Determining whether life insurance makes sense for a retiree requires a deep dive into their retirement and estate planning goals, as well as a careful cost-benefit analysis.Rawpixel/iStockPhoto / Getty Images
Life insurance can be a valuable estate planning tool for some retirees, whether for offsetting tax liabilities, equalizing an estate, or charitable giving.
But determining whether life insurance fits into a retired client’s plan and how much to purchase requires a deep dive into their retirement and estate planning goals as well as a careful cost-benefit analysis.
There are several situations in which retiring couples may consider purchasing life insurance, says Léony deGraaf Hastings, certified financial planner (CFP) with deGraaf Financial Strategies in Burlington, Ont.
One of the most common scenarios, she says, is retirees looking to even out their estate between beneficiaries when a real asset such as a second home is involved, as life insurance payouts are distributed to the beneficiary tax-free, outside of the estate.
For example, Ms. deGraaf Hastings has a client who wants their son to have the family cottage, as the other child has no interest.
“The mom wants to equalize the estate so the son can take over the cottage and the daughter is left with just as much,” she says.
Another typical situation, she says, involves retirees who own a family cottage or rental property and are looking for a way to help their heirs cover the capital gains taxes on the asset after their death.
Determining the most appropriate kind of insurance also requires in-depth analysis, Ms. deGraaf Hastings says. That means examining the lifetime cost for premiums versus the plan’s cash value and death benefit.
“The premiums are that much higher if you’re taking out a new policy,” she says.
Cara Boston, CFP and co-principal of Saltwinds Financial in Halifax, has also seen retired clients seek out life insurance as an estate planning tool in situations where they expect an income shortfall for the surviving spouse, to offset taxes on RRSPs or RRIFs for adult children beneficiaries, and for charitable giving.
Ideally, says Ms. Boston, the life insurance conversation would take place before retirement, when policies are cheaper and easier to qualify for.
To find the best solution, advisors need to take a comprehensive look at the client’s budget, whether assets can be set up more tax-efficiently, and what they’re trying to accomplish – whether providing protection for a spouse or covering final expenses.
Broadly, she says clients in this demographic are looking at two options: costlier permanent insurance, where premiums are building up equity in the policy, with a guaranteed payout to the beneficiary upon the policyholder’s death; and term insurance, which she likens to renting a policy for a set time. In some cases, however, term policies may only be available until age 80 or 85.
In this age bracket, Ms. deGraaf Hastings says clients typically purchase a permanent Term to 100 or a whole life policy with cash value, where premiums don’t increase with age and are often easier to work into their budget.
“It might take clients a year or two – or more – to wrap their heads around it and see the benefit that they really do want to keep the cottage in the family but there are no means to pay the capital gains,” she says. “So, it really becomes the only solution.”
For some, she says, the solution has been for the adult children to pay the premiums on their parents’ policy.
Adam Chapman, CFP and founder of YESmoney in London, Ont., also sees permanent life insurance as a useful tool for retirees in cases where their estate will require liquidity.
Paying the capital gains tax on the family cottage is one example, he says. Another is to replace defined benefit pension income for a spouse from a second marriage when the pension holder passes away, if they originally elected for the survivor benefit to go to their first spouse.
In other scenarios, however, with premiums a significant consideration for many retirees, he suggests other ways to mitigate an estate’s tax liability. Rather than purchasing life insurance, a client could consider spending more of their money now – on themselves, their family or by increasing their charitable donations.
Alongside a comprehensive financial plan, this approach, says Mr. Chapman, will likely require advisors to have deeper conversations about any emotional barriers that retirees may have with spending or gifting in retirement, such as the fear of running out of money.
“Usually, you’re doing it at a time that they still have to be healthy to get the insurance, so there needs to be a long enough runway or a long enough expected runway that a lot of these things can probably be mitigated with better planning instead of insurance,” he says.