Caveat: This is the third article that I’ve written about Survivor Benefit Plan. It is meant to be read with the other two articles so you can formulate your own educated opinion about your personal situation, which may be different from outlined here. This article is also the basis for a chapter for an ebook that I’m currently writing about the Survivor Benefit Plan, which I plan to release by summer. If you’d like to receive updates, please send me an email or join Military in Transition on Facebook. I hope you like it.
I’ve written a couple of times about the Survivor Benefit Plan (SBP). Both articles received some unanticipated pushback from different people.
The first article vs. the second article
The first article received some pushback from several fee-only financial planners (not insurance salesmen) who work with military personnel, and a couple of accredited financial counselors (including one who works on my local installation). These people told me that SBP is a very expensive annuity when compared to other options (it is an annuity, and its terms are defined by law), and that I should advise EVERYONE to steer clear of SBP.
The second article, which outlined reasons you should strongly consider NOT purchasing SBP, was written partially in response to those planners and to a couple of people who asked me to look where else you could put your money that would replicate the SBP payout. It also received a lot of pushback from people who are champions of SBP, or who are otherwise concerned that today’s servicemembers aren’t properly educated about SBP. Although my intended message was that you should consider not purchasing SBP, my article came away sounding like you should not get SBP, and get a term insurance policy instead. In fact, my personal opinion is somewhere in between. I believe that SBP makes sense in some situations, and that a term life insurance makes sense in a lot of situations, including my own. Before we go further, we should clarify that I don’t make a dime from any insurance recommendations, which are purely based upon my analysis of a particular situation on a case-by-case basis.
I compared SBP to a term insurance policy because SBP is much better than commercial annuity products. And there is a lot of risk in trying to build a portfolio on your own…you might die before you get anywhere close to being able to replicate SBP. So the counterbalance to that risk is a life insurance policy. Term life insurance is generally the cheapest kind of life insurance. It’s definitely better than trying to build value in a whole life, universal life, variable life, or variable universal life (VUL) policy.
You might wonder why I wrote an article that seemed to advocate SBP, then followed it up with an article that seemed like SBP-bashing. I did so for two reasons. First, both articles seek to provoke critical thinking…I think I soundly met that objective. Second, putting those two articles side by side shows my true focus…when you’re looking at your decision to retire from the military, you need to make sure you address SBP properly. After all, if you make the wrong decision, you’re stuck with it. With that said, I got hit up on both sides of the debate.
Getting hit up on both sides got me thinking about a couple of things:
First, each situation is different. If this seems repetitive, then good. I want you to understand that your situation is not exactly like anyone else’s, so you need to educate yourself and form your best opinion. If you need to hire someone to help you, by all means, do so. If you’re confident in your ability to gather the relevant facts, that’s great. However, you still need to do the analysis or have it done for you so you can make your decision.
Second, since each situation is different, I believe that you cannot universally prescribe a ‘one-size fits all’ solution that is best for everyone. You can prescribe a ‘one-size fits all’ solution that generally works for most people (like SBP does, or like a term life policy does). However, it occurred to me that if you read one article without the other, it appears that I’m only advocating that course of action…or my tone indicates that I have an agenda. I don’t.
Third, I really appreciate the discourse from both sides (even if I felt like the punching bag both times). This indicates to me that there a lot of people who are doing a lot of hard work to help others, and I’m very glad to be a part of this community. Personally, I think the decision to choose (or not choose) SBP is an individual one, and I’ve tried to structure my articles to emphasize that decision, not a preconceived notion of a one-size fits all solution. Hopefully this works.
There are many situations where SBP may not adequately address a financial need, or is a more expensive way to address the same financial need than term insurance. For example, SBP may not be a good choice for female servicemembers, who are statistically more likely to outlive their male spouses. It might not be the best use of money for people who are otherwise financially stable and don’t need to rely upon a pension because their post-military career and choices have more than made up for it.
However, there are also situations where SBP makes perfect sense: an older male with a much younger female spouse may benefit from SBP for a very LONG time (at least she will…). For example, my grandmother outlived my grandfather for 30 years (she was 2 years older) and received SBP the whole time. So for a male servicemember marrying a second wife who is 10 years younger, this makes perfect sense, since she’ll likely benefit for 40 years or more. SBP also makes sense if there are health-related insurability concerns, which might make term insurance unaffordable, or even unattainable. Also, if you outlive a 30 year term policy, you get nothing, while SBP is guaranteed for life—if choosing a life insurance policy over SBP, this should be planned accordingly from the beginning to make sure the pension is accounted for by other means (such as earnings from your retirement assets).
There are also situations where the decision isn’t so clear. For example, a lot of people feel they may be on the right track to retirement, and they think their inflation-adjusted pension might be enough to support their spouse’s needs when combined with retirement assets and social security. However, what happens if you’re in your 40s or 50s (prime earning years with the highest living expenses for most people), and something disastrous happens? Your beneficiary might receive a guaranteed pension…but that doesn’t replace the expected income or the assets you expected to accumulate over time. Nor can you expect it to cover living costs while paying a mortgage and supporting kids at home.
The Third Article
So, I decided to write a third article that attempts to outline a particular situation. While this doesn’t reflect everyone’s situation, I think it’s a pretty common one. In fact, it’s my personal situation. I’m a 40-year old soon to be military retiree in decent (not Ironman excellent) health). My family has 3 children, a mortgage, one car payment (very low interest), a couple of small student loans (less than $10K total). My wife is 1 year older than me, and my children are in elementary school, with two dogs, two canaries, and a lizard (uromastyx, if you’re interested). In other words, nothing unusual, and probably a situation a lot of people can identify with.
Let’s start by identifying my financial need. My number one concern is the financial risk to my family if I die in the first 20 years after my military retirement. Why 20 years? After age 60+, I expect to have accumulated enough assets for my wife to pay her living expenses and provide for herself after I die, even without my military pension. We will have paid off our house and possibly even downsized, and our children will have been long gone, so her living expenses will be much lower. Before that point, though, my wife will be looking at having to handle our pre-retirement expenses, and my plan needs to address that.
In my situation, I could either obtain SBP or a term insurance policy. My SBP would protect approximately $4,000 in monthly income (providing a $2,200 monthly payout, with annual COLA increases), for about $260. Since this is pre-tax money, that comes to about $195 per month after taxes. For that $195, I’ve been able to get underwriting on a 30-year, $1.5 million insurance policy. I’m using a 30-year policy as a ‘just-in-case.’ I believe that 20 years would be sufficient to reach our financial goals, but I’m willing to purchase a 30 year policy to eliminate any doubt. We will compare the SBP payout (55% of $4,000 or $2,200 per month) to the cash flow that a $1.5 million payout would provide.
First, a few caveats:
- Peace of mind should be your number one priority. If SBP is your answer & nothing will change your mind, do not read further. However, this article does attempt compare SBP to another option which might better address your situation.
- If even the thought of some investment risk (even US Government-backed securities or bank CDs) scares you, stop. While this discussion goes into scenarios with very low, achievable investment returns, which can be reasonably achieved with very safe investments, such as a treasury bond ladder or CDs, nothing is ever guaranteed.
- This article assumes fairly low COLA (inflation) rates. This could change, and should be considered accordingly. However, the assumptions are generally in line with inflation rates used by financial planners.
- This article ONLY addresses the cash flow issues that happen when there is a sudden loss of income before there are enough retirement assets to support living expenses. For this example, I’m more concerned about my wife raising our 3 children and paying the mortgage if I die in my 40s than I am about cash flow needs in our 70s. By the time we reach retirement age, our plan is to not have to rely upon my pension (or SBP payout) for her to afford her living expenses. In this case, term insurance provides protection against a defined insurable need: the sudden cessation of pension income while you’re still building your retirement assets.
- This article doesn’t try to compare whether SBP is cheaper than insurance. I’m using information from my previous article, where I outlined how much insurance I would be able to purchase with the amount of money I’d otherwise use for SBP. You may find that you can buy more or less insurance, based upon your particular situation.
- This article does not attempt to compare the amount invested in SBP vs. the amount invested in the insurance policy. It assumes that the same premium would purchase either the guaranteed SBP payout, or a certain amount of life insurance. In this case, the comparison is between the SBP coverage of a $4,000 pension (which is $2,200 per month), or a $1.5 million payout. Your situation may allow for a lower or higher payout. Whether you die at Year 1 or a Year 29, you will have paid approximately the same amount for either outcome.
- This situation assumes that at the end of a 30-year term policy, you will have enough accumulated retirement assets to offset your SBP benefit. If you’re not comfortable with the fact that in Year 31, your pension could go to zero, stop.
- There are worse things than outliving a 30 year term policy. However, if the thought of getting nothing for that money concerns you, it’s the exact same result as if the servicemember outlives their spouse…you keep your WHOLE pension, and you were protected against that downside risk.
- This article assumes your insurable need is for a 30 year term policy. You may find lower rates (or a higher insurance policy for approximately the same premium) if you’re willing to accept a 20 year term, which some people may be willing to do if they are older and closer to financial independence.
- This article assumes that SBP proceeds are 100% taxable, while the insurance payout is not. However, earnings on the principal are taxable. We will assume the 25% tax rate from the previous article.
- This article does not assume any special needs, or any situations other than what I explained above. If your situation is significantly different from the one outlined above, you may have to do your own analysis to figure out what is right for you. In fact, you should do your own analysis anyway. It is YOUR life and you need to OWN your decisions.
If you want, you can go to the DOD Actuary website and download an Excel file that does the exact same thing I’m about to do: compare the numbers and give you a recommendation as to whether or not SBP or term life insurance is better for your situation.
Caveats out of the way, let’s get to work comparing the two scenarios.
Break-Even: Using a side-by-side comparison of the payout numbers allows for us to analyze the ‘break-even’ point…at what point does the COLA-adjusted SBP pension become a better financial option than a lump sum payout. The break-even point is defined as the year in which the invested lump sum, which replicates the SBP payout, is depleted. After the break-even point, SBP is the better option. Any shorter, and the term insurance is more attractive. To clarify:
- AFTER Break-even: SBP wins
- BEFORE Break-even: Term Insurance wins
Returns: We will adjust the COLA for SBP and hypothetical investment returns for the payout. These hypothetical investment returns are very low. In fact, the highest rate, 4%, is a generally accepted distribution rate in the financial planning industry that still allows for the long-term preservation of capital. However, anything above the US-Government 30 Year Treasury rate (currently at 2.75%) involves some sort of investment risk, however slight.
Calculating distribution: Instead of just assuming a 4% distribution rate, as was done in the previous article, we’re comparing the guaranteed $2,200 monthly pension (adjusted annually for cost of living allowance increases), to how long a $1.5 million policy would last, if set aside and used to match the after-tax SBP payout. For example, at a 4% annual COLA adjustment, the $26,400 in Year One will become $27,456 in Year Two. After tax, this becomes $19,800 and $20,592, respectively. The distribution from the lump sum investment will match this, first with earnings, then with principal. The calculations reflect the tax impact from earnings, but zero taxation on principal.
For the illustrations in this article, I’ve used a 40 year time horizon. At the bottom of each illustration is a bullet point summary of how much money you would have at the end of this period, as well as the SBP break-even point.
Illustration 1 represents the break-even point with an annual COLA adjustment of 4%. 4% is a very high number, especially in light of recent COLA increases. However, most financial planners use 3-4 percent as an inflation assumption when preparing financial plans, so 4% is a conservative estimate (on the high side), just to demonstrate the likely worst-case scenario.
As you can see, even with a 4% COLA, there is no situation in which a $1.5 million portfolio would last less than 30 years. The SBP break-even point is at least 35 years for any of these scenarios. Even if you took the money and put it under a mattress, you would be able to match the SBP payout for 35 years. And at a 4% income, you end up with more money than you started with at the end of 40 years! Although it’s not in the chart, 30-year Treasury rates were around 2.75% as of March 11, 2016. Assuming you did not build a bond ladder (which staggers bonds with maturity dates, so that you’re continuously reinvesting as each bond matures, and taking advantage of rising interest rates) and only received the current Treasury rate, you would still have almost $600,000 at the end of 40 years.
Numbers below: Amount after 40 years Breakeven Point
- 0% Income $ 0-Run out of money at 35 year mark 35
- 1% Income $ 0-Run out of money at 38 year mark 38
- 2% Income $ 114,437.54 40
- 75% Income $ 584,267.18 44
- 3% Income $ 772,879.56 45
- 4% Income $ 1,725,825.83 53
Illustration 2 is calculated the same way as Illustration 1, but with a COLA adjustment of 2.3%. Why? It was hard to find any single document with the historical COLA increases for military pensions. In fact, I couldn’t find any DFAS press releases older than 2011 showing the next year’s increases, so I didn’t have much historical context. Here’s what I found:
2013: Couldn’t find it online
So, with that information (or lack thereof), I had to turn to an ‘informal’ source. The first lead I found was from Mike at Military Pay. Mike’s website has a retirement calculator, and according to his FAQ, he’s incorporated previous COLA rates and has religiously updated the pension numbers since the War of 1812. He also uses a projected rate for future earnings. According to my napkin math, this projected rate appears to be 2.3%. So that’s the projected COLA adjustment rate for this illustration.
In this illustration, you can see that there is no scenario where this payout does not last 40 years. Again, even if all you do is dole out money from under your mattress to match what you’d have received from SBP, you’d still have money left over at the end of the scenario. At the 30-year Treasury rate of 2.75%, you’d have your starting amount, and at 3%, you’d have more money than you started with.
Numbers below: Amount after 40 years Breakeven Point
- 0% Income $ 95,576.94 41
- 1% Income $ 453,168.59 46
- 2% Income $ 972,722.41 54
- 75% Income $ 1,504,953.05 63
- 3% Income $ 1,715,799.71 68
- 4% Income $ 1,725,825.83 108
For example, let’s imagine Tania used $500,000 to do whatever she needed to do, and had $1,000,000 set aside to provide her annual income. In the worst case scenario (4% annual COLA, that she matches with under the mattress money) that $1,000,000 would still be able to match the SBP payout through year 27. Instead of 108 years, $1,000,000 would get her through Year 57 under the 4% income, 2.3% COLA scenario. In addition to providing a means for a steady income, an insurance policy gives you flexibility to address immediate needs…SBP cannot offer this.
Although these projections seem outlandish, they may not be as longevity increases keep pushing the boundaries of our life expectancies. There are plausible situations where my wife could outlive me by 50-60 years, and need income into her 100s. However, that scenario is not as much of a concern to me as the liquidity and immediate cash flow concerns.
Conclusion: In this scenario, a term insurance policy seems to be a more financially sound option than SBP.
However, if I predecease my wife by 30 years or more, she might be better off with SBP. With that said, 30 years gives Tania plenty of time to take control of her life after my demise, and to find the help she needs to take move forward with her financial life.
Again, this article does not seek to persuade you into one decision or another. However, it does aim to show you an expanded definition of peace of mind. In my situation, peace of mind comes from the fact that:
- Selecting a term life insurance policy is a more cost-effective way to replicate the SBP payout
- The liquidity that a term life insurance policy provides so that Tania can get through that first few years after I die.
- Once my term policy expires, my wife and have reached the point that she won’t need either it or SBP anymore in case I die.
Recognize this is a bit longer than my normal posts, but I hope you appreciate it. Just remember, if you don’t want to do the math yourself (it’s exhausting, trust me), just go to the DOD Actuary website.
Note: After I did all the research, and basically wrote this, I found the OSD Actuary’s website. I backtested my scenario against the OSD actuary’s calculator, and the calculator validated my conclusion that term insurance is more likely to provide the bigger payout when compared to SBP. However, you should run this scenario for yourself and come to your own conclusion.
As always, this blog serves to answer your questions and address concerns. If you like this blog, please forward it on to other people who may benefit. If you have issues or concerns, or if you have a question you’d like me to answer, please feel free to contact me. You can reach me through my website, or via email. In the meanwhile, take charge of your life!