Defined-benefit Pension Plan In-Service Death Benefits; The Life Insurance You Didn’t Know About

Few employers sponsor this type of pension plan these days, however they are still typical for government employees, military, school systems, and utilities. DB plans remove classic retirement challenges like stock market volatility or living too long, but they require their own decisions, such as which survivorship option to elect or should I buy back years if eligible.

One often overlooked aspect of these plans that smacked me in the face, when asked to help a school superintendent at retirement time, was how it should have influenced how much life insurance he carried before retirement. He had carried voluntary payroll deduction term life insurance most of his career, which ended at retirement. and wanted to know what to do about it. Premiums were over $200/month. A danger of payroll deduction is out of sight out of mind. He’d elected five times salary, and as his salary and age crept up, his premiums followed.

What he’d been oblivious to was a significant lifetime income for his wife had he died, once he had become vested after 10 years. That line of demarcation varies among plans, yet had he had an “in-service death” (died during employment but before retirement) his beneficiary would have received a lifetime income similar to what the employee would receive if they had retired at that point. The formula is 2%, times number of years of service, times current salary.

His salary was the highest in the system, so let’s consider a teacher making $40,000/year working for 15 years. If they died, 30% of their salary (two times number of years of service) or $1,000/month would go to their beneficiary for life. How much life insurance does it take to generate this much income? $250,000 of life insurance, invested at 5%, yields about $1000/month. In other words, this in-service death benefit is similar to owning a $250,000 life insurance policy.

Most participants in defined-benefit pension plans are unaware of this. Adding insult to injury, many sign up for voluntary term insurance which ends at retirement, and it only duplicates the in-service death benefit under the pension. That premium could have accelerated the mortgage or funded a Roth, for a definite future benefit, instead of renting term insurance expiring at retirement.

If you are under such a plan, call human resources and find out if you have an in-service death benefit, if not when you will and for how much. Then calculate how much life insurance it takes to yield this income.

One ancillary point: employer sponsored voluntary term is usually not a good buy for a healthy person. An individually underwritten policy requires a physical, blood work, etc., while the group term does not (guarantee issue; “just check the box”), so its rates are higher. Also rates for term through work usually increase every five years, versus 10, 15, or 20 for a personal policy.

So when you call HR to find out about the in-service death benefit, if you’re in a voluntary term plan, find out the rate schedule for future years so you can later compare it to a level premium term policy.

However, don’t bog down in comparing rates until you first fine tune the amount of coverage in light of the in-service death benefits and other assets. As Peter Drucker said, “There’s nothing more wasteful than doing efficiently that which shouldn’t be done at all.” Buying life insurance to duplicate an in-service death benefit you didn’t know you had usually shouldn’t be done at all.

 

 

 

 

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