Military Retirement and the Big SBP Decision

This article was jointly written by Adrienne Ross, CFP ®, AFC ®, and Pam Bergeson, CRPC

As you’re working your way through your pre-retirement checklist, you may have discovered a couple of decisions that you need to make before you out process one last time from the military.  Of all these decisions, none is more important or more permanent than your decision to accept or decline the military’s Survivor Benefit Plan (SBP).

This blog dives into some of the most common questions about SBP and shares a few examples of when the SBP can be most useful.  It also addresses some of the common myths surrounding the military’s SBP.

What is the Survivor’s Benefit Plan (SBP)? 

The most important fact to know about the amazing military pension you’ve earned during your 20+ years of service is that it ends at your death.  The only way to ensure your spouse and/or your dependents continue to receive a portion of your retired pay is to sign up for the Survivor Benefit Plan.

In the event you pass away before your spouse or your dependent children, SBP continues to pay an inflation adjusted monthly benefit, known as an annuity, to your survivors.  In the case of your spouse, the annuity continues until their death or remarriage in some instances.

What may surprise you is that while you’re on active duty, you’re already covered by SBP at no cost.  If an active duty service member dies of a service connected cause, their survivors are covered by the Survivor Benefit Plan.

Of all the decisions you’ll make at retirement, the SBP election is the most critical because it is largely irrevocable.

Why is your SBP decision so critical?

The exact decision comes in the form of either accepting or declining SBP in the weeks before your final out processing.  If you’re married and decide to decline SBP or accept less than the full SBP benefit, your spouse will need to sign off on that decision during your out processing. The rationale behind requiring your spouse’s concurrence is he or she has the most to lose if you decline SBP.

If you decline SBP, it is very unlikely that you’ll ever have a chance to regain it, your decision is final.   On the other hand, if you elect to accept SBP, you will have an opportunity to discontinue it during the period between 25-36 months after your retirement.  To be extra clear – this window of opportunity to change your mind in your third year of retirement is a one-way decision – exit only.  You can only choose to discontinue SBP, you cannot regain access to SBP.

The only other opportunities to change your SBP decision occur when you have a qualifying major life event that changes the status of your dependents.  The death of your spouse, marriage to a new spouse, or the birth/adoption of a child are examples of potential events that could trigger a short window to change your SBP decision.  The rules surrounding these life events and which ones do or don’t trigger an opportunity to add SBP coverage are complicated and require detailed information to understand fully.

The decision to accept or decline SBP is unique to each service member and their family.  Because there are so many important variables to consider, it is vital to make your own decision with your family’s specifics in mind rather than simply following the decisions of your peers.

Your SBP decision requires careful consideration of your family’s make-up including your ages, age differences, health status and each spouses’ earning potential along with your children’s ages, health, and educational goals, and finally your spouse’s financial interests.  We take a closer look at many of these variables in the next few paragraphs.

Why do you need SBP?

If your family depends on your income, then your decision on SPB is critical to your financial plan.  

If you’re married or have dependent children, chances are they rely on your military pension for a portion of their monthly living expenses.  If your family depends on both your post retirement civilian income and your military retirement income to cover their living expenses, the impact of your passing would be even more devastating.

If your spouse’s lifetime earnings have been hindered by multiple military moves over the course of your military career, they most likely have accumulated fewer retirement assets of their own.  In this case, the SBP annuity may prove even more important in providing long term security to your family.

As difficult as it is to imagine, you must ask yourself if your family had to live without you, and without your civilian income and your military pension, could they pay the mortgage or rent, would your family be able to afford college tuition, and would your spouse have sufficient income to cover their living expenses well into retirement and old age?

What’s so special about SBP?

In today’s retirement savings environment, pensions are rare; a pension with a cost of living adjustment is like finding a unicorn.

Inflation protected.  Your military pension and its survivor benefit are that rare unicorn.  Your military pension adjusts each year to keep up with inflation and your SBP will continue to do so as well.  SBP ensures your survivors continue to benefit from your decades of dedicated service through continued payments from your inflation-adjusted pension.

As the cost of living increases, so does the SBP payment to your survivors.  For example, if your spouse lives twenty years longer than you, the value of their SBP annuity will keep pace with inflation over those two decades.  A payment of $1000 in 2021 could more than double over the course of your spouse’s lifetime.

SBP eliminates two of the most significant risks a widow or widower faces – longevity risk and inflation risk.  

Risk management. Longevity risk is the risk that your surviving spouse will outlive the money you’ve saved for retirement.  With SBP, you don’t have to worry how long your surviving spouse will live, the payments continue as long as he/she is alive, or in some cases, until he/she remarries.

Inflation risk is the risk that the value of the money you’ve saved for retirement won’t keep up with the cost of living over the decades after you retire.  The SBP payments increase each year commensurate with the national inflation rate.  This increase ensures the payment your spouse receives can still cover key expenses as their costs increase.

A third type of risk avoided with SBP is default risk. Default risk is the risk that your life insurance or annuity provider will run out of money or go out of business before paying all the payments they’ve promised you.  Because the SBP is backed by the US Government, the risk of default is nearly zero.

Pre-tax premium.  Beyond eliminating risk in your long-term retirement plan, your SBP premium is paid before your taxes are calculated, meaning the amount you pay is lower than it appears.  For example, if your SBP premium is $300 per month and you’re in the 15% tax bracket; your pre-tax SBP payment is only $255.  For more senior retirees the benefit of SBP’s pre-tax premium is even greater.  A $800 SBP premium for someone in the 28% tax bracket only costs the retiree $576.

Are there situations when I don’t need SBP?  

There are certainly a few examples of situations where you might not need SBP.  First, if you don’t have anyone depending on your income, no spouse or dependent children, you likely don’t need SBP.

If you’re a dual military couple without dependents who’ve earned very similar military retirement benefits, you may not need SPB, or you may be able to take less than the full SBP rate and still cover your future expenses.

This isn’t true of all dual military couples.  When a dual military couple has substantially different career lengths and where there is a significant difference in rank at retirement between the two service members, the SBP decision is less straightforward.

The same comparison is true if your spouse has their own pension through their civilian employer.  Or if the non-military spouse has higher life-time earnings and retirement savings that set them up for a self-sufficient retirement.

What are some special considerations with SBP?

Special needs. If your retirement income will support a dependent with special needs you may want to designate a special needs trust to receive your SBP benefits instead of passing directly to the special needs child, so as not to negatively impact their access to other government benefits.  If this situation applies to you, you’re advised to work closely with an attorney who specializes in special needs trusts in advance of making your SBP election.

Divorce.  If you’re divorced, your former spouse may have a legal claim to a portion of your pension and therefore a court order could require you to obtain SBP coverage.  Learn more about these requirements at this link. https://militarypay.defense.gov/Benefits/Survivor-Benefit-Program/Costs

Reserve Component. The rules for Guard and Reserve retirees differ slightly in terms of when you make your SBP election and the cost of your SBP premium.  We’ll cover the specifics of the Reserve Component Survivor Benefit Plan (RCSBP) in a future post.

If you’re still wondering why you need SBP, let’s explore some of the myths about the costs and benefits of the program. 

Data from 2018 suggests that retirees from each service have different outlooks on the benefits of SBP.  On average, the participation rates of Army and Air Force retirees exceed 60 percent, while Navy and Marine retirees participation remains below 50 percent.  These differences between services may reflect variations in understanding and potentially misunderstanding of the benefits of SBP.  Let’s explore some of the myths surrounding SBP that may impact your decision on SBP.

Some myths about SBP

Myth #1: I can buy term life insurance a lot cheaper than SBP.

Fact: Depending on your age and health, term insurance may in fact be less expensive than your SBP premium.  What is important to consider is that term life insurance is a temporary solution to a long-term challenge.   Term insurance by its very nature is for a specific term or period of time.  The premium you pay is based on your age and your health; as you age, your premiums will increase dramatically.  Have a history of high blood pressure, smoking or asthma?  These and other health conditions will dramatically increase your premiums. Love to scuba dive or pilot airplanes, you may not be insurable.

Fact: The second part of the “buy term” equation is that you need to “invest the difference” in order to cover your family’s loss of your military pension when your access to inexpensive term life insurance ends.  Because it is difficult to secure affordable term life insurance beyond age 60-65, you will need to use the time between your military retirement and reaching your sixth decade to build up a substantial investment portfolio to offset your lack of life insurance.  The savings you reap between the cost of SBP and the cost of term life insurance needs to be invested in order to earn sufficient gains to cover your family’s expenses and to stay ahead of inflation.  This requires not only persistent discipline to save, but also the willingness to take on investment and market risk to generate long term gains.

Myth #2: I’ve done the math; I’ll save money by not selecting SBP.

Fact: There is way more to your SPB decision than just a math problem.  For that math problem to work in your favor, you need to accurately predict how markets and inflation will behave and then you must accurately predict how you and your beneficiaries will behave.

Inflation & Markets: To adequately replace SBP with term life insurance requires you to accurately estimate several very important unknowns, including inflation over the next four to five decades, investment returns over the same 40-50 years, your life expectancy and your spouse’s life expectancy.  These are some important variables, all of which you have no control over.

In the case of future inflation and investment returns, even economists won’t venture to estimate these factors forty years into the future.   If you’re able to create a scenario where the math works in favor of term life insurance, all you need is a steady increase in inflation or a couple of stock market declines to turn your carefully crafted mathematical solution upside down.

Human Nature: There are also several key behavioral predictions necessary to make this math problem work out.  First is the one mentioned above, you need to follow through with the disciplined investment of the “save the difference” if you buy term life instead of taking SBP.  Then you need to have the aptitude and willingness to take on the necessary market and investment risk to grow your investment in order to come out ahead of inflation.

Next, your spouse will need the aptitude to safely manage the life insurance windfall.  She/he will need to continue to manage these investments, balance risk factors and make decisions about taxes in order to generate sufficient income to pay the bills for the rest of their lives.

Myth #3: Life Insurance proceeds are tax-free, SBP payments are taxable.

Fact: Life insurance proceeds are income tax-free, but once those proceeds are deposited in your spouse’s checking account, she/he will need to invest them in order to generate sufficient income and capital gains to keep up with inflation and replace the loss of your military pension for the remaining decades of their life.   Guess what? Investment earnings are taxed as either income or long-term capital gains, depending on the type and duration of the investment.

Conversely, SBP premiums are paid before tax and life insurance premiums are paid post tax.  This means you can discount the cost of your SBP premium by a factor equal to your tax bracket.  Once you calculate the tax advantaged cost of SBP, there may be very little difference from your post tax term life premiums.

Concluding thoughts on SBP

Unfortunately, myths and misinformation surround SBP.  What’s key to remember is that your SBP decision is the single most important decision you’ll make when you retire from the military because your decision to accept or decline SBP will impact your family when you’re no longer there to support them.

It’s critical to consider all the facts and make an informed decision that best supports your family.  Because this decision can have impacts well beyond a carefully crafted math equation, it is important to consider the lasting impacts on your family and your financial plan.

Sometimes it comes down to one simple consideration: which decision helps you sleep at night knowing your family is protected.  

Because the right answer is unique to each military family, we recommend working with a financial planner who understands your military benefits from firsthand experience. As financial planners who help military families every day, we know from experience that each military family’s SBP decision is unique and depends not just on their present-day budget, but on all the elements that go into a great financial life plan.

The financial planners at the Military Financial Advisor Association can help you work through the various SBP scenarios so you can make the decision that best meets your family’s needs.  Reach out to one of us today!