Some questions arose after last week's discussion of Enrst & Young's analysis of different pension strategies. The core of a handful or so of these issues focused on buying time and investing the difference scenario, basically the hypothetical couple continued to pay insurance premiums to the pension? We do not know the answer to that question, but there were some who asked this question and noted that it would be a bad idea to keep insurance in retirement. Catalog
I think the proposal to keep life insurance in retirement is a bad idea to be a very "privileged" point of view. I do not mean this in connection with race or social class, but rather in the sense that things have simply worked well. It's kind of like the middle class relative we all who were lucky and never managed to experience much economic downturn in their lives who like to speak out when there is a rumor of a common familiar misfortune. "It seems that they are not good at managing their money," these people often suggest — while knowing very little about the special circumstances of the adversely affected individual.
I would like to address this idea directly today and highlight a significant weakness in the BTID philosophy because it is not talked about closely enough.
Things do not always go as planned
The idea of buying life insurance instead of full or universal life insurance and investing the difference is certainly not new. It is a philosophical song that dates my existence and many of you others. So if it had decades to go, why do we hear that economic security among Americans is getting worse instead of better? Here is a graph from Pew that traces the average wealth of Americans from 1983 to 2016:
I'm not saying that BTID does not work. What I'm saying is that people either largely ignore it, or can not make it work for them. If this is not true, the graph above should be similar to this:
This is a chart of an investment of $ 1,000 per year in the Vanguard S&P 500 Index Fund (VFINX) from 1985 to 2016 – from 1983 was not an option). The growth patterns are obviously different from what we see shows average wealth among Americans, according to Pew.
The problem with the idea of BTID and losing life insurance coverage at retirement is that it adopts "perfect world scenarios" … it makes no provision for your child who needs to go to rehab when they are 21 to cost you $ 100,000, the local health department that determined your business is insignificant and shuts you off for 6 months or the fact that most of your retirement savings are included in a qualified plan and leave your heirs (non-spouse) not with the balance but with the balance minus income taxes.
It also does not take into account that there may be a need for insurance after retirement. In my experience, even people who obviously have no need for life insurance often need a certain life insurance in retirement. And they have long since lost the term coverage or survived it. They are now in the late 60s to early 70s. Now they are faced with buying a small permanent cover that is quite expensive or difficult to obtain because they now have a thick bundle of records documenting their demise.
Responding to the need is too late
The costs associated with life insurance if you wait and then decide you need it are significant, especially for those who have a normal middle class income. Here is an example that Brantley used in a previous blog post to illustrate this point.
And do people really reach retirement age and then decide that they need life insurance? Yep, they sure do. Here is a blog post from several years ago that looks at third party universal life insurance sales data. Important things from that post are that people 65 years and older make up a large proportion of UL buyers, and they make up an even larger proportion of premium payers – this is because it gets more expensive as you age.
A serious weakness in the BTID strategy is that you do not know that you will need life insurance in retirement until you actually retire. The strategy leaves no readiness to plan ahead. It is hoped that stocks and bonds will provide ample returns to capitalize on you in such a way as to "self-assure you". If this does not happen, you will have to spend a lot of money to fix it.
Alternatively, if some of your pension planning funds go to permanent life insurance, you will theoretically lose some of the accumulation money that you would otherwise achieve by investing it. But … and here's the key … you can easily find out exactly what the "loss" is from the beginning – and it's not as much as you might think.
On the other hand, if you go the BTID route and stop missing the mark, you have no idea what your losses will be from having to liquidate assets and buy life insurance at a time when it is significantly more expensive. The purpose of planning is to prepare you for unforeseen circumstances and to protect your interests from their negative consequences. BTID is more wing-and-a-prayer than it is a plan because it offers little or no guarantee — or even reasonably high probability — that it can protect you from the financial setbacks of less-than-perfect life evolving.