. After entering the costs, you have to enter the amounts you would receive on death. For term insurance, this will be the face value of the policy.

If you are considering a more complex form of insurance (generally a mistake in my view) where you will have to guess at some kind of a growth rate, then you would enter an equation in the special income insurance section. In particular, you would enter a Future Value equation with some assumed real return and a period equal to your age to die less your current age. The real return is approximately the actual return minus inflation. So, for a 6% return and $100,000 investment for a policy on your life, a Microsoft Excel equation would read: =FV(6%-[Inflation],[Age to die]-[Current age],,[-100000]). In the Simplified Financial Planner, the equation would be =FV(6%-C71,A6-C59,,-100000).

After cycling through some ages to die, compare the amount you can afford to spend for all other expenses except life insurance. Your decision about how much insurance to buy will be a judgmental call. When you cycle the ages-to-die, you likely will see an advantage to life insurance for an early death and disadvantage for longevity. You’ll have to decide whether you think the cost is worth the survivor benefit, but at least you’ll have some numbers to compare, not just a salesperson’s word.

The Simplified Financial Planner is designed to help you with survivor benefit decisions. Fortunately, you do not have to do the kind of analyses described above much more than one time in your life. Once you have made a decision, it’s very easy to continue using the program throughout your life to determine how much you should be saving before you retire or how much you can afford to spend after you retire. The effort required to consider survivor benefits is very small compared with the consequences of making poor survivor benefit decisions. You should be able to arrive at some reasonable judgment with a couple of hours work. That time is but an infinitesimal fraction of the years you have ahead of you and potential misery of a surviving spouse. In fact, it is likely to take considerable less time than one trip to an auto dealer to investigate a new car purchase. Which do you think will have more influence on your future comfort?

To get a good estimate of how much you should save before retiring and how much you can spend after retiring, you should have already selected your survivor benefits. Most of the easy-to-use programs don’t let you enter key survivor needs or benefits, so you are easily misled into overly optimistic results. The Simplified Financial Planner does both: It helps determine the optimum survivor benefit alternatives at the same time you develop your plan to save before retirement or spend after retiring. The Dynamic Financial Planning Pro is more thorough, offers a wide range of scenarios, and has a more realistic way of representing a retiree’s behavior to changing market values. Nevertheless, the vast majority of people without complex financial situations are more likely to work with something that’s easier to use. Both of these programs are on www.analyzenow.com.

Decisions like these are so important, that it pays to take your analysis to a professional financial planner and discuss your results and other factors the planner may want you to consider. It always surprises me how people are willing to pay for professional medical help to get over a problem that lasts a relatively short period but are reluctant to seek professional help for something that will affect their outlook for the rest of their life. To get the most benefit from a professional planner, you should thoroughly test your alternatives with a computer planning program before the meeting. That way, your concerns will be sharply focused, and you will be able to question common mantras often used by planners to minimize the effort they invest while developing recommendations for clients.

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