Advanced Wealth-Strategy

Upscale Planning

Leveraging Social Security benefits with life insurance

by Russell E. Towers JD, CLU, ChFC

Mr. Towers is Vice President – Business & Estate Planning for Brokers’ Service Marketing Group, Providence, RI. Connect with him by e-mail:

Upscale clients who are thinking of retirement may not need their Social Security retirement benefits to cover their fixed costs of living.

They may have other sources of income such as rental income, defined benefit pensions, K-1 “pass-through” income from ownership of S Corps or LLCs, required minimum distributions from IRAs, and other investment portfolio income.
Whether they retire at the full Social Security retirement age of 66 (born prior to 1955), or wait for a maximum benefit at age 70 to take advantage of a payout that may be over 30% higher than age 66, these clients will have to decide where to place their after-tax Social Security benefits.

Your clients can simply place their unneeded after-tax Social Security into low yielding money market accounts, bank CDs, bond mutual funds, or U.S. government securities. And the low historical yields on these fixed assets are taxable as well.

Or they can allocate their after-tax Social Security benefits into an annual premium for a no-lapse UL or SUL policy where the death benefit for their heirs is income tax free and the Internal Rate of Return (IRR) at life expectancy is substantially greater than current fixed financial asset yields.

A Long Term Care rider on the life insurance policy can offer additional protection from future extended care costs.

Identify current and future expenses

In the planning process, your clients should identify the amount of Social Security income that is NOT needed for their current and future retirement expenses. Inflation and potential long term care needs should be factored into the equation. Then, your clients must decide where to place the after-tax funds NOT needed for fixed expenses. Shall it be a low-yielding side fixed financial asset or shall it be for an annual life insurance premium?

they can allocate their after-tax Social Security benefits into an annual premium for a no-lapse UL or SUL policy where the death benefit for their heirs is income tax free

Depending on total income from all sources, Social Security benefits may be taxable. If one-half of Social Security benefits plus adjusted gross income exceeds certain thresholds, then up to 85% of these Social Security benefits are taxable as ordinary income.

Your clients can potentially increase the net inheritance to their heirs by purchasing the life insurance policy. The policy may be owned personally or owned by an Irrevocable Life Insurance Trust (ILIT) if federal estate taxes and/or state death taxes are a concern.

Let’s take a look at a simple example to illustrate the difference between placing the applicable after-tax benefits in a low-yielding and taxable fixed financial asset versus the leveraged income tax-free death benefit of a Survivorship UL policy (SUL).

Facts of Case and Comparison of Alternative Fixed Financial Asset to Life Insurance

Assume Mr. and Mrs. Johnson are both 66 years old and have decided to take their full Social Security retirement benefits.

They have significant income from their rental real estate properties as well as a defined benefit pension from Mr. Johnson’s prior working life. They expect to receive a combined Social Security benefit of about $45,000, which when added to their other income, will mean that 85% of their Social Security benefits will be taxable income. Based on the Joint Life U.S. government Table VI, they have a joint life expectancy of 24 years (age 90/90). Their assumed marginal income tax bracket is 35% (i.e. they get to keep 65%).

Calculation of After-Tax Social Security to be Re-Allocated

  • $45,000 SS benefit x 85% = $38,250 of taxable income and $6,750 of tax free income
  • $38,250 x 65% = $24,862 after-tax PLUS $6,750 tax free = $31, 612 total after-tax
  • Assume a rounded-off after-tax amount of $30,000 will be placed into either a low yield fixed financial asset with an after-tax yield of 2% (3% pre-tax) or placed as an annual premium into a no-lapse SUL policy with preferred underwriting

As you can see from the simple comparison above, the life insurance death benefit provides a great IRR at joint life expectancy year 24 (8.06 % IRR). This is a tax-free benefit which, in a 35% tax bracket, translates to a pre-tax equivalent IRR of 12.40 %. If the clients live to age 95, the fixed asset fund would only grow to $1,187,042. Even at age 100, the fixed asset fund is only $1,469,834. ◊