(Thanks again to Tomcat98 for backing up my research with impressive actuarial data!)
This “simple little SBP summary” mutated into a two-part description. Today we’ll cover SBP for active-duty retirees and in the next post we’ll cover the Reserve Component SBP.
The SBP will cost you up to 6.5% of your pension, so it’s a significant effect on your retirement budget and on the amount of savings needed to reach financial independence. The SBP decision has to analyze (1) whether it’s necessary and (2) what level of support to provide for your survivors.
This post will only give a broad overview of the SBP and its requirements. The program started in 1972 and its eligibility criteria are now full of caveats, special situations, and unusual circumstances. If your specific question isn’t covered here then you (and your survivors) may still be legally eligible to buy the coverage. Start your research with the links in this post and then contact the Defense Finance and Accounting Service (DFAS) to discuss the details of your situation. Even after talking to DFAS you may wish to review the SBP legislation with a lawyer to determine whether your eligibility has been affected by recent court rulings.
The SBP is a one-time decision that has to be made at retirement, or within a year of a change in your situation (like remarriage or parenthood). If you retire with a spouse then it’s not even your decision! By law, your spouse and children are automatically enrolled at full coverage (which costs 6.5% of your pension) unless your spouse elects a lower amount or declines coverage. It’s their choice.
If you buy SBP coverage and later change your mind, then during your third year of retirement you can cancel your coverage (no refunds). After that you generally can’t change your decision unless your situation changes, usually through divorce or spouse’s death. If you’re married or a parent at retirement and they elected not to have you buy SBP coverage then that decision can’t be changed either, even if you later remarry or have more kids. The only widespread exception would be if Congress passes a law to allow a “second chance” of open enrollment. It’s happened just four times in the last 39 years.
The SBP is generally only available to veterans who have retired from active duty or from the Reserves/National Guard. It’s a retirement program, so it’s not for veterans who have separated before retirement eligibility. SBP offers special provisions for Reserve/National Guard who have filed for retirement but are not yet drawing their pension, and we’ll cover those in the next post.
Your SBP premium buys a life insurance policy that’s paid as a survivor’s annuity with a cost-of-living adjustment (COLA). While you’re alive, the premiums are deducted from your pension. The cost of insuring your spouse is up to 6.5% of your pension (before taxes) and children’s premiums are a fraction of a percent (based on their ages). When you die, the “full coverage” option pays 55% of your pension to your survivor(s). Lower coverage can be elected by your spouse (which means a lower monthly premium). Once you reach age 70 and have made 360 monthly premium payments, the SBP coverage is considered “paid up” and no further premiums are deducted.
The SBP is the world’s cheapest survivor COLA annuity, and it’s backed by federal law. Congress pays about 40% of the program costs and the rest is covered by the SBP premiums. If your spouse wants the coverage, or if you want to insure someone else who qualifies as an “insurable interest”, then this is the best combination of affordable and trustworthy insurance. No commercial insurance policy can compete. However your first question should still be whether you want to buy this insurance, and then your second question is how much. Only about 75% of active duty retirees enroll in the SBP, although it’s much more likely that women will outlive their male spouses.
Regardless of the cost, do your survivors really need the SBP? If you retire while you’re unmarried and childless then you probably don’t need the SBP– you have no survivors. (Divorcees are a different situation, and you may decide to elect SBP as part of a divorce decree.) If you later get married or become a parent then you could start SBP coverage within a year of that event. You could also elect SBP coverage for someone with an “insurable interest”, such as a close relative or a business partner.
Instead of the SBP, you could try to self-insure your survivors. If you plan to leave your spouse enough assets after your death, or if your spouse expects to receive their own pension benefits, then they may elect to decline SBP. When my spouse and I both retired from the military, we both declined each other’s SBP. (She doesn’t carry comprehensive auto insurance on the beat-up old clunker in our garage, either, and she says it costs a lot less to operate & repair.) If I die before her Reserve pension starts, my pension stops but she’ll still have enough assets to bridge the gap.
If you or your spouse still aren’t sure whether to buy SBP coverage, then analyze the benefits to assess their value. Although “full coverage” provides 55% of your pension to your surviving spouse and minor children, beneficiaries can elect to receive less than full coverage. The premium is paid from your pension before taxes, so SBP cost is even lower than comparable life insurance or survivor annuities bought with after-tax dollars. Finally, SBP payments receive the same COLA as military pensions. (Which admittedly has been zero lately, but COLA annuities from civilian insurers are much more expensive.) There does not appear to be a survivor’s COLA annuity that can even compete for the same price as the SBP. If there is one, regulators would be skeptical of the company’s ability to pay the claims.
Is SBP worth the expense? Well, how much would your spouse need if you died? Is it worth giving up 6.5% spending today for assurance that they’ll have at least 55% of your income after you’re gone?
The first step is to forecast your survivor’s budget. Some expenses may not change (the mortgage or the rent) while others will go down (not needing a second car, buying fewer groceries). Your activities and hobbies that you don’t share with your spouse would also drop out of the budget. Include Social Security in your planning, because your spouse will be able to collect it on your earnings record or on their own.
Another approach would be to insure your survivors against large expenses such as a mortgage. Maybe your survivor’s budget doesn’t need your pension if they don’t have to pay the mortgage. Instead of paying 30+ years of SBP premiums, you could accelerate the payoff of the mortgage (before you retire) or buy term insurance (or, um, mortgage insurance) during retirement until the mortgage is paid off.
Once you forecast your survivor’s spending then you can decide how much of your pension they really need. Instead of collecting 55% of your pension, your survivors might only need 40% or even 20%. Maybe they just need a large lump sum to pay off a mortgage or to bridge their expenses until they can collect Social Security. Lower SBP coverage would give you and your spouse more pension money now to enjoy together during your retirement. Again, it’s the spouse’s choice.
Every major financial decision has both an analytical part and an emotional part. When you do the math you may not be able to quantify all the factors, and probabilities are notorious for failing to go your way when you most “need” them to. The issue with the emotional part of the decision is that even if the numbers do add up, any emotional conflict can cause an investor to fail to follow through or to “sell out” at the worst possible time. While your analysis could conclude that the SBP numbers don’t add up for your marital/parenting situation, it still might not “feel” like the right decision.
So run the numbers, but consider your spouse’s feelings. Even when it’s not economically cost-effective, insurance brings confidence during disastrous situations. Your spouse could elect for the full amount and pay 6.5% of your pension to ensure everyone’s peace of mind. It’s their choice anyway.
It’s like the credit-card commercial:
Doing the math– time-consuming but reassuring.
Domestic harmony– priceless.
Two other aspects of SBP apply to Reserve and National Guard members. We’ll cover those in the next post.
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