Navigating Life Insurance Decisions in Retirement: When to Keep, Drop, or Modify Your Policy

When it comes to financial planning, one of the general principles is that if your death wouldn't cause financial hardship for anyone, you likely don't need life insurance. For example, a single person with no kids or dependents often has little need for life insurance.

But what about retirees? Once you've retired or achieved financial independence, do you still need that life insurance policy you've been paying into for years? The answer, as with many financial matters, is: it depends.

Let's take a closer look at when it makes sense for a retiree to keep paying life insurance premiums, and when it may be better to let the policy lapse.

KEY TAKEAWAYS

If your death would cause financial hardship for someone else, you likely need life insurance. If not, you may not need it.
If paying life insurance premiums would threaten your retirement security, it's probably best to let the policy lapse. But if you can comfortably afford the premiums, it's worth considering keeping the policy.
The expected value of a life insurance policy—the payout multiplied by the probability of the payout—rises as you age, even as the premiums stay level. In the later years of the policy, the expected value is often significantly higher than the premium.
Life insurance can be a tax-efficient way to leave money to heirs, since the death benefit is generally income-tax-free and, with proper planning, can sometimes be estate-tax-free as well.
Ultimately, the decision to keep paying life insurance premiums as a retiree depends on your unique financial situation, your bequest motives, and your comfort with the numbers. It's a decision best made in consultation with a financial planner who can model out the scenarios for your specific case.

FACTORS TO CONSIDER

There are a few key things to think about when deciding whether to continue paying life insurance premiums in retirement:

Your retirement security: If the premiums would put a real strain on your finances and negatively impact your retirement lifestyle, that's a good argument for letting the policy lapse. There's no sense in jeopardizing your own financial wellbeing for an insurance policy you may no longer need. On the flip side, if your retirement is fully secure and you can easily afford the premiums, keeping the policy becomes a more viable option once more.
Dependents: The classic reason for life insurance is to provide for your dependents if you pass away. If you're retired and your kids are grown and financially independent themselves, you may have no dependents relying on you anymore. One exception is if you have a spouse who would depend on the insurance payout, especially if you have a pension with little or no survivor benefit. Another reason to keep it is if you have a child with a disability who you need to provide for.
Bequest motives: If your retirement is secure and you're confident you won't outlive your money, your financial decisions start to impact your heirs more than yourself. The question becomes less about your own financial security and more about the after-tax value of your estate. If you want to leave money behind, keeping a life insurance policy can be an efficient way to do that, as we'll see in the example below.
Health: Of course if you have an illness or reason to believe you have a higher chance of passing away in coming years then that would be a reason to keep the policy.

OTHER CONSIDERATIONS

Of course, there are some caveats and additional factors to consider:

Type of policy: Term life policy are usually straightforward while whole life, universal life, and other permanent life insurance policies are more complex, with an investment component. The more complex the policy the more analysis that needs to be done to find out if there is a reason to keep or surrender a policy.
Your health: Insurability is a key factor in life insurance. If you've developed health issues since initially buying the policy, you may not be able to get a new policy at an affordable rate. This could argue for keeping your existing policy.
Opportunity cost: Every dollar paid in insurance premiums is a dollar not invested elsewhere. If you're an extremely skilled investor who can generate better after-tax returns than the expected value of the life insurance policy, you might choose to invest the money instead. It might especially make sense if you feel like the chances of a term policy paying out are low.
Peace of mind: There's a non-financial benefit to life insurance, which is the peace of mind it provides. Knowing that your loved ones will receive a payout no matter when you die can be comforting, even if it's not strictly necessary from a financial perspective.
Estate Planning: Life insurance can play a significant role in estate planning. The death benefit from a life insurance policy can provide liquidity to pay estate taxes, debts, and other expenses, ensuring that your heirs do not have to liquidate other assets to cover these costs.

Real-Life Client Examples

Scenario 1: Letting a Policy Lapse

Meet Susan:

Susan is a 68-year-old retiree who has recently achieved financial independence. She has a robust retirement portfolio and receives a steady income from Social Security and her pension. Susan's children are grown, financially independent, and live on their own. With no dependents relying on her income, Susan considers whether she should continue paying the premiums on her term life insurance policy.

After evaluating her financial situation, Susan realizes that the primary purpose of her term life insurance was to provide financial security for her children if something happened to her while they were still dependent. Now that they are independent and her retirement savings are more than sufficient to cover her needs, the life insurance policy's original purpose is no longer relevant. Additionally, continuing to pay premiums would reduce the funds available for her travel plans and hobbies.

After consulting with her financial advisor, Susan decides to let her term life insurance policy lapse. This decision frees up additional resources for her current lifestyle, allowing her to enjoy her retirement years without worrying about unnecessary expenses.

Scenario 2: Keeping a Policy Active

Meet Robert:

Robert is a 70-year-old retiree who enjoys a comfortable lifestyle with his wife, Linda. Robert has a pension that covers most of their living expenses, but it lacks a survivor benefit, meaning Linda would face financial difficulties if he were to pass away. This potential shortfall has led Robert to reconsider the importance of maintaining his whole life insurance policy.

The whole life insurance policy Robert holds offers a significant death benefit that would provide Linda with financial security in the event of his passing. Robert also has a child with special needs, requiring long-term care and financial support. The life insurance policy serves as a critical part of his estate plan to ensure his child's continued care.

After analyzing his financial situation and discussing it with a financial planner, Robert decides to continue paying the premiums on his whole life insurance policy. The peace of mind it provides, knowing his wife and child will be cared for, outweighs the cost of the premiums. Moreover, the policy's cash value offers flexibility should he need to access funds in the future.

WHAT IF YOU NO LONGER NEED LIFE INSURANCE?

In our office, when we work with clients who have met all of their retirement and savings goals and are in good health, we often recommend that they consider dropping their term life insurance policies.

Term life insurance is designed to provide financial protection for a specific period, often during the working years when individuals have significant financial obligations like mortgages, child-raising costs, or college tuition.

Once these obligations are met and you have sufficient savings and investments to support your retirement lifestyle, the original purpose of the term life insurance policy may no longer apply.

If you have a whole life policy or another type of permanent life insurance policy with cash value, and there is no longer a need for life insurance, we usually recommend a different approach. In these cases, we often advise clients to consider a 1035 exchange.

This is a provision in the tax code that allows you to transfer funds from a life insurance policy to an annuity or another life insurance policy without triggering a taxable event.

Specifically, we often recommend a 1035 exchange into an asset-based long-term care policy utilizing the cash value of the life insurance policy. Long-term care insurance helps cover the costs of long-term care services, such as in-home care, assisted living, or nursing home care. These costs are not typically covered by health insurance or Medicare and can be substantial.

By transferring the cash value of a life insurance policy into a long-term care policy, you can repurpose those funds for a type of insurance that may be more relevant and valuable in retirement.

This strategy allows you to leverage the money you've already put into the life insurance policy to provide protection against a significant financial risk in retirement.

Of course, every situation is unique, and these recommendations may not apply to everyone. It's important to consider your specific financial circumstances, health status, and personal goals when making decisions about life insurance in retirement.

A qualified financial advisor can help you assess your options and make a decision that aligns with your overall financial plan.

CONCLUSION

Remember, everyone's situation is different. This guide provides a framework for thinking about the decision, but it's not a substitute for personalized advice from a financial professional who understands your unique circumstances and goals.

If you're a retiree with a life insurance policy and you're unsure whether to keep paying the premiums, it's a conversation worth having with your financial planner.

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