The CSRS Survivor Annuity vs. Life Insurance: The Dilemma
The Conversation Starts
The CSRS survivor annuity option is part of every federal retirement annuity. This option is not free, but your spouse has to give consent if you decide not to take it.
It can reduce your annuity up to 10% if your spouse is five or less years younger than you.
If your spouse dies before you, you won’t be refunded the reductions you’ve paid. However, your annuity from that point on will be bumped up to the unreduced amount.
The survivor annuity has no death benefit, so when your spouse dies the money flow stops.
The Survivor Annuity: What Does it Pay?
The maximum survivor benefit is 55% of your full annuity.
Your spouse can select a benefit amount from 55% down to no benefit at all.
If no benefit amount is taken, your spouse cannot keep any Federal Employee Health Benefit (FEHB) coverage after you die.
Life Insurance as a Replacement for the Survivor Annuity
Most people who choose a reduced survivor annuity, or no survivor annuity at all, purchase life insurance as a replacement to protect their spouse.
Benefits of Life Insurance
- Life insurance is a tax-free death benefit.
- Properly invested and managed, it can provide a sufficient stream of income for your spouse.
- When your spouse dies, whatever amount remains can be given to the beneficiary of your choosing.
The Negatives of Choosing Life Insurance over Survivor Annuity
- There are no COLA increases with life insurance. If you purchased a $50,000 life insurance policy 20 years ago and then died tomorrow, your beneficiary would still get $50,000. (Both your annuity and the survivor annuity include COLA increases.)
- Purchasing life insurance later in life can be expensive.
- There is always the danger of running out of money.
Term Life Insurance
For non-smoking men buying life insurance at 60 with a 20-year term and a $500,000 death benefit, premiums run from $5,150 to $6,034 per year. A $1,000,000 death benefit is $10,340 to $11,278 per year.
At 65, the premiums jump to between $9,470 and $12,160 per year for a $500,000 death benefit and $18,765 and $23,760 per year for a $1,000,000 death benefit.
Worried a 20-year term is not long enough? Consider whole life insurance.
At 60, a $500,000 policy costs between $7,885 and $11,113 per year, and a $1,000,000 policy costs between $15,280 and $21,550 per year.
At 65, the $500,000 death benefit costs between $11,143 and $26,365 per year, and the $1,000,000 benefit costs between $21,305 and $29,090 per year.
To Forgo the Survivor Annuity or Not
The problem you face when making this decision is that you don’t know how long you or your spouse will live. The longer the period that your spouse collects the survivor annuity, the more profitable that choice becomes.
Example 1A – No Survivor Annuity
In this first example we are going to give you a $100,000 unreduced retirement annuity. Nice, right?
You’ll live 20 years into retirement and your spouse will live for another 10 years after you die. Sorry. It’s just an example.
Let’s say that your spouse consents to forgo the survivor annuity. With an average COLA of 2.5% a year, your annuity grows to $163,862 at the end of your life and you collect a total of $2,618,327 over the course of your retirement.
Example 1B – With the Survivor Annuity
On the other hand, let’s say that you take the maximum survivor annuity option and your annuity is reduced to $90,000.
With the same COLA increases as before (2.5%), your reduced annuity grows to $147,475 in year 20 and your total payout is $2,356,495. That’s $261,832 less than the full annuity…but before taxes.
Now let’s add up the survivor annuity for 10 years.
The survivor annuity is 55% of your full annuity at the time of your death, $90,124. The survivor annuity grows to $115,366 in year 10 and the total survivor annuity payout is $1,034,935.
In this scenario, the total payout is $3,391,430. That is $773,103 in favor of taking the maximum survivor annuity.
Example 1C – Purchasing Life Insurance
If you made one change to the first scenario and purchased a 20-year term policy at age 60 with a $1,000,000 death benefit, the difference is $20,097 (after subtracting $206,800 in premiums paid) in favor of not taking the survivor annuity.
This difference could be higher or lower depending on investment gain, loss or income generated from the life insurance proceeds.
In our second example, you die immediately upon retirement and your spouse lives another 20 years.
Before any COLA increase, the survivor annuity is $55,000 ($100,000 x 55%).
The survivor annuity grows to $90,124 in year 20 and has a total payout of $1,440,080. A $1,000,000 life insurance policy would need a 5.70 % average rate of return to equal that survivor annuity payout.
For a third example, let’s say that you and your spouse both die 20 years into your retirement. Since you both die at the same time, your spouse didn’t collect anything from the survivor benefit you selected.
If you took the maximum survivor annuity, your total benefits were reduced by $261,833. In addition, because you didn’t purchase the life insurance you lost a $1,000,000 death benefit to give to your children or grandchildren.
Now, let’s consider what happens if you live 20 years after you retire, but your spouse only lives 10.
If you took the survivor annuity option, your reduced annuity would become unreduced in year 11 (after the death of your spouse).
If you didn’t take the survivor annuity, but chose a life insurance policy instead, you could consider stopping the premium payments on the life insurance at that time.
You could also continue making the premiums, which would leave your updated beneficiaries with a tax-free windfall of $1,000,000 after your death.
There are countless scenarios that can be looked at to evaluate what choices would maximize your CSRS benefits, and there are many options in between taking the maximum survivor annuity or taking a $1,000,000 death benefit that we haven’t discussed here.
For a better picture, you have to consider a variety of factors, such as you and your spouse’s ages, health, family situations, and complete financial circumstances to determine what is truly your best option.
For over 30 years, federal employee retirement planning has been a key focus of Medallion Financial Group. We recognize that FERS retirement benefits have extra layers of complexity, such as the Thrift Savings Plan (TSP), 401K, Pension plan, FEGLI and more. It’s easy to get lost in a sea of bad advice when so few people understand the basics. We help with the basics and beyond to enable our clients to get the education and advice they need to retire with confidence.
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