Q.
I am a physician with a fairly large amount of life insurance. I have a non-working spouse and a daughter. I would like to see an article aimed at a potential surviving spouse regarding how to best manage and utilize a large death benefit, in order to maintain a comfortable standard of living. I believe that there are many physicians in situations like mine whose spouses could benefit from having a plan in place if the unthinkable would happen. Pitfalls to avoid in that situation would also be valuable.
A.
I often tell doctors to buy oodles of term life insurance if they have someone else depending on their income. Getting that in place is far more important than having a pre-set plan about how to use it in the unlikely event it actually pays out. Nevertheless, this is an interesting financial planning question to think about, no matter how morbid.
In some ways, it is no different from any other windfall. But there are some unique things about getting a life insurance payout due to a spouse's death that we can discuss. In reality, you should have the outline of a financial plan in case of your death (or the death of the person whose income you depend on) before you buy the life insurance. How much you buy really depends on that plan. For example, if the plan is for your spouse, the orthopedist, to continue working then there might not be any need for life insurance on you at all! For this reason, we don't have any insurance on my spouse. We figure between our savings, WCI income, and clinical income, even if I cut back some, that we can scrape by. However, if I die, things might be a little different. We're rapidly approaching financial independence, but we're not there yet, so we still carry significant life insurance on me ($1.75 Million actually, in a $750K 20 year policy that will expire when I'm 52 or so and a $1 M 30 year policy whose term goes to when I'm 57 or so.)
You all know I like making lists, so let's make one about all the things to consider if you are the unfortunate recipient of a big life insurance benefit check.
# 1 Don't Do Anything Quickly
There is no reason you have to do anything for months after your spouse's death. This is the time to grieve. While it might be nice to distract yourself a bit with some financial chores, don't feel like you have to do any of this for a while. As long as you had a big life insurance policy on the breadwinner and you're not grieving your way into the Lamborghini dealership, you can likely ignore your finances for the most part for at least a few weeks, if not a few months. When they send you the life insurance check, deposit it someplace safe. Remember that each of your bank accounts may only have FDIC (Bank) or NCUA (Credit Union) insurance for $250K. So if it is the usual $1-5 Million I recommend, you may want to split it up a bit, just in case.
# 2 Consider Your Other Income
The one problem with heliskiing is that every run starts and ends in a terrible windstorm
There's a good chance that you have some other income, aside from the earned income of your deceased spouse. The more you have, the less you will depend on that life insurance money to provide your income. This might include income from a rental property, your own earned income, income from a taxable investment account, or book royalties. Be sure not to forget about the Social Security survivor's benefit, and I'm not talking about the bizarre one-time $255 check they'll send you. You can check for the real survivor's benefit on your (or your spouse's) annual Social Security statement, (or log on to the Social Security website) to see how much you (or your spouse) may get. For example, my statement says that if I die my spouse caring for my child will get $1,961 per month and each of my children will get $1,961 per month, with total family benefits totaling not more than $4,577 per month. The rules are a little weird, but in my case, if I die my spouse starts getting $4,577 per month, indexed to inflation. That will continue until my second youngest graduates from high school more than a decade from now. Then it will decrease to $3,922 for another 4 years until the youngest is 16 at which time the spousal survivor benefit goes away until she hits full retirement age. But for another 2 years until the youngest turns 18 and finishes high school, she will continue to get $1,961 per month. At that point, my spouse will be 56 and closing in on retirement age anyway. At full retirement age, she would get $2,615 per month. The bottom line is that just the Social Security survivor benefit would pay my surviving spouse almost $55,000 per year for over a decade, with a lesser amount for most of another decade.
# 3 Consider Your Earned Income
The plan for many couples in the event of the untimely death of the breadwinner is for the spouse to go back to work, if not immediately then eventually (such as when kids are in school full-time or after they leave home.) That can obviously provide significant living income. If you carry enough life insurance, you can eliminate that need, but it is okay to bake that into your plan as well if your spouse is okay with it.
# 4 Figure Out The Student Loans
Now would be a good time to see what happens to your student loans in the event of your death. Federal loans are generally forgiven in the event of the borrower's death, but that is not always the case for private loans (including loans that have been refinanced.) So read the fine print. That's not to say don't refinance, but if you refinance with a lender that would assess your loans against your estate in the event of your death, use some of your interest savings from refinancing to buy some more inexpensive term life insurance. If the loans are going to be forgiven, make sure you don't pay them off with the life insurance money!
# 5 Consider Reducing Your Fixed Costs
While you shouldn't do anything in the first few days, weeks, and maybe even months, as soon as you have moved through the initial grieving process it is a good idea to look into any fixed costs you could reduce. For example, if you are now the only driver in the family, you can probably sell one of the cars. That will reduce licensing, insurance, and maintenance costs, but also depreciation. Plus, if the car is worth anything it will boost your savings by a bit. You may also want to get rid of “his” (or “her”) toys like a boat, RV, guns, snowmobiles etc for the same reasons. Pay off any consumer debts like credit cards or car payments. Pay off your student loans. Consider using some of the insurance money to pay off the mortgage. While all of this reduces your available cash, it has a more important effect of reducing your need for cash flow. In fact, you might even get it down to the point where Social Security and investment income is enough to meet all your needs.
# 6 Remember Your Retirement and Other Savings
As time goes on, the retirement portfolio eventually replaces the life insurance need. Chances are by the time your spouse dies, there will at least be something of a nest egg started. If what was formerly the retirement nest egg makes up a relatively small portion of your new nest egg (previous savings plus life insurance), then maybe you should just let it continue to compound for your retirement and plan on using the life insurance for living expenses in the meantime. However, if the old nest egg makes up the majority of the new nest egg (and this is usually a good thing) then you may want to incorporate it into your current income plan. Don't be afraid of the Age 59 1/2 rule, it's relatively easy to work around.
# 7 Time For A New Financial Plan
Your financial life has now changed dramatically, and so must your financial plan. If you feel knowledgeable and confident doing that yourself, then go right ahead and draw up a new one. If that makes you quiver, now is a good time to seek some professional help. Even a couple of hours with a good hourly rate financial planner can make a big difference.
In a scenario like that of the question at the beginning, where the family's only breadwinner has been replaced by a big life insurance check, the retirement date for the spouse has basically been moved forward. That means retirement will last longer and there will be a longer period of “retirement” before spousal (not survivor) Social Security benefits and Medicare kick in. So you may want to use a slightly more conservative initial withdrawal rate, perhaps as low as 3-3.5%. (i.e. a $3 Million nest egg provides $90K-105K in additional income per year. Now the retirement accounts, your taxable account, and all of the insurance money that didn't go toward debt reduction is one big pot of money with a single goal- to help you live comfortably for the rest of your life. So you should probably revisit your asset allocation with these changes in mind.
# 8 Withdraw Tax-Efficiently
Be conscious of how you withdraw from each account. If you're careful, you may have a very low effective tax rate. You won't be paying any payroll taxes. At least some of the Social Security survivor's benefit won't be taxable (remember a big chunk of it technically goes to your children and so will be minimally taxed if at all.) If you are in a low enough bracket (i.e. the 10% or 15% bracket) you won't even have to pay taxes on any capital gains or qualified dividends from a taxable account. You can continue to tax loss harvest and use appreciated shares for charitable donations to further reduce your tax burden. Like a typical retiree, you can carefully balance withdrawals from the tax-free and tax-deferred retirement accounts to determine your own maximal marginal tax rate. You may be surprised at how low the rate applied to your tax-deferred dollars can be. Remember, of course, the general rule is to spend taxable assets (including life insurance benefit money) before retirement assets, thus preserving the tax-protection and asset-protection benefits of the retirement accounts as long as possible. But opportunities to get tax-deferred money out at very tax rates (like 0-15%) are the exception to the general rule.
If this is all very intuitive for you, then you likely will not need a financial advisor. If it is not, then don't feel badly about hiring one. You really don't want to blow this. But do make sure you are hiring someone who is giving you good advice at a fair price and remember that money used to pay that fair price is money you cannot spend on something else.
# 9 Extra Money?
Now, if there is more money than you really need, there are two other considerations. The first is to give some to your children, perhaps as a 529 or UGMA contribution. Many people buy enough life insurance to pay off the mortgage, provide for their spouse for the rest of their life, AND pay for their kids' educations. The second is to give some money away. Just like any retiree with more than “enough,” giving money away can enrich your life.
What do you think? Did I forget anything? What would you do if you had a big life insurance windfall from your spouse's death? Comment below!
I have not been through widowhood but my mother did. My mother was left widowed at age 35 with 2 small boys. This was in the 1950s. Her first husband did not have life insurance so she moved in with her parents and got a job. She remarried at 39 to my father. She deposited those social security checks every month into accounts for my brothers. They both went to college with the money. One is now an engineer and the other a lawyer.
Thanks for sharing such an inspiring story. I’m glad it worked out for your mom. It’s always great to get help from family in case of an emergency. Mr. FAF and I have gotten a lot of help from our parents and extended family. We can’t wait to be able to give back to them as well =)
Excellent considerations. I think in most situations, the surviving spouse will need a financial advisor to guide them through the process, at least in the beginning. One thing the couple could decide on in advance is the financial advisor the widow would hire to guide him or her through this process should it be necessary. This would give both people peace of mind that the finances will be managed properly if the physician passes away.
This reminds me of of Phil DeMuth’s worry in The Affluent Investor:
“I have a nightmare. I have died, and, after a suitable period, my wife is at a cocktail party. A brylcreemed young stockbroker discreetly turns the conversation to the stock market, and in passing drops the name of some space-age investment product that pays spectacular dividends. The next day at his office, he looks over her portfolio, and says, ‘Yes, I see what Phil was trying to do for you. This was really the best that could be done at the time. Of course, today you could be making a lot more money….’ and then in a couple of years everything is gone.”
#7 should prompt couples to include financial education for the non WCI reading spouse while both are alive. In addition to the money you’ll be glad your family hAs after you’re gone, knowing it will do its job of providing for them without someone cheating them or overcharging them is as reassuring as carrying the right amount of life insurance.
Also, while WCI should have the money to cover the costs of all his wife does for him if he’s widowed, as an advisor made us realize when my second pregnancy was the most risky thing going on and my term life would end when that baby was 4, a doctor widow/er will spend a whole lot of money and/or hassle keeping a full time physician job and caring for maybe small children and a home solo. I got another policy to get us to the teen years with enough dosh to hire a nanny if one of us died (beats remarrying too quickly)!
And though he might have been teasing me, my husband’s financial education started during the first pregnancy when, after I reminded him of the large sum of cash coming should I die, he quipped “that’s a lot of money! Maybe I’ll get a plane. Or race horses!”
Very good points.
My wife really can’t stand dealing with investments and the thought of what she’d do if I pass away tomorrow is a top reason I’m not 100% self-managed. If I were, she’d likely hire someone at 1% or more. Using a robo-investing solution like we do now, all she really needs to know is a safe withdraw rate and which account(s) to draw from.
Regardless of your decisions, everyone should at least have some sort of plan for a surviving spouse.
This was a timely article for me as I’m in the process of putting together a what to do if something happens to me document for my wife. She has no interest in finances whatsoever so I’m trying to leave explicit instructions. The only things I see missing from above is what happens to the hsa account and is there any effect on preexisting 529 accounts?
A couple of weeks ago, I put together such a document for my wife and daughter. It’s simple, but I’ve walked her through everything. Mostly, it says to use my life insurance money to pay off the house and deposit the remainder in a brokerage account with Vanguard. I’ve told her the AA (65/35) to use as well as the specific funds. She would use a 4% flexible withdrawal rate (4% of assets every year). I’ve also told her specifically to not invest with anyone but Vanguard and to absolutely not let anyone put her assets under their management. For computing taxes and for additional advice, I’ve instructed her to have a CPA help. Finally, I’ve instructed her to sign a pre-nuptial agreement with her future husband stating that he’ll never have any claim on her assets.
529s are easily dealt with. With the Utah one you can name a Successor account owner and a secondary successor account owner. So just put your spouse as the successor account owner.
If your spouse inherits your HSA, it simply becomes his/her HSA.
So many people forget the social security payout. Honestly I hadn’t thought much about this from my side as I’m the primary bread winner. From my wife’s perspective I did have insurance set up to cover five years for her to settle back into work should something happen. However in the last few years when coupled with social security it’s getting to the point where she will be done working. As such the bigger concern is I manage the investing today and my wife is not comfortable doing so. As such the big one in our case is to simplify accounts ahead of time and setup someone who can give her investing and financial advice should something ever happen to me.
It would be a really good idea to write out some straightforward instructions for my wife in the case of my untimely demise. Here’s where the money is invested, these are the passwords, this is how you’ll access the money, and here’s who you can contact for help.
I didn’t know about the social security survivor benefit. $4,577 a month would cover the bulk of the family expenses.
Best,
-PoF
It might be illegal for her to use your access on bank accounts etc if you’re dead and remember Nora in The Doll’s House; maybe even if you’re temporarily incapacitated. I do everything at USAA on my husband’s number- and they know I do so- but would immediately swap out to mine (hmmm better keep that somewhere I can find it, don’t have it memorized like his) if he were gone.
I think this is one of the reasons I am always talking to my wife about personal finance. She does not have a natural interest for this stuff. So I figure it is my job to talk about it intermittently. Hopefully if I pass and she gets the big windfall, she will know the basic tenants to good Personal Finance.
I also have never refinanced my loans in the case I die. They will be forgiven. I am still paying them off earlier then I have to because I don’t plan on dying, but if it happens at least that cost will disappear.
“the general rule is to spend taxable assets (including life insurance benefit money) before retirement assets”
Just to clarify, it is my understanding that life insurance proceeds are not considered taxable. I’m assuming this is referring to putting the 1-5 million dollar life insurance payout check into a taxable investing account, the gains of which are taxable?
The assets are taxable in the same sense that money in the bank is taxable. As it earns money, it is taxed, but you’re not taxed just for having it. So your understanding is correct.
I listen to the Dave Ramsey show, and he often gives term life insurance such a bad rap. I’m not sure how it works, so I have no comment on that. I have life insurance through my job, and my husband will get his through his new job. But it’s good to know how we should plan if something happens in the future. Thanks for sharing!
Actually, his big hobby horse is whole life insurance. It can be appropriate in a very few instances, but it’s probably wrong for 99% of the people out there. He highly recommends term life insurance, which is what the lion’s share of people actually need.
I think you are thinking Dave hates whole life insurance. One of his major sponsors is a term life only firm and he recommends them all the time.
The problem with employer provided insurance is it usually isn’t portable and it is rarely enough.
Thank you for this post. My wife is a wonderful wife and mother, but she grew up with parents that were so openly nervous about finances, that the thought of dealing with money gives her chest pain and palpitations. I forwarded it to her and will archive it in case I die.
My biggest take home from the comments is to have a written plan with all the contact info for the financial advisor, accountant, insurance broker, etc with all the account information. It seems that for the spouse unable to deal with finance, it would be best to have her contact the financial advisor with all the info and just ask how to deal with it. Seems peace of mind is worth more than a little extra commission, if needed.
Don’t forget you have 9 months to file for portibility law. Which means if the second spouse die with more than 5.5 million than the family won’t lose 2\3 of the money over 5.5M to estate taxes. Also start taking Roth RMDs before end of next year otherwise the entire Roth will be delivered to you in cash in 5 years. If the spouse was more than 70.5 make sure to finish that years IRA RMD other lose 50%to penalty. If you are younger make sure to start taking RMDs with your age calculations by December of next year
Good reminders.
You must be referring to Roth 401(k) RMDs, because there are no Roth IRA RMDs. So the usual move is to roll a Roth 401(k) into a Roth IRA to avoid RMDs.
A spouse under 70 can just roll traditional IRAs into their name and defer RMDs until they reach 70 if they want.
http://www.kiplinger.com/article/retirement/T032-C000-S004-when-a-spouse-inherits-an-ira.html
Excellent points! However, the social security check is not guaranteed if the remaining spouse still has income. I am a newly graduated medical student and my physician mother passed away last summer at the age of 52. She was receiving disability benefits due to complications from lupus. When my father who is also a physician tried to claim those benefits, they denied him because his income was too high. The social security office said it was a little known fact. “If you’re younger than full retirement age during all of 2017, we must deduct $1 from your benefits for each $2 you earn above $16,920. If you reach full retirement age during 2017, we must deduct $1 from your benefits for each $3 you earn above $44,880 until the month you reach full retirement age.” https://www.ssa.gov/pubs/EN-05-10069.pdf
Interesting. Thanks for sharing.
I was widowed 5 years ago and did receive a large life insurance pay-out. I am glad to read your advice and know that I have done just about what you have recommended. It would have been helpful if my husband had left me the name of a financial adviser, but I was able to find help when I needed it. However, I had to be wary of who to take advice from and I am still very cautious. This money came to me at a very high price and I am a conservative investor. I commend all of you who are making a plan to help your surviving spouse. My husband was in his early 50’s and died quite suddenly after a brief illness and his death was very devastating. I was not prepared and there was lots of work to do. I am doing well now and am very thankful that he did provide for us even in death. I am glad you wrote this article.