A recent conversation with an aspiring federal retiree led us to his view of the survivor annuity being too expensive and not worth taking. But is it really expensive, and is it worth taking?

The federal employee’s actual statement was this:

“I’m not going to take the survivor annuity because it costs over $500 a month. I’ll just invest the money instead.”

While I’m glad he is thinking about his retirement choices ahead of time, he doesn’t quite understand the impact that a survivor annuity can have versus investing $550 a month. There really isn’t a comparison between the two.

The survivor annuity is essentially a life insurance policy that only benefits your spouse (outside of an insurable interest, which usually isn’t practical). In this employee’s case, he was going to have a FERS Annuity of $5,500 a month; his plan was to take a reduction of $550 a month so his wife would receive a benefit of $2,750 a month if he passes away before her. It also allows a nonfederal spouse to continue FEHB, but—in this case—the spouse is a federal employee as well.

If he dies a year into retirement, she will begin receiving the survivor annuity of $2,750 monthly and will get cost of living adjustments (COLAs) annually. If he does not take the survivor annuity, she would only receive what he has saved from getting the higher FERS Annuity:

$5,500 – $4,950 = $550 a month.

Would investing the difference be better?

It could be, but it would take a lot of time. You first must reduce the $550 to around $450 because it will be taxed federally and possibly by the state. The amount needed to produce an income of $33,000 a year ($2,750 month) is around $660,000 if you assume a 5% distribution. How long would it take to get to a lump sum of $660,000?

• Earning 7%, it would take about 32 years
• Earning 10%, it would take about 26 years

The age of the spouse must be considered in these cases. She is five years younger, so if he passes away at the age of 55, she would only be 50 and would need to replace his income for the next 40 years or so. Another thing to consider is that the survivor annuity of $33,000 a year will be higher due to COLAs in 20 or 30 years.

What if he doesn’t need a survivor annuity?

This is a scenario in which it could make sense not to elect a survivor annuity. If the spouse doesn’t need additional income from his FERS Annuity, then by all means – go without the survivor annuity.

However, if there is a need to replace part of his FERS Annuity income for the surviving spouse, the only two options are a survivor annuity and life insurance. These are two similar yet very different things that both provide a benefit at the insured’s death. More information on the difference between the two can be found here.

Federal retirees have many decisions to make, and we specialize in helping federal employees make choices just like this. For help with your specific situation, you can schedule an introductory call here.

Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.