Federal retirement expert, Chris Kowalik, breaks down how the survivor benefit plan works for federal employees who wish to protect income for someone other than a spouse in retirement.
Key takeaways:
- clarification on two important benefits: the “insurable interest survivor benefit” and the “children’s survivor benefit”
- the requirements for electing these survivor benefits
- an analysis of the best and worst case scenarios on costs (with specific examples)
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Scott: Hello and welcome to another episode of Fed Impact, candid insights on your federal retirement. I’m Scott Thompson with myfederalretirement.com. I’m here again today with Chris Kowalik of ProFeds, which is the home of the Federal Retirement Impact Workshop. In today’s episode we’re going to be talking about the survivor benefit plan, and specifically the insurable interest and the children’s survivor benefit options. Welcome Chris.
Chris: Thanks Scott. So that all of our listeners know exactly what they’re in for on this podcast I want to offer a little bit of clarification. This podcast today is focused on the survivor benefit options to leave money to someone other than a spouse. For our listeners who are married or maybe have a former spouse, I highly encourage you to go listen to the spousal survivor benefit podcast. They’re really different programs.
The scenarios that we’ll be covering in this podcast are for employees who are not married and don’t have a former spouse. Most often the people interested in this topic are people who have children or other loved ones that they would like to see their pension be paid to upon their death. I just want to make sure that everyone is clear on what we’re doing today.
Chris: Of course. The first benefit is called the insurable interest survivor benefit. That can protect a portion of the pension, which is the retiree’s paycheck. Now a retiree might wish for this money to go to a wide variety of people, like I mentioned before, their children, siblings, nieces, nephews, et cetera.
The second benefit that we’ll be talking about today is called the children’s survivor benefit, and this protects a flat dollar amount to a child or children of course if there’s more than one, but this is not protecting the pension for the child. These are two wildly different programs, but two that get confused so often that we needed to put them in one podcast to make sure that we could show the difference between these two programs.
Scott: Okay. That makes sense. Let’s start with the insurable interest benefit. I guess the most obvious question is what is insurable interest?
Chris: Yeah. An insurable interest is a person who is related to you, closer than a first cousin, and who would reasonably expect a financial benefit from your continued life. That’s the definition. So the people that we mentioned before, a child, a niece, nephew, brother, sister … All of those would likely be considered insurable interests.
Now from a technical standpoint a spouse could be named as an insurable interest. The reason someone might choose to do this are beyond the scope of this podcast, but I do want you to know it’s technically possible to name a spouse. I’ll give everyone the real quick notes version. The reason that an insurable interest might be used is that if a former spouse were awarded the entire benefit under the spousal survivor benefit, technically an employee could use the insurable interest program that we’re talking about today to provide a benefit to a current spouse. Again, that is not what we’re going to be talking about today. We’re going to be under the assumption that there is not a current spouse or even a former spouse with a court order in the mix for this conversation today.
Scott: Okay. At a basic level, how does this insurable interest program work?
Chris: Again, we’re going to assume that we have someone who is not married at the time that they retire. Because of this, because the fact that they’re not married, they’re not permitted to leave their pension to someone under the spousal survivor benefit plan because they don’t have a spouse. What this plan under the insurable interest program allows someone to do is still leave a portion of their pension to someone other than a spouse. It’s a different kind of benefit, but the same idea.
Scott: Is this an automatic option or does someone have to qualify for this benefit?
Chris: To elect this benefit, an employee who is approaching retirement must prove that they are in good health by going through a physical and answering medical questions, all that jazz. This is very similar to the process to get life insurance out in the private sector.
Scott: Okay. How much of the pension could be left?
Chris: The calculation of what could be left to an insurable interest is a little bit complicated. Since we’re in audio format today on the podcast, I’ll try to give some easy numbers for everyone to follow along with. The amount that can be left for an insurable interest is 55% of the retiree’s pension after it has been reduced by the cost of the benefit. Don’t you love the way the government explains things?
Scott: Yeah.
Chris: Okay. So to give a little bit of contrast, the spousal survivor benefit can protect up to 50% of the retiree’s pension. Now at first glance you might think that the insurable interest is providing more since it’s 55% instead of 50%, but remember it’s 55% of the pension after it has been reduced by the cost of the benefit, so it ends up protecting less through this program as opposed to the spousal survivor benefit. All in all, when we compare the insurable interest survivor benefit to the spousal benefit in the insurable interest program we protect a lesser dollar amount and it ends up costing us more than the spousal benefit.
Scott: Okay. What would the typical cost be for this type of benefit?
Chris: This is another area in which the insurable interest survivor benefit is very different than the spousal benefit. The cost for the insurable interest benefit is dependent on the age difference between the insured person, in this case this is the federal retiree, and the person that they are naming to receive the benefit at the time of their death. The bigger the difference in age between those two people means the bigger the cost to provide the benefit.
From a math standpoint, I see where the government is coming from when they price it this way. After all, if we named a person who’s considerably younger than us to receive the survivor benefit, which is a pension payable for the rest of their life, that means the government would be on the hook for a longer period of time than if we had named somebody closer to our own age. But for someone to name their children to get part of their pension, this is not news to their ears. They don’t want to hear this part of how this program works.
Let me go though two extremes of the cost of the survivor benefit for insurable interest, kind of best case and worse case scenarios. For those of you listening today, if you want to see the table that I’m referring to we’re going to put that in the show notes embedded in the transcript. So if you scroll down below where you hit the play button, just keep scrolling, you’re going to see a transcript of today’s episode. Feel free to scroll down and in this section you’re going to see the tables that I’m going to walk everybody through just over the podcast.
Again, I’m going to show you best case and worse case scenarios as far as the price goes. If we were to name someone who is either older than us, the same age, or less than five years younger than us and we’re the federal retiree, the cost to provide that benefit to them will be 10% of the retiree’s pension. If anybody has listened to the spousal benefit, we know that it’s 10% of the retiree’s pension over there as well.
But the other extreme of that is if we name someone who’s 30 or more years younger, like a child or a niece or a nephew that’s considerably younger than us. We would have to give up 40% of our pension while we’re living so that that individual gets a portion of our pension moving forward at the time of our death, so it’s a considerable cost, especially when we’re giving somebody much younger than us.
Scott: Right. Now that we know the different price points based on someone’s age, could you give us a couple of examples of the benefit someone could expect to be paid in comparison to the cost so that we’re sure that we’re tracking here?
Chris: Yeah. In order to give you some numbers, I’m going to pull and example from the live training that I do specifically with financial professionals who need to understand the intricacies of a program like this. This is a little bit too complicated for us to teach in our retirement workshops to federal employees, but certainly the financial professionals need to know this as they work one-on-one with employees who are seeking their guidance on really big decisions like this.
The two examples that we’re going to use today, one is CSRS and one is FERS. These examples are going to assume that we have an employee that has 30 years of service and a $50,000 high three average salary. We’re going to plug those into the pension formulas and use those numbers as a starting point. Just like we did for the cost table, we’re including these tables embedded within the transcript at the bottom of this page.
As a side note for anybody that happens to be listening to this podcast through iTunes or any of the other platforms out there, you can gain access to this transcript and all of these tables that I’m referring to by going to myfederalretirement.com, clicking on the fed impact podcast, and selecting today’s episode on the survivor benefit plan for insurable interest. We know our listeners listen from all different places, but we want to make sure you have access to these tables.
Let’s assume that the federal retiree has selected someone who is the same age as them, maybe a brother or sister. The coverage that would be provided to that person would be 55% of the pension, which is $28,125, minus 10% of that pension, $2,812. That number that could be protected let’s say it’s a brother to receive is $13,922. We just established the cost to the retiree is $2,812 per year, so the retiree is going to give up $2,800 a year so that their brother can receive about $14,000 a year upon the retiree’s death. That’s the baseline that we’re going to talk about.
The other extreme to that example is if this person were to name one of their children. If we throw all of that into this same formula, the child in this case would receive 55% of the pension after it’s been reduced by the cost. In this case the child would be receiving $9,281 per year, and you’re not going to believe what it costs the retiree. It is going to cost the retiree over $11,000 a year to provide that benefit to their child. So the retiree gives up a $11,000, the child receives $9,000 per year. This is not an ideal scenario to leave money to a child or someone who is much younger than the retiree. That’s CSRS.
Let’s transition over into talking about FERS. With a FERS employee that had 30 years of service and a $50,000 high three, that would yield a pension of $15,000 per year for the retiree. If they were to select an insurable interest … I’ll use the same scenario. They’re going to protect a benefit for a brother. It would be 55% of $15,000 after it’s been reduced by the $1,500 cost, because it’s 10% of the pension that they have to give up. So the cost to the retiree in this example is $1,500 per year, the person they’re naming as the insurable interest, in this case their brother, is receiving about $7,500 per year. Not terrible, but not as good as it would have been had it been a spouse who is receiving this benefit.
Again, the other extreme example is naming a child to receive this benefit. In this example, the retiree would give up $6,000 of their $15,000 a year pension and the child would receive under $5,000 a year once the retiree dies. I hope for all of our listeners today that what you’ve gathered from these examples is that attempting to provide a survivor benefit through the insurable interest option can be crazy expensive, especially when you try to leave this to someone considerably younger than you are.
Scott: Well Chris, that’s a true eyeopener for anyone thinking about implementing this option. I would have never guessed that this program would be so expensive and provide a relatively small benefit to someone like a child of a federal retiree. It seems as though the government is really trying to dissuade federal retirees from selecting this option. Is that fair to say?
Chris: Yeah. You’re right on point there. The government simply does not want federal retirees selecting this option. That’s the long and short of it. The mere fact that an employee would have to qualify healthwise to even obtain this benefit means that it can’t even be used as a fallback strategy in the event that the employee might try to get life insurance and they were declined. They can’t just say, “Well, I’ll do the insurable interest,” because they have to qualify for this one too.
I do want to point out for all of our listeners who may not be really familiar with the life insurance side, the health standards for obtaining private life insurance and the health standards required to provide the insurable interest, they’re right in line. For instance, someone who has a terminal illness may have the desire to leave their pension to their child. They may have tried to apply for private life insurance and of course they would have been declined if they had a terminal illness. Likewise they’d be declined for this benefit too.
Scott: Right. This probably comes as somewhat of a disappointment to many employees who have heard about the program and assume that they could simply name someone other than their spouse to receive a part of their pension. If we could shift gears here for a moment, let’s assume that we have an employee who is healthy enough to qualify for both the insurable interest program and for a private life insurance program. When we compare programs like this, could you give our listeners some tips on what to be looking for or things to be cautious of when they’re making a decision on what to do?
Chris: Yes. I love giving these tips, or what I like to call thinking strategies, to help employees to know how to dissect the pros and cons in the decisions that they are making. I’m not here to tell any of our listeners what they should or shouldn’t be doing, but I am here to tell you the things you should be thinking about as you’re making these really important decisions.
We’ve got really four big ones. The first is you want to know what you’re trying to protect and for how long you need that protection in place. If we have a child who is disabled, we have a very different dollar amount and length of time we are trying to protect that child versus a typical child that is not disabled, that is going to grow up, go off to college, be able to care for themselves and not need mom or dad’s help. It’s just a very different scenario. You really want to get clear on what it is that you’re trying to do.
The second tip is you want to compare the flexibilities between programs in the event that things don’t happen in the way that you expect. Let me give an example. Let’s say that we have someone who retires, maybe they’re 60 years old and they end up naming one of their children to receive the insurable interest survivor benefit. If 10 years later that child passes, there’s no one else that can get that benefit. It can’t now be switched to another child or a niece or nephew or a brother or sister. You’re stuck. When the insurable interest dies so does this benefit.
Another example would be if later you decided to change your mind, once you get past the 18 month window after you’ve retired this is an irrevocable decision. So if we’re in a scenario … Let’s say we tried … The example that we gave at the very beginning, that’s the thing I don’t want anybody to do, which is to be looking at providing this benefit for a former spouse, hoping that the money eventually makes it to the children. Things might be amicable at the time of retirement, but things might change, right? I mean there’s a reason they’re an ex-spouse.
There’s all sorts of things that can change in life, but this is a program that if you selected it and 18 months has passed after you’ve retired it’s a done deal. You’re stuck, and that is never a feeling that people like to be in, when they’re stuck in a decision that they can’t escape from.
Tip number three is don’t be afraid to look outside of the government option to see if there’s a better way to protect your family other than what the government is willing to provide. A couple of things I’ll bring to your attention. First is the concept of life insurance to generate an income stream.
The whole way that life insurance works with respect to generating an income stream for a survivor, or in this case what we call a beneficiary, is that if we’re trying to protect a certain dollar amount on a monthly basis we have to do some backwards math to figure out how large the life insurance policy needs to be that upon the death of the retiree the amount is big enough to generate the monthly income stream for that survivor without running out of money. Financial advisors who work in this space in providing life insurance coverage are able to do those calculations to get you the right dollar amount that you should be looking to protect.
The next thing that I would really want you to be looking at if you’re thinking of this whole life insurance piece and maybe that provides a different option for you is to think about the amount of coverage that can be provided. For instance, if we go back to the very first tip, which is figuring out how much you’re trying to provide and how long you’re trying to provide it for for this insurable interest person, what is the dollar amount that needs to be provided, and also what is the dollar amount that the government is willing to protect?
Those might be two very different numbers. What the person needs and what the government is willing to give might be very far apart from one another, so it’s important to have those two numbers in place and recognize that sometimes even the very best of the government option can’t satisfy the entire need that a beneficiary or a survivor would have.
Another scenario, or something that I would really want everyone thinking about when they’re thinking about private life insurance and maybe some other options to solve this problem is the idea that when life changes in ways that maybe we didn’t expect … Maybe our beneficiary dies. We already know under the insurable interest that if they’re named under the government program and they die that’s it. The gig’s up. Nobody else gets any of the benefit. But under a private life insurance policy you can name anybody that you want, so if your beneficiary dies and you’ve had this plan in place for 20 or 30 years and your beneficiary dies before you do, you simply name somebody else to get it.
That way you don’t look backwards for 20 or 30 years and say, “God, what did I pay all that money for? Now nobody is going to get this.” It’s a different level of flexibility that you have on being able to rename a beneficiary that you want to receive it.
The next thing I would want everyone to be thinking about is how the benefit is paid out. Under the survivor benefit, whether it’s the spousal benefit or an insurable interest benefit, those benefits are paid out monthly to the beneficiary, to the survivor. Well, not all of the needs that we have in life come to us in little monthly chunks of things that we need, right? There might be things, expenses that they have, that are bigger than what they would get in a monthly check.
The idea of life insurance, because it’s all paid out in a lump sum, that frees a beneficiary to be able to utilize the money in the way that they need it and not in the way that the government is willing to give it to them. Again, I’m not saying the survivor benefit program under the insurable interest is bad. I am saying it’s inflexible in ways that many people, if given the opportunity, wouldn’t want it to work that way.
The next thing … We haven’t talked about this at all on this podcast but this is a great one. Any of the benefit that a person receives from the survivor benefit program, whether it’s a spouse or an insurable interest, is fully taxable to them. On the flip side, all life insurance proceeds that a beneficiary receives are income tax free. These are big differences between these two programs, but the one thing that must be true in order to get life insurance out in the private side is you have to be healthy enough to qualify for it, so don’t wait until the very end.
This brings me to my fourth tip, which is understand the role that your health has in the options that will be available to you to protect your family. Health is so important in this entire decision. Don’t wait until you retire to put life insurance plans in place. This is a discussion you should be having today. If you didn’t have it 10 or 20 years ago maybe when it was the best time, the next best time is right now.
At the end of the day, the choices we make on programs like this must be in our family’s best interest. If we have needs, sometimes they are best filled by government programs and other times we need to look out into the private sector for a solution that fits us.
Scott: Right. At the start of this podcast you had made a clear delineation between the insurable interest program, what we just covered, and the children’s survivor benefit, so I’d like to transition into that second topic of the children’s survivor benefit. How should we get started on that Chris?
Chris: Let me start by telling our listeners that this is a pretty straightforward program and it only takes a few minutes to explain. This benefit, the children’s survivor benefit, is payable to children whose parents are under CSRS or FERS regardless if the parent was still working or has already retired at the time of their death. For this purpose, children are those who are up to age 18, or 22 if they’re a full time student. They would qualify to receive this program. In addition, children who are deemed disabled and incapable of self-support prior to the age of 18 will receive this benefit indefinitely.
Scott: Okay, and would you give us an idea of what a qualifying child would receive?
Chris: Yeah. These numbers change each year, so for 2017 … There’s kind of two different categories. The first category is if there is still one living parent who was married to the deceased person. Mom and dad have a child, mom passes, dad’s still living. The child would receive $513 per month, and that would be payable up to three children. If there’s more than three children, then they simply get a pool of money to share, so that ends up being $1,539 per month. If there are 10 children, then they get to split that $1,539.
The other category of children are children who have no living parents, or if there is a living parent they were never married to the deceased parent. So mom and dad were never married, one of them is still living, or neither one of them are still living, so kind of a mixed category here. That child would receive $614 per month. Again, payable up to three children. If there’s more than three children they simply split a pool of $1,842 per month.
Now with the survivor benefit plan I want to make a very important distinction here for the children’s survivor benefit. The children’s survivor benefit is a flat dollar amount and is irrespective of the pension that mom or dad was entitled to. Like most things we talk about on these podcasts, of course there’s always a catch, right? The catch is that any money payable under this program, under the children’s survivor benefit, is offset dollar for dollar based on money received from the Social Security program. This would assume that mom or dad had Social Security benefits payable to them.
While on the surface this program looks good, most children never actually see this money because the amount that they would have received from Social Security would be higher, so it would have completely offset this program.
Scott: Right. Now does receiving this benefit have any effect on other benefits for any children?
Chris: Yes. Being entitled to receive this benefit allows children to continue to have access to the federal employee’s health benefits program. This is true even if the entire children’s survivor benefit is offset by Social Security. They don’t actually have to receive any of the money. Just the fact that they were entitled to it initially before it was offset means that they get the health insurance. This essentially means that even after both mom and dad have passed, a child of a CSRS or FERS parent would retain their eligibility to keep FEHB.
The key takeaway for all of our listeners is that if you have a minor child or a disabled child even beyond the age of 18, they get to keep their FEHB, but we must leave them enough money to pay the premium. These children will get to keep FEHB for as long as they were entitled to the children’s survivor benefit payment.
Scott: That’s interesting that a benefit that might not actually yield money for a child ends up making them eligible for a benefit that is so important like the FEHB.
Chris: Right. Funny that it happens that way sometimes, isn’t it?
Scott: Yeah.
Chris: So Scott, I hope that our episode today helped to dispel some myths about the insurable interest survivor benefit and the children’s survivor benefit programs. My best hope is that our listeners take this information and become a better advocate for themselves and make the best decisions to benefit their families the most.
Scott: Yeah. Chris, you always have such a great way of really breaking down these big subjects in a way that helps our listeners feel like they can start to take action. I also know that seeing you and your team live is a game changer for the employees who have had the opportunity. If our listeners today wanted to see if there was a live workshop in their area, how can they find the list of dates and locations?
Chris: Of course I love getting podcast listeners into our live session. I mean how exciting is that, that they heard us in this platform and then they get to come to the live training? Any of you listening today, if you want to get the dates and locations of our live workshops sent right to your inbox, you can visit fedimpact.com/learnmore. You’ll enter a little bit of information and we’ll send it right over to you, so we hope to see you at a live workshop near you soon.
Scott: It’s always a great pleasure to have Chris Kowalik of ProFeds with us. We’d like to ask you to stay tuned to the Fed Impact podcast to get straight answers and candid insights on your federal retirement.
