Over the years, many clients may have obtained million-dollar life insurance policies to help address survivor needs. Although a million-dollar policy might have sufficed to provide that needed survivor benefit 10 years ago, or even eight years ago, some of today’s clients may need policies with face values that are twice that amount.
Why the difference, when many aspects of our economy seem to be improving? And what’s a good entry point for the conversation with clients?
Let’s start with the evolvement in taxes, which is a great reason to conduct a beneficiary review. When Congress changes tax laws, the American people take notice. The federal changes wrought by the American Taxpayer Relief Act (ATRA) earlier this year are a compelling reason to talk with clients, many of whom may need to add coverage, as mentioned previously. In some cases, the common threshold of $1 million of life insurance may need to be doubled, or nearly so, if clients are to attain their financial goals.
Survivor income is a universal issue for clients. ATRA has removed the “furlough” from the two percentage point reduction in payroll taxes that had been in effect during 2011 and 2012. In addition, some clients are affected by the higher income surtax in the Patient Protection and Affordable Care Act, as well as by the increased personal income tax rates. Keep in mind, survivor income takes into account what would have been earned by way of dividends and sale of capital assets after the capital gains tax; both of these may well have been impacted by the new legislation in terms of higher taxation. Adding it all up, the time is right to take a serious survey of the adequacy of existing coverage for survivor income purposes.
Low Inflation and Low Interest Rates Compound the Issue
Another consideration for survivor income is the prospect of higher inflation rates in the future. Did you know that the average 2012 inflation rate of 2.1 percent is lower than the inflation rate that we experienced in 60 of the previous 98 years? The inflation rate in the first quarter of 2013 was lower than it was in 2012. Does this mean that future inflation rates will be higher?
Nothing is certain, but history would point us in that direction. For a more current perspective, 22 of the past 50 years have seen an average inflation rate of 3.5 percent or greater. How many of us are using a 3 percent inflation rate to determine income needs? Is it conservative enough when planning for a survivor who doesn’t want to run out of money?
Last, but not least, the historically low interest rate environment in which we live provides an unprecedented lack of return on savings, and less that can be counted on by way of self-insurance when calculating the need for survivor income.
To show the universal nature of this opportunity, let’s set aside income taxes for a moment and simply look at the impact that the current low interest rate and inflation rate environment can have on the survivor income needs analysis.
Client Scenario: Mike and Becky
Let’s look at a scenario to examine this opportunity surrounding the current rates and their impact on survivor needs coverage. Meet a couple named Mike and Becky. Mike is the primary wage earner and the spouse whose passing would engender the most financial risk without appropriate life insurance.
In 2007, with the help of their insurance advisor, Mike and Becky purchased a $1 million policy to cover Becky’s survivor income need of $50,000 per year, inflating each year for 45 years, until Becky reaches age 90. Two key factors determining the amount of the insurance policy were the return that they would expect to earn on the $1 million in order to provide the income and the inflation rate by which to increase Becky’s survivor income each year. In 2007, they believed that a 7 percent return was a conservative, long-term investment rate while a 3 percent inflation assumption would be adequate.
Now it is six years later. Mike and Becky are meeting with their advisor again and they have a much different view of the economy – as do most Americans. They no longer feel that 7 percent is an achievable, long-term, conservative investment rate. Additionally, they fully expect that inflation will return in rates higher than their original 3 percent assumption. They opt for a 5 percent investment rate and a 4 percent inflation rate.
Adjusting Becky’s survivor income goal for inflation from 2007, we check the adequacy of the $1 million at 5 percent to provide $56,000 per year, considering a 4 percent inflation rate. The result? The money runs out in half the time: 20 years. At this point, Becky’s age would be 71, not the age 90 goal originally desired.
The revised goal will require a total of $1.8 million, almost double the original coverage. With their agent’s help, Mike and Becky purchase an additional $800,000 of life insurance.
In years past, as with Mike and Becky, consumers often believed a $1 million policy would cover their needs, including survivorship. Now, however, they may need a face value of twice that amount to provide sufficient survivor protection and income generation. Given the continued low interest rate, higher taxes and capital gains rates, and rising cost of living overall, it’s critical to sit down with clients and take another look at that million-dollar policy to ensure they will meet their lifetime income, planning and survivor goals.
A “Best-Case” Scenario
We have addressed this issue so far from the due diligence perspective of the worst-case scenario: in this example, the family losing Mike relatively early in life. What if Mike and his family enjoy a very long life together? We know from research, as well as anecdotally, that many Americans are concerned they will outlive their savings.
While leading clients through the important process of survivorship planning, including dual survivorship, let’s remember to review products specifically structured for survivor protection and income generation. Universal life (UL) products often feature a guaranteed death benefit, guaranteed access and guaranteed cash value. UL can be coupled with a newer type of lifetime income rider featuring guaranteed monthly withdrawal benefits after as few as 15 years, regardless of the surrender value within the policy. Savvy producers can recommend riders that handle the best-case contingency, while helping clients plan for the unknown.
Diversification and flexibility are key in responding to the factors that have affected the value of the traditional $1 million policy. Your clients need you now more than ever to provide guidance and counseling so that they make the best decisions for their future.