We Don’t Talk About This Enough!
I recently read an article by Ashley Terrell, IAR in Kiplinger Magazine entitled Widow’s Penalty: Three Ways to Protect Your Finances. It is well written and lays out some very real financial problems and decisions that widows are faced with when they should be afforded the time to grieve.
The three issues that Ms. Terrell highlights are:
- The loss of a Social Security payment if both persons in the couple were collecting Social Security. The same could apply if the deceased had a pension with either no or lower survivor benefits.
- The potential for increased Medicare Parts B and D premiums.
- The loss of the ability to file taxes as a married couple and a reduction in the standard deduction.
These three items alone can cause significant financial stress to a widow, but there is more. Mainly, if a widow – who may now need more income to make up a reduced Social Security payment or pension, to cover higher Medicare Premiums and possibly pay higher income taxes – is required to take income from taxable accounts such as a 401K or IRA, it will trigger even more income taxes.
Similarly, if there are non-qualified accounts that are available for income, taking money from these accounts may trigger capital gains taxes. It is a vicious cycle.
Ms. Terrell makes some excellent planning recommendations, including:
- Creating non-taxable buckets of funds such as Roth IRAs or HSAs;
- Selling the primary home to downsize and enjoying the spousal step up in basis, thereby eliminating (or reducing) capital gains taxes; and
- Social Security strategies that can help maximize survivor benefits.
For recommendation 1, she states:
I am not a Medicare or Social Security specialist and will defer to her and other Financial Planners who know a lot more than me. However, I am an insurance expert, and Ms. Terrell’s comment on index universal life is confusing.
First, the statement “index universal life policy death benefits” implies that the ONLY life insurance available is “index universal life”. Or maybe Ms. Terrell thinks that whole life, term, non-index universal life, and variable life policy death benefits are taxable. Likely not, but let’s not put the tax-free nature of ANY life insurance into question. Life insurance death benefits, according to Section 1.101-1 of the Internal Revenue Code, are income tax-free. Full stop. Are there some occasions where a transfer-for-value of a life insurance policy could cause the death benefit to be included as gross income? Yes, but these situations are very rare and result from ignorance or “rookie advisor” mistakes.
Second, she does not mention distributions from the cash value of life insurance as a possible strategy for tax-free income. As I have written about many times, this can be an effective strategy for tax-free income during retirement. I will spare our readers with more on this but if you are interested, please see Cash Value Life Insurance – the Gift that Keeps Giving.
What I am encouraged about is that Ms. Terrell recognizes the value of TAX-FREE life insurance policy death benefits as a possible solution to a widow’s income problem at the death of her spouse. Clearly, this is not just a widow’s problem, because it is not always the men who pass away first – this is a gender-neutral issue, and the same problems exist for either spouse.
In February of 2024, I commented on an article that also appeared in Kiplinger titled If You’re Retired, Do You Still Need Life Insurance? and my response was somewhat scathing, addressing several reasons why one would want or need life insurance when you are retired – Our Financial Planner Said We Didn’t Need Our Life Insurance When We Retired… Then My Husband Died .
Admittedly, I missed the points that Ms. Terrell raises in her recent article which, frankly, should have been my opening salvo, but as I said, I am not a Medicare and Social Security expert. I just did not think of the most obvious reasons to own life insurance during retirement.
A healthy male, age 40, could buy $500,000 of permanent life insurance with payments to normal retirement age 67, for around $3,000 per year. A healthy female could buy the same amount of coverage for under $2,500 per year. At age 50, the corresponding premiums, also to age 67, are around $5,700 for a male and $5,100 for a female.
Paying the insurance premiums for a longer period (beyond 67 and into retirement) would reduce the annual outlay, but it would then eat into income needed during retirement. There is no right or wrong answer as to how to fund permanent life insurance, but the “wrong thing to do” is nothing at all!
Many financial advisors recommend term insurance for income replacement needs prior to retirement, but most term insurance will not likely be in force to solve the problems brought to light by Ms. Terrell. We should be recommending some amount of permanent insurance for younger couples, in addition to the term they need as they buy homes, take on debt and raise\educate families. At a minimum, we should make sure that the term life insurance that is being recommended has appropriate term conversion privileges.
Imagine what $500,000 TAX-FREE could provide as a supplement to the income needs of a widow or widower at a time when Social Security income drops, Medicare premiums increase, and income taxes increase as well. Widows should not be burdened with these challenges during a time of grief, given the simplicity of the solution. My thanks to Ashley Terrell for educating me.
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