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Retirement & You

By Philip Kozloff, Kozloff Consulting, philipkozloff@mindspring.com

No discussion of retirement finance strategies can be complete without an exploration of the insurance arena. It is important to use insurance to enhance retirement financial health as an estate-management tool.

Conventional standards of familial responsibility dictate that dependent heirs need to be provided by their more well-off spouses, parents and other providers. There are a number of suitable devices for that ranging from straightforward gifts to arcane trusts. Some approaches have more tax consequences than others, and careful estate planning requires expert advice.

Life insurance (or “assurance”) is a wealth transfer mechanism. Strictly speaking, whatever financial good it does is for the beneficiary, not the premium payer. Life insurance converts a stream of current payments into a fixed payout amount upon the demise of the payer.

Cynically speaking, buying life insurance is betting against oneself or, more charitably, creating a hedge for your heirs. The payoff is a windfall if the payer meets his maker very “early”, a reasonably good investment if the payer dies well ahead of mortality tables expectations, and certainly a poor investment thereafter, the more usual outcome.

Life insurance works best for young households even if it compares unfavourably to other investment media. It is a safety net in the event of the early loss of the principal wage earner. Besides the emotional devastation suffered by a family brought on by premature death, its financial well-being can be stressed severely. The loss of a major source of household income will force a family to find other financial resources to meet its dreams and aspirations.

Few options meet these needs as well as life insurance policies. Fortunately, actuarial science makes such coverage relatively inexpensive for younger families. But better yet, companies frequently provide basic life insurance for its employees as part of their benefits package. Additional levels are frequently offered at reasonable rates.

Term life insurance may meet the needs of a younger family. The premiums tend to be more affordable, because the policy is only in effect for a stipulated number of years. In other words, you have to die before the term is up for the beneficiaries to get the pay off. Term insurance is best for bridging the financial mortality risk. If a continuation of life insurance is required after the expiration of the term, you are in almost certainly for a premium increase.

But as the family ages and wealth is accumulated, life insurance’s role changes and needs to be judged in financial terms. It may even no longer be needed. If financial assets have been accumulated to the extent that there are reserves to take care of family members’ needs, you now have the luxury of viewing life insurance as a form of investment.

Disregard the fact that the payer and the payee are bound to be different people: it is a single estate. The effects of having a specifically named beneficiary, as would be the case in an insurance policy, can be replicated with a well-crafted will.

Current payments of insurance policy premiums are subtractions from the payer’s present wealth. Ask yourself, “at what point in time does the future value of the cumulative payment stream, enhanced by the expected investment returns, equal the contractual amount of payout?” If that crossover point is a long time in the future, particularly in view of the foreseeable mortality of the policyholder, then it may not be such an attractive strategy.

Or pick a realistic lifetime horizon for the holder and compute the investment-basis internal rate of return for the eventual payout against the stream of premium payments. If that rate of return compares poorly (it usually does) to your expected portfolio rates of return, then the life insurance policy is an inferior investment medium.

It is not necessarily an act of selfishness to seemingly put the preservation of your living estate ahead of the interests of your inheritors. Don’t forget, passing along a nice financial portfolio to your loved ones should serve them well. Although there may be some tax-management advantages to using trusts and life insurances, care should be taken not to be over-awed by these purported benefits.

Don’t be distracted by the “mutuality” aspect of some life insurers. Such companies combine the benefits of being both risk-underwriter and client at the same time. The apparent conflict of interest confuses analysis of the merits of each position, if one attempts a disaggregated view.

Efforts by various insurers to “demutualise”, to reconstitute themselves as conventional stock companies, may resolve this schizophrenia. Then you will be able to evaluate a life insurance policy and the shares of an insurance company, each on their own merits.

Except under the most benign national health delivery systems, medical insurance is a real hot-button for retired folks. Ageing brings on increased medical expense. Some costs are relatively modest and routine, such as prescription drugs to manage geriatric maladies. These are easily absorbed in the cash flow estate.

Medical science has advanced magnificently in the last few decades, but frequently with enormous price tags. Some sudden, unexpected and life-saving interventions can be financially overwhelming. Even if the patient survives, the financial portfolio might be devastated with severe fallout consequences for all family members.

National social security safety nets cover some costs. But we may want to have more options, including private medical care. Health insurance can be purchased, but it is usually pricey. Many employers provide medical insurance that continues with the employee and his family into retirement.

For some this “fringe benefit” might be the most valuable part of their retirement package and a real incentive to stay with an employer until qualified (but no longer) for formal retirement. This can be an important element in the retirement decision. Post retirement medical benefits usually are fixed regardless of when one retires or income level. Therefore, this is one feature of your retirement package that won’t get better as you continue to slog it out in the trenches.

However, it is best to review exactly what your post-retirement health benefits are. Not all coverage continues: dental, psychiatric and screening services might not be included. Get your teeth fixed and your head straight before you retire. Retired employee contributions to the company-sponsored plan and co-payment requirements may increase. But it is almost certainly better than available commercial health insurance.

These two areas are closest to home: life and health. But insurance is an important wealth-management tool for dealing with other risks. Those will be discussed in a future column.

Profit & Loss

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