Home  >  Financial Articles and Q&A  >  What are the benefits of having life insurance tied to a...

What are the benefits of having life insurance tied to a 403B? Are the costs worth the insurance?

Feb 16, 2014 by Linda from Mt Pleasant, SC in  |  Flag
4 Answers  |  6 Followers
Follow Question
3 votes

Hi Linda,

By insurance I am assuming you mean that your 403(b) plan offers variable annuity separate accounts as investment options inside your 403(b). Variable annuities are life insurance products in that, in their simplest form, the insurance company promises to pay your heirs at least the amount you invested in the variable annuity should you die when the value of your investment is lower than what you invested. There a separate fee charged, called Mortality Expenses (M&E), for this protection. The fee can range from 0.50% to 1.5% per year.

I’m not a fan of variable annuities inside 403(b) plans or any other tax deferred vehicle/account. I don’t believe that the insurance protection component of the investment is worthwhile inside a retirement account. If you have invested properly for your age you should not need the protection and the cost will eat into your retirement account balance. If you are younger you probably should be invested aggressively. In this case you should expect the investment market to decline temporarily many times during your investment time horizon. However if you believe the permanent market return trend is up then you expect the markets to recover with time. In other words you don’t need the insurance. Instead the insurance will cost you 18% of your account balance over 20 years if you earn 6% instead of 7% due to an additional 1% cost. Unlike the temporary market declines, this expense is permanent. If you are older and closer to retirement then you should be invested more conservatively and not need the insurance.

Variable annuities (and fixed annuities) do offer tax advantages. However you already have the same tax advantage with any investment you own inside your 403(b). Investments inside your 403(b) account will grow tax deferred until you withdraw from the account. Therefore there is no reason to pay extra for a variable annuity to achieve tax deferral since you have it in the first place.

If an annuity makes sense for you after you retire then you can purchase the annuity then by rolling your 403(b) balance into an IRA and then purchasing any annuity available on the market. In other words you are not passing up the opportunity to purchase an annuity if you choose not to do so inside your 403(b). Someone will be happy to sell you an annuity later.

This is actually a fairly complex topic and I’m suspect you will receive additional advice from my colleagues.

3 Comments   |  Flag   |  Feb 16, 2014 from Woodbridge, VA
Rich Winer

I would love to know exactly what Linda is considering (i.e. what products and who recommended it). There are some gimmicky life insurance products that I've seen bundled with retirement plans and sold to teachers by the same predatory companies that push tax-sheltered annuities. I would love to know more specifics about what was recommended to Linda.

Flag |  Feb 16, 2014 near Woodland Hills, CA
John A. Frisch CPA/PFS, CFP®, AIF®, PPC

You’re right Rich. We work with many retirement plans. My experience is that sophisticated individuals have for the most part come to understand the importance of objective fee-only investment advice versus conflicted, hidden fee investment sales in their personal investment accounts. Back in the 80s and 90s this was not the case but sometime around 2000 the word started to get out. About 5 years ago 401(k) sponsor started to slowly catch on. The 2012 fee disclosure rules really sped up the learning process. Fees are falling fast. But 403(b) plans are very unfortunately still in the dark ages. I just hate it when I meet with a recently retired teacher who was sold a high commission annuity in her plan with a 9 year surrender period just as she was retiring. I can’t wait for the 403(b) sponsors to catch on and act like fiduciaries. They are dealing with their employee’s retirement and should take it much more seriously. But, in my opinion, we are years away.

1 like | 
Flag |  Feb 16, 2014 near Woodbridge, VA
Rich Winer

Most school districts have the worst selection of investment plan providers and custodians. Even worse, they open their doors and teachers lounges to the most predatory insurance companies. I've met teachers in their 20s (with 40 or more years until retirement) who were sold fixed and indexed annuities with 10 year surrender periods. That's criminal.

2 likes | 
Flag |  Feb 16, 2014 near Woodland Hills, CA

1|600 characters needed characters left
3 votes

My answers are none and no.

Tying together life insurance and investment decisions just complicates the two issues. The 403b is investment, so invest the money directly in a suitably diversified portfolio of investments based on your age (more fixed income / guaranteed funds as you get older, more growth fare (stock funds) if you are younger.) As for life insurance, term life insurance is the best choice for most people, the details of which depend on your family situation and are best determined by a fee only financial planner who is NOT selling the insurance you need to buy! Yes, you pay him money - but you will avoid being sold more insurance than you need, or expensive products with bells and whistles you don't need - so the investment will pay for itself. And he/she can help you with those 403b options as well. Look on this site or at CFP board or NAPFA websites for an advisor in your area who will work for an hourly fee.

Comment   |  Flag   |  Feb 17, 2014 from Bridgewater, NJ

1|600 characters needed characters left
1 vote

I'm in total agreement with everything that was said prior.

I feel like someone needs to play devil's advocate since this is a discussion site, so...

What if you can't get life insurance because your health won't let you qualify? Maybe having the life insurance that goes along with the annuity to at least guarantee the principal paid in might give some piece of mind.

3 Comments   |  Flag   |  Feb 24, 2014 from Alexandria, VA
James D. Kinney, CFP®

If the cost benefit of this made sense, then fine, but it doesn't. You get very little coverage when you think about it. The so called insurance only pays if your portfolio is under water at the time of your death. But let's say in 10 years the portfolio has doubled in value, what is the insurance worth then? Nothing. But you have to keep paying forever because you are locked into a contract. Like I said, buy insurance separately, if you are properly insured your family will not care if the portfolio is down 10%.

1 like | 
Flag |  Feb 24, 2014 near Bridgewater, NJ
James D. Kinney, CFP®

Or let's say your 100k portfolio is down by 10% after 10 years (maybe because of all those hefty fees you paid). And maybe you have the misfortune to die. So your "insurance" pays your heirs 10k. But if the annuity feature cost 1% then you effectively paid $1000 a year for $10000 in benefit. Not a good deal in my book.

1 like | 
Flag |  Feb 24, 2014 near Bridgewater, NJ
James D. Kinney, CFP®

Sorry I missed the part "if you can't afford insurance" the answer is still no, because this is not really a replacement for insurance, IMHO. It is so ridiculously expensive for the tiny potential benefit.

1 like | 
Flag |  Feb 24, 2014 near Bridgewater, NJ

1|600 characters needed characters left
1 vote

I would argue that if you are trying to save for your retirement, you should try to do so, all things considered, with the most reasonable cost structure, and mutual funds would be a far less expensive cost structure than annuities or life insurance.

Here is another argument for not having life insurance in a 403(b). Life insurance, even death benefits of an annuity, if paid with pre-tax dollars, as it would be in a 403(b), should be subject to taxation on the death benefit. I would check to be sure this is correct in your specific instance.

Because no one is aggressively marketing the mutual funds, employees often are not aware that they are available. It is possible, but not probable, that your employer does not offer mutual funds, but I would call HR ask specifically if their plan does.

Comment   |  Flag   |  Mar 25, 2014 from Delray Beach, FL

1|600 characters needed characters left