Scott recommends a strategy for protecting a surviving spouse from loss of pension income.

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Scott Hanson: AJ, you're with Hanson McClain.

AJ: Thanks for taking my call, Pat and Scott.

Scott Hanson: Sure.

AJ: I'm a federal government retiree, been retired for about three years. About age 49 I saw that my insurance premiums through the federal employee government life insurance were going to go up significantly, so I switched to a term insurance policy outside the government.

Scott Hanson: Okay.

AJ: Expecting to have 20-year term, I was hoping for coverage through about age 70. Recently found out that my 20-year term is actually a 10-year term.

Pat McClain: Okay.

Scott Hanson: How did that happen?

AJ: That's a good question.

Scott Hanson: Okay.

AJ: I'm trying to find that out. I think I got sold a bill of goods and I should've read the fine print.

Scott Hanson: Didn't read it. Well, you can't read everything. That's the problem with things.

AJ: Right. Now I'm faced within about the end of next year I'll need to either convert to another term insurance policy or just switch over to market rates. He's telling me upwards of $13,000 or $14,000 a year which is ridiculous for about $600,000 worth of coverage.

Scott Hanson: Here's the question we have, AJ. Life insurance is designed to replace an income stream that is dependent upon one's life most of the time, which is either to replace income in case something happens to them, or if they have a pension that is tied to them. We also see life insurance used sometimes for estate planning purposes, but you probably don't have an estate north of $11 million I'm guessing.

AJ: Not yet.

Scott Hanson: What's the point of this life insurance?

Pat McClain: Yeah. Why do you own it?

AJ: The reason is I would like to be able to replace the pension income lost if I pass away to my wife.

Scott Hanson: Got it.

Pat McClain: What pension option did you take when you retired?

AJ: I'm under the civil service retirement system. We have survivor benefits for my wife.

Pat McClain: Do you have full survivor or 50% survivor?

AJ: She gets 50%.

Pat McClain: Okay. How old are you now?

AJ: I am now 58.

Pat McClain: Okay, you're 58 years of age.

Scott Hanson: How old is your wife?

AJ: My wife is the same age.

Pat McClain: You have a joint and survivor, so she'd receive 50% of whatever you're receiving, correct?

AJ: Correct, and I'd like to make up that difference with the term insurance.

Pat McClain: Correct. Tell me about your overall financial picture. How much money do you have in savings? Do you own your home? Tell me about that, because I question whether you need it at all or whether you just want it.

AJ: Sure, sure, I'm glad you asked. We have about $300,000 in money market mutual fund and TSP government securities like you were just talking about.

Pat McClain: Okay.

AJ: We have about $300,000 in equity of our home.

Pat McClain: Okay.

AJ: We owe about another $40,000 on it. My pension from the government is about $70,000 a year, so it would be cut in half when I pass away for my wife.

Pat McClain: Did you go back to work at all?

AJ: No, I'm enjoying a full retirement.

Pat McClain: I think...

Scott Hanson: And will you both be eligible for Social Security?

AJ: I will not be. My wife will be.

Scott Hanson: Okay.

Pat McClain: I think...

Scott Hanson: Do you have any idea what her Social Security will be?

AJ: I think it's in the range of about 800 a month or something.

Pat McClain: And will you...

Scott Hanson: And that's at age 62?

AJ: That I think was a little higher than that. I think it was...

Scott Hanson: It was at a normal retirement at age 66?

Pat McClain: Wow.

AJ: I think it was 66.

Pat McClain: Okay, okay. I think you probably could use a little bit of insurance.

Scott Hanson: Yeah, because if you died today your wife's income is going to be cut in half. She doesn't have Social Security. She still has a little bit of mortgage on the house. As you get older, you're going to need less and less.

Pat McClain: Here's what we look at. $35,000 a year would bring you back. Remember, life insurance comes out tax free so you could cut that down by about 25%. You need about $25,000 or $26,000 a year to fund that. You could probably get away with a half a million dollars in term life insurance policy. I would probably just do a 20-year level term or a 15-year level term.

Scott Hanson: Well, that's going to get expensive at his age, 58. What about a decreasing term insurance?

Pat McClain: My point was I was going the same direction, Scott. Either you could buy a decreasing level term, or you could just lower the face value automatically every year over the next 15 years.

AJ: Okay.

Scott Hanson: I would look at decreasing term.

Pat McClain: I would look at a decreasing term but doing it a little bit differently which is me lowering the face value.

Scott Hanson: Yeah, but the problem is if they underwrite him for a 20-year level policy, they're taking on the risk that he could keep this policy in force for the next...

Pat McClain: In a decreasing level of term. Are they less expensive? I don't know.

Scott Hanson: Oh yeah. Yeah, yeah, because with decrease, let's say you had a policy that declined from 500...

Pat McClain: AJ?

AJ: Yes.

Pat McClain: Hold one second while Scott explains this to me, because I truly don't know.

Scott Hanson: No, you have a policy that's $500,000 today and it declines to zero over let's say the next 25 years.

Pat McClain: Okay.

Scott Hanson: Just an example. So, 20 years from now instead of having $500,000 the insurance company is not on the hook for $500,000.

Pat McClain: So, they're going to underwrite it more favorably.

Scott Hanson: Absolutely, but less expensive because as you get older they're on the hook for less and less. You're going to die one day. They know that.

Pat McClain: And, they don't have that mortality rate if you become sick because it's an automatic.

Scott Hanson: You're going to need less and less as you get older.

Pat McClain: I like the idea. How much would you start with, a half a million dollars decreasing term?

Scott Hanson: Or, maybe do a $100,000 policy at a 20-year level and then do the remainder at a decreasing term.

AJ: Okay.

Pat McClain: All right?

Scott Hanson: All right. Wish you well, AJ.

AJ: Thank you very much, gentlemen.

Pat McClain: All right, appreciate it, thanks.