I’m asked so often from retiring service members about whether or not to sign-up for the Survivor Benefit Program (SBP); I figure it’s time for me to put an answer down on paper.
If you are thinking I’m going to state 100% “yes” or 100% “no”, you’re fooling yourself. As in any financial product, there is no totally good or totally bad product. Everything’s a shade of gray. I have no bias for or against SBP. It’s your family, not mine. I will help you define the issues and that should drive you to a clear choice for you and your family.
First, the basics. SBP provides a survivor the benefit of 55% of your base amount potentially for life. For this article I will assume your base amount will be your entire retirement paycheck amount—you have a choice you know. You are allowed to select, with the approval of your spouse, a base amount of coverage that can start at $300 a month up to the full amount of your retirement check. Your premium is typically 6.5% of your base amount. Your premium could be less than 6.5% if you have service prior to 1990 and you select a base amount around or less than the threshold amount. Check with your SBP office for the current threshold amount--it’s a relatively small amount. And yes, as your base amount increases with cost of living adjustments (COLAs) each year so does your SBP premium since the premium is a percentage of your base amount.
So if your retirement check is $2500 a month and you cover the full amount under SBP, upon your death, your spouse gets $1375 a month for life with annual cost of living adjustments. Benefit payments are suspended upon remarriage and start again should the remarriage end. Those are the basics, now let’s define the issues.
The choice isn’t between SBP or life insurance. The choice is ‘SBP and life insurance’ versus ‘life insurance alone.’ You’re going to need life insurance regardless of SBP. Chances are 55% of your retirement pay is not close to your family’s current standard of living. If you are still working, you will be replacing two incomes, your job and military retired pay. Projecting into the future when you are “retired-retired”, as we say, you will be replacing income from military retired pay, a piece of Social Security, and possibly a part-time job. That means you will need life insurance to supplement the SBP payments. The extra life insurance will cover debts and/or provide an investment that can generate an additional income. Does your spouse earn a paycheck? If so, that probably minimizes the need for either SBP or some life insurance.
SBP is dirt simple; life insurance isn’t. It’s tough to put a price on simplicity but it is definitely valuable. When the military member dies, the survivor notifies the proper pay agent and the payments begin, that’s it. Payments keep rolling in every month and receive COLAs annually. The COLA adjustments will be extremely valuable when inflation is the double digits. An inflation rate of 10% means the costs of life doubles in 7 years. Without SBP, you have investments usually created from life insurance. How long will your investments last if your survivors need to withdraw larger and larger amounts to afford to live? The regular and consistent payments of SBP are a source of supreme comfort to a survivor. Life insurance is complex and requires projections that may or may not come true.
How much insurance do you need now..later? What about in 10, 15, 20 years? You buy more later, it will cost you. If you have to buy more later, will you even qualify based on the health check? Bad things happen as we age. What type of insurance best serves your needs? After you die, what becomes of the huge lump sum? Is your spouse ready and able to manage a huge portfolio and make it last for decades? Will you use an immediate annuity to create a lifetime income with the life insurance proceeds? Who can you trust to manage the money for your family after you’re gone? When inflation hits, your investment will have to be precisely managed to increase the return and allow for larger withdrawals or your family will run out of money early.
I’ll lower my base amount to decrease my premium. Sure, you can do this. However, it’s not about you and your premiums. You’re dead! It’s about your survivors and the amount you leave them. At some point, lowering the base amount to save on the premium makes the actual survivor benefit virtually worthless. A base amount of $500 gets the survivor $275 a month. Of value or not? Only you and your spouse know for sure. The benefit should drive the base amount decision, not the premium. Keep in mind that the premium comes out of your gross pay, pre-taxed, so the take-home pay is not impacted $1 for $1 due to the premium amount. The SBP premium reduces your tax burden so a 20% income tax rate is like getting SBP at a 20% premium discount.
Social Security may or may not be available. Social Security survivor benefits aren’t automatic for every survivor. A survivor with dependent children can collect benefits for the kids until they turn age 16. If there are no children, the survivor has to wait until age 60 to start survivor benefits. A survivor could start receiving benefits because of young children then stop receiving the payments once the children age out of the program. The survivor will go without benefits once the children age out of the program until the survivor turns 60. This hole in the Social Security coverage may cause a significant gap in your financial plan.
I earned that military retired pay! Without SBP, the military retired pay you risked your future for stops at death. This alone may cause some of you to get SBP just to ensure your sacrifice does not go for naught. Your spouse also had to pay for your military service. Lost career maybe, the stress, the worry, managing a household, taking care of kids alone, basically allowing you to keep your mind on the mission and not have to multi-task with things on the home front. There’s a lot to be said about the principal that the pay should continue because two people earned it.
How much life insurance do you need? Aw, the age old question. Generally, speaking, do you want coverage for only your debts, debts and short-term income needs or long-term income needs? There could be possible estate tax issues for some of you but that’s for another day.
* Debt only option. This option leaves no money for living, just paying debts. If you want your family to be debt free at your death, add up your debts to get a total amount for life insurance purposes. What debts? Credit cards and loans pop into mind but what about…the mortgage? Kids college funds? Money to move? Burial costs? How might this figure change over the years?
* Income for a short-term? Short-term might be $40,000 a year for three years. Just do the math.
* Long-term might be lifetime income. Suppose you want $40,000 per year with an annual cost of living adjustment into the unforeseeable future. Now things get cosmic. I oversimplify this but to provide a thumbnail guide, figure the annual income is 4% of a lump sum investment. A $40,000 annual income would require a $1,000,000 portfolio. If these amounts represent how much you need today, with a high inflation rate as is expected, you may need $2,000,000 in 7-10 years for the same buying power–if you don’t die until later. The tricky part is that this investment will need to last potentially a long, long time; many decades. It must be properly and carefully managed. Who you gonna trust? Another lifetime income option is to use the life insurance proceeds to purchase an “immediate annuity” from an insurance company. I used the Vanguard annuity calculator to determine a $1375 monthly lifetime income can be created by purchasing an immediate annuity with $470,000. It takes about $820,000 to generate a $3300 monthly income with an annuity. Got that much life insurance or other assets you are willing to plunk down on an annuity?
How long will you need life insurance? The default answer is until you have enough in other assets to live on. Then the life insurance is no longer needed, theoretically. How long will that be? How much do you have in assets now? What’s your game plan for reaching the magic amount? How’s that game plan working so far with the economy and the markets? What happens if you lose a job for a while? The last thing you want to happen is having your insurance run out and your investment game plan didn’t work out. Guess you’ll be working a while longer. How’s that health?
Life insurance is cheaper than SBP. That may be true…but not always. We started with an example of $2500 military retired pay creating a $1375 benefit check. That benefit is $16,500 a year in income. That amount of income would require an investment portfolio of at least $415,000 ($16,500 / 4%); IF managed properly of course. Or, from my example above, a $470,000 investment in an immediate annuity. You may be able to find $500,000 in life insurance for less than the cost of $163 a month in SBP premium ($2500 x 6.5%). It all depends on your age, health, type of insurance, and length of insurance coverage. What about generating $3300 a month ($40,000 yr)? Now you need a $1,000,000 portfolio. That monthly amount is from a $6000 a month retirement check or $390 a month in SBP. An SBP payment of $3300 a month to a survivor will grow to $7800 a month in 10 years if future inflation averages 9%. Will your investments allow an eventual $7800 mo/$93,600 yr withdrawal and not run out of money early? The SBP COLA adjustment is a significant value that must be figured in the premium–its value will be hugely appreciated by survivors in high inflationary times. This benefit is possible due to the heavy subsidies provided by the government for the SBP.
That’s quite a bit to chew on. You and your spouse need to do a little role playing to put yourselves in the right frame of mind. To set the stage, the retired military member is dead along with the salary from the current job and the military retired pay. How will the remaining family survive financially; now and in the future? The best case scenario is the retired military spouse dies after the family has built enough wealth to continue at full financial strength. Worse case is death with no or little family assets. Keep in mind that even the best plans to build assets and wealth can go astray and at the very least it takes decades to built real substantial wealth. Money may not buy happiness but it sure buys security.
