Why You Should Strongly Consider Not Participating in the Survivor Benefit Plan
My first book, Military In Transition’s Guide to the Survivor Benefit Plan, is available on Amazon.
Previously, I wrote about the Military Survivor Benefit Plan (SBP). That article’s primary purpose was to take the ambiguous information that resides on the DFAS website & consolidate it into an organized manner which you can clearly understand. However, that article did not attempt to impose an opinion one way or another as to whether you should participate in SBP. This article will, in fact, do just that.
In order to decide whether you should pay into SBP, you need to have the answers to these questions:
- What other options would I look at, if I wanted to put my money somewhere besides the Survivor Benefit Plan?
- If I put the money elsewhere, would I be better off?
Let’s take this one step at a time.
You have a couple of options. First, you can invest in SBP. Second, you can take the money you would have invested in SBP, and put it somewhere else, such as an investment or insurance policy. Let’s take a look at some of the most likely options:
- Survivor Benefit Plan. It’s simple, it’s easily calculated as a percentage of your pension, and it’s automatic. Most beneficial, the payout is a guaranteed number. However, it may not be the most cost-efficient place to put your money.
- Instead of investing your 6.5% (or so) monthly premium into SBP, you may be able to put this money to work by simply adding it to your investments. However, if the servicemember/retiree dies before this money has a chance to work, their spouse has a very good chance of outliving the remaining money. Not a great idea.
- You could buy a deferred annuity. However, the same situation applies…you might not have put enough money into this product to get any real benefit. Also, I’m not an insurance agent, so I’m not going to compare annuity products, which I generally don’t recommend in most situations.
- Term life insurance policy. This is probably the simplest comparison to make. Your $65 per $550 in payout (what the surviving spouse would receive for every $1,000 in pension income that the Survivor Benefit Plan covers) can be compared to the premium on a term policy. The lump sum payout can then be used to generate an income stream similar to SBP. You just have to ensure you buy enough life insurance to cover your income needs.
Let’s compare SBP to a term life insurance policy.
How do you compare the Survivor Benefit Plan to term life insurance?
Good question. This article does a more in-depth comparison of life insurance and the Survivor Benefit Plan. But we’ll show some highlights here so you can see some times when it makes sense to skip SBP in favor of a term life insurance policy. We’ll spell out a couple of assumptions below:
- USAA provides an online quote tool for term life insurance. Although you may be able to shop for cheaper rates elsewhere, there are underwriting limitations that may alter the actual rate. For this situation, we will use USAA’s quote system and alter a couple of the factors (age, health, military status, sex) to come up with several scenarios.
- A term life insurance policy generates a lump sum payment. Ric Edelman uses a rule of thumb for generating income requirements: take the annual income you want, double it & add a zero. This would indicate a 5% withdrawal rate. Let’s go a little more conservatively and assume that our target insurance payout would replicate the SBP payment with a 4% withdrawal rate. The financial services industry generally considers 4% withdrawal to be sustainable over the long term.
- SBP premiums are pre-tax, insurance policy payments are after-tax, so we’ll account for that.
- We will not calculate state taxes in this. Depending on the state you’re in, SBP payouts may or may not be taxable.
- We will assume that SBP payouts will be subject to federal tax. The insurance payout itself is not taxable, but earnings are.
- Assume SBP payments are at the federal maximum-6.5%. This means SBP premium could be lower depending on your personal circumstances.
- Assume the 25% tax bracket.
We know the basic calculation: Up to 6.5% for each $1,000 in pension. Upon death, beneficiaries are eligible for up to 55% (in this case, $550) of the previous monthly income. For this situation, we’ll use the SBP I calculated when I examined how retirement pay works in a previous article, rounded down to $4,000 per month (my pension). That means I’d pay $260 per month in retirement for up to 30 years (after which my SBP would be paid in full), in exchange for my wife receiving $2,200 in monthly income for life when I croak. Let’s go insurance shopping and see what $260 per month gets us.
First, before we figure out what $260 per month gets us, we need to figure out what the insurable need is, and the tax impact on that $260 per month (which is pre-tax money for SBP). Turns out that in the 25% tax bracket, our $260 per month is actually only $195 after taxes. That means we have $195 to work with. The insurable need is the amount of money that generates the $2,200 in monthly income, or is $26,400 per year.
At a 4% withdrawal rate, I’d need $660,000 in life insurance to ensure that my wife receives $26,400 per year (not adjusted for inflation). Turns out that I could buy a 30-year level term (meaning premiums don’t go up for 30 years) $1.5 million life insurance policy for $156.65. This assumes that I purchase the policy now, while I’m on active duty. If I adjust 1 year (as if I retired 1 year ago, and am 1 year older), the premium goes up to $171.65. A woman in similar health as me would see premiums of $127.90 (active) and $137.90 (retired) respectively. A couple things here:
- No major history of medical illnesses (raises rates)
- No tobacco use in the previous 12 months (raises rates)
- I’m a male (females get lower rates as you can see)
- I used age 40 for the active duty quote and 41 for the retired quote
- I don’t participate in risky or hazardous activities, and I’m not deploying in the near future
- I live in Florida
Now that we have the assumptions out of the way, let’s see what the $1.5 million policy gets us. If you use the 4% withdrawal rate, that means $60,000 in income for my wife. That is more than twice the income she would have received under the Survivor Benefit Plan. Also, she’s got $1.5 million in cash, which gives her a lot more financial flexibility. Finally, the payout number isn’t adjusted for inflation, while the SBP payout is annually adjusted for inflation. However, it would take quite some time for the inflation-adjusted SBP payout to reach the $60,000 in income that the insurance earnings would provide.
There are some caveats, and you should do your own research to make sure you understand the choices.
The spouse has to grant permission to forego the Survivor Benefit Plan. What’s this mean? It means servicemembers can’t unilaterally make this decision without having discussed this in depth. Be prepared for the inevitable questions like, “What do you mean I have to give up my right to part of your pension when you die?” Make sure that your research and eventual decision are done with full disclosure & cooperation on both sides.
Don’t rely on online insurance quotes—go through the underwriting process before you compare an insurance policy to the Survivor Benefit Plan. You can find plenty of insurance companies with online quote tools (like I did on USAA). However, you will not know the price of an insurance policy (aside from SGLI or VGLI) without going through the underwriting process. You may find that during the underwriting process, the insurance company will analyze your health, medical history, location, habits, and other factors in much more depth than during your initial quote. Any number of these factors may cause you to receive a much higher quote, put you in a different insurance class or in some cases, become ineligible for coverage due to items that were found during the underwriting process.
Get multiple quotes, and compare apples to apples. Just like shopping for a major purchase, you’re not going to want to take the first quote you see. You should find three different policies, from reputable insurers, so that you have reliable information. Here are some of the things you should look at from an insurance company:
Longest possible term policy period. Generally, this would be 30 years. For a military retiree, a 30 year policy gets you to your late 60s or 70s, by which you shouldn’t have an insurable need. You should be financially secure so that your remaining assets will be more than enough to cover your family’s expenses, especially if you’re only caring for your spouse. If you are concerned about outliving your policy you can buy a return on premium life insurance policy. But the hope is you will reach a point of financial security that you won’t need any life insurance.
Financial standing. You want an insurance policy from a company who can afford to pay out when you die. That’s why you buy an insurance policy. So, how do you find out a company’s financial standing? You can research it yourself, or just shop around the names of companies that you are familiar with…however, you probably won’t do yourself justice if you don’t know what you’re doing. You can either talk to an insurance agent (who will get a commission for selling you the policy, and who may have a conflict of interest in giving you advice), or you can talk with a fee-only financial planner. A fee-only financial planner, who doesn’t get a commission for referring your business, can help you analyze your insurance needs, then work with trusted insurance professionals to make sure you get quotes from reputable companies.
Similar terms. Keep an eye on riders (additions to a policy may slightly change the terms, which usually affect the premium or benefits). To the maximum extent possible, you should try to make sure you’re comparing apples to apples. Again, a fee-only financial planner can help you work with insurance companies to make sure you’re making the right comparisons.
You might pay more for certain things. If you like to scuba dive right after sky diving, or you smoke 3 packs of Lucky Strikes every day, you might pay more for your life insurance than the person who jogs 40 miles per week. Seriously, life insurance companies look risk factors similar to the items previously discussed. You can’t do much to change your sex or family history, but you can stop bad habits, lose weight, and some of the other activity-based risk factors. You should seriously consider losing that weight, or quitting smoking.
This is one aspect of your financial planning. You shouldn’t make a decision one way or another, then ‘set it and forget it.’ You should take some time to look at your entire tax life, whether it’s insurance, investments, cash flow, retirement planning, college education, tax planning, or any of the other ways in which money impacts your life. If you don’t like what you see, talk with the good folks at Military OneSource or your local installation. If you feel that your concerns have graduated above what you think those folks can handle, then try to find a fee-only financial planner in your local area whom people know, like, and trust. Working with the right financial professional will ensure that you’re on track to address your financial goals.
Recognize this Survivor Benefit Plan article is a bit longer than my normal posts, but I hope you appreciate it. The decision to choose the Survivor Benefit Plan or to choose an alternative should not be taken lightly. As my articles, and my ebook indicate, each family’s situation is quite different. If you don’t feel as though you’ve found the right answer, I have written some case studies in my ebook that may help you conceptualize the Survivor Benefit Plan decision for your particular situation. Please feel free to order the book Military In Transition’s Guide to the Survivor Benefit Plan.
As always, this blog serves to answer your questions and address concerns. If you like this blog, please forward it on to other people who may benefit.