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life insurance, SBP

SBP or Life Insurance?

If you are nearing retirement you may be considering purchasing life insurance instead of taking the full survivor benefit plan (SBP). In making this choice you might be wondering how much coverage you need to make up the difference. It’s an important question, so approach the subject carefully.

First, consider what you’re comparing. The SBP provides the spouse of a military retiree a guaranteed income for life. Period. The amount of the benefit is based of 55% of the “base amount.”

The SBP has some attractive features, including a cost of living allowance, pre-tax deductions to pay for the cost of the benefit, and a program that is, in fact, subsidized by the US Government.

So, to state a simple example, if the base amount is $4,000, the spouse would be assured of an income of $2,200 per month, or annual benefit of $26,400 per year.

The amount of life insurance you need to equal this benefit is entirely dependent on the age of the spouse when they begin taking their benefit. Because the decision to take the SBP must be made in the first year of retirement, you have to assume the worst case scenario…that the spouse begins to take their benefit immediately. Assuming that the spouse is 40 years old, and female, she will need income for 41 years. The present value of this stream of payments, assuming a 3% rate of inflation is $618,000. This amount is padded a bit because your spouse will be eligible to begin taking a reduced Social Security benefit at age 60 and the full benefit at age 67.

Still, this figure does give you a point of reference to consider when you develop your options. If, indeed you decide to reject the SBP, purchase term life insurance, and invest the difference with the goal to be self-insured, then you can compute what your investment might be worth.

The SBP premium, in our earlier example, would be $260 each month. If the life insurance costs $60/mo for 20-year term, then you’d have $200 to invest. If that investment were invested in the SBP equivalent of Treasury Bills, the investment would be worth about $62,000. If at that time the spouse needed to begin taking benefits, assuming a 4% distribution, she would only be able to take $200 per month! Even with a Social Security Benefit, the veterans spouse’s ability to maintain her current lifestyle would be in serious doubt.

Could you do better than T-Bills in your investment? Sure. But remember you are comparing two alternatives with very different levels of risk. By comparing the interest rates at the T-Bill rate you get a better understanding of the risk adjusted value of the Survivor Benefit Plan.


4 thoughts on “SBP or Life Insurance?

  1. Aren't you completely forgetting that the term life insurance will pay out, and then add to that invested amount? If you have insurance for 500k, that is pretty close to the amount needed to maintain the same lifestyle.

    Posted by Ana | September 24, 2011, 8:21 pm
  2. Thanks Ana. Your comment suggests that you die either on schedule or early. I hope to die long after my term policy expires. The calculation is designed to compare the difference between taking the SBP or purchasing adequate term life insurance and investing the difference. If you compare products with low risk (and you can argue that the SBP is a ZERO risk product) than you'll find that it's very difficult to become self insured by rejecting the SBP.

    Posted by Lee | September 25, 2011, 12:05 pm
  3. So maybe I didn't understand this completely then – what you are saying is that the goal is to get rid of the term insurance at 20 when it matures? And then self insurance is just what you've managed to make with the difference?Assuming we make it all the way to retirement, my husband and I have talked about this and it seems to make more sense to carry good term life insurance on him for the rest of his life, not just 20 years. But, we aren't there yet so I am not sure how the numbers work out which is why I appreciated this post.

    Posted by Ana | September 26, 2011, 8:46 pm
  4. Ana;Many personal finance commentators will encourage you to buy term life insurance and invest the difference in good grown stock market mutual funds. The intent is to replace your need for life insurance with a stock market portfolio that guarantees income for the rest of your life. The only problem with this technique is the risk that your returns will not be large enough to make sure that your run out of time before you run out of money. If your plan is to renew your life insurance at the end of the term, I encourage you to compare the rates for term life for a person 20 – 30 years older. You'll find it's a lot more expensive. And, if your health situation has changed, you may find that you are not insurable.So, you may find that what you really need is a portion of the full SBP, supplemented by a term policy and then a second career to create enough wealth to eliminate your need for life insurance later.I also wanted to point out that the SBP is considered paid in full after 30 years.

    Posted by Lee | October 2, 2011, 8:57 pm

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