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Monday, November 12, 2007

SBP Versus Life Insurance

One of the first ten questions originally posted on this site was how much life insurance you would have to purchase to equal the benefit of a fully funded Survivor Benefit Plan. I called USAA to ask them that question. Instead of working through the numbers with me the representative recommended that I take at least a portion of the plan. He said that the SBP had three significant advantages over most other options.

1. The plan is backed by the strength of the U. S. Government. It is the lowest risk of any insurer.
2. The costs are low and fixed.
3. The benefits are adjusted to inflation.

These answers have merit, but do not answer the specific question. It is difficult to answer because answer depends on how long you will live and how long your spouse will live. In addition, the benefit ends when your spouses remarries before they turn 55. A life insurance benefit is easier to quantify and sets a fixed benefit.

So to attack the question we have to work through a couple of examples.

1. Colonel Jones is 64 and is married to Mrs. Jones, who is 60. Both are in good health and are retired. Colonel Jones retired from the Air Force 10 years ago and elected to take the a $1,210 SBP allowance. The premium for the policy is $143 and adjusts upward annually with the cost of living adjustments.

2. TSgt Bills is 45 and is married to Mrs. Bills who is 43 and they have two children. As with the Jones, they are in good health, but the future Mr. Bills is planning on taking a job after retiring from the Air Force after 24 years of service. They also plan on taking the $1,210 SBP allowance. The premium is the same.

The cost for each family is different. One way to calculate the cost would be to estimate the life expectancy of the retirees and the spouses and determine how much insurance coverage is required to make up the difference. Another way would be to calculate the benefit required to meet the spouses’ needs only from the present, the “worst case scenario.” If the retiree were to die today, the spouse would collect benefits for the longest period of time for no premium! The cost would be 0! If however the retiree outlives the spouse or the two die within a few months of each other than the premium would be “wasted.”

With these two situations defined, let’s compare the cost of insurance that would be required to supply the SBP benefit for the life of the spouses.

1. Mrs. Jones is 60. Her life expectancy is 23 years (http://www.ssa.gov/OACT/STATS/table4c6.html). Her benefit is currently $1,210 each month. Without adjusting for inflation, Mrs. Jones would need a nest egg of just over $250,000 to continue the monthly withdrawals. (Since SBP payments are guaranteed by the United States, this calculation is based on money saved in a passbook savings account earning a paltry 2.5%. While it is likely that you could exceed this rate, you are comparing it to a RISK FREE source of income.)

Col Jones can purchase a 15 year $250,000 term-life policy for about $1,600 per year. His cost for the SBP would be $1,716. The difference is vitually a wash.

2. The cost for Mrs. Bill’s benefit is more complex. It is important to remember that her benefit would end if she remarried before she turned 55. To compute the benefit the same way as we did Mrs. Jones, her life expectancy is 38 years. Her required nest egg is more than $380,000.

TSgt Bills could purchase a 30 year $400,000 term-life insurance policy for about $850 per year. He would need to purchase another, more expensive policy later on to cover his anticipated life span.

Neither of these figures are corrected for inflation. Mrs. Bill must also consider the needs of her children. Without TSgt Bill’s post-retirement income she would probably not be able to maintain her existing standard of living without going back to work or purchasing additional life insurance.

The bottom line is that military retirees must consider if they could secure enough life insurance to replace their stream of income if they declined the SBP.

As for me, I will elect to take the full SBP benefit.

6 comments:

Col S said...

Did you price compare insurance. I'm retiring at age 45 and a $1M, 25 year term policy will cost me about 100/month (no increase in premiums over the 25 years). For $850 a year, I can get roughly $750,000 -- big difference than $400K. If I got a policy equal to my SBP payment, I could get $1.5M.

Also, there are so many additional factors to consider. We will move and rack up a sizeable mortgage -- the $1M will enable my spouse to pay off the mortgage early and save $$$ in interest (yes, there's the reduced tax writeoff, but if I die, she'll be in a low tax bracket depending on how much unearned income she withdraws).

If I survive to 70, then I'll have earned another 15-20 years of income (and a 401K in addition to the growth in our Roths) from a second job and my wife can then claim full social security. Yes, inflation will erode the value to 50% if inflation rises at an annual rate of 3%, but I'm not worried if I'm alive.

Seems SBP is only a better deal if you are an older retiree and have a (relatively) significant age difference with your spouse..or you can't qualify for a decent rate term life insurance policy.

ArindamSenIndies said...

Yes, SBP is probably an option when you can't qualify for a term life product. But if you're shopping for life insurance, don't fall prey to those no-exam life policies.

Always remember that it's easy to get over an under-writing process, but it's equally tough when your claim gets rejected later on. Your insurer may call you for a health check-up, or may wish to go through your past health records at any point of time. So, don't always run after an easy life insurance offer.

webxpress8 said...

There are many companies in the US that offers Group Health Insurance that is highly competitive. I agree that this is very important to us today.

Peter said...

There are various types of term life insurance quote, they all have some common attributes. You pay an insurance company what are called premiums. At your death, the life insurance company pays an amount to the people you named in your policy, called beneficiaries. Also it's interesting that if you named a beneficiary(ies) they'd receive the insurance amount free of income tax.

Blue b said...

Some times these types of questions are asked frequently and some may want to explore the low cost term life insurance through such process.

Blue b said...

Some times these types of questions are asked frequently and some may want to explore the low cost term life insurance through such process.