Federal Employee Life Insurance

Edward A. Zurndorfer

The month of September has been designated by the Life Insurance and Market Research Association (LIMRA) as “Life Insurance Awareness Month”. Since many federal employees have a need for life insurance, the FEDZONE is presenting a series of columns during September discussing issues associated with understanding and purchasing life insurance. This is the fourth of these columns and presents the topic of avoiding the most common mistakes when purchasing and owning life insurance.

Purchasing life insurance seems like an easy process, particularly when it comes to the Federal Employees Group Life Insurance (FEGLI), the group-sponsored life insurance offered by the Federal government to its full-time and part-time permanent employees. New or rehired employees need not furnish evidence of medical insurability to qualify for FEGLI coverage. But Federal employees still make mistakes when it comes to purchasing life insurance, whether it be FEGLI or individually purchased life insurance policies.

Unfortunately, these mistakes can be expensive. Fortunately, these mistakes can in most cases be corrected.

The following is a list of the most common mistakes made by individuals when it comes to purchasing life insurance, and what these individuals need to do to avoid or correct these mistakes.

  • Naming one’s estate as the beneficiary. Naming one’s estate as beneficiary of one’s life insurance policy will likely result in the gross life insurance proceeds being needlessly subject to state inheritance taxes in those states that have an inheritance tax. Naming one’s estate as beneficiary of life insurance proceeds will also guarantee that any life insurance proceeds earmarked for loved ones will be likely subject to unnecessary probate expense, potential aggravation, and the delay of probate. Federal employees enrolled in FEGLI should therefore make sure their FEGLI beneficiary form (Form SF-2823) is properly filled out with proper beneficiaries listed and current. Those employees with life insurance coverage through a private insurance company also need to make sure they have named the proper beneficiaries of their life insurance policies.
  • Failure to name at least two contingent beneficiaries. If a primary beneficiary dies before the insured and there is no other named primary beneficiary or secondary beneficiary, then at the death of the insured the life insurance proceeds will be paid to the insured’s estate and subject to problems, as discussed above in the first bullet. Naming at least one or two contingent beneficiaries is therefore highly recommended. In case there is no individual who can be named as a primary or secondary beneficiary, then naming one or more charitable organizations as contingent beneficiaries is recommended.
  • Not reviewing one’s life insurance policy beneficiary designations at least every three to five years. It is all too often that upon an individual life insurance policy owner’s death, the life insurance proceeds are paid to the deceased’s ex-spouse to whom the insured obviously did not want to bequest the proceeds. Children born after a life insurance policy was purchased were often not added as beneficiaries prior to the insured’s death. An individual who is single purchases a life insurance policy designating his parents as beneficiaries but never updates the beneficiary designation even though he or she gets married and has a family. The parents subsequently die leaving no one as beneficiary.
  • Owning the wrong type of life insurance. Too often individuals purchase the wrong type of life insurance given their need for life insurance. For example, they have a need for permanent life insurance, but they purchase term insurance. As a Federal employee, they will have a need for life insurance for many years past their retirement from Federal service, but they elect to reduce their FEGLI coverage when they retire. They are not permitted to increase their FEGLI coverage during retirement even during an “open season”. Some life insurance policy owners drop their current individual life insurance policies before they are able to obtain another life insurance policy. They should only drop their current life insurance policy only when they have been approved for a new policy and have the new policy “in hand”.
  • Amount of life insurance coverage is inadequate, given one’s needs. For example, a life insurance policy owner has a policy in which there is an insufficient amount of life insurance to pay off and debts of the policy owner. There are insufficient life insurance proceeds for named beneficiaries to be able to pay their bills including food and housing.
  • Life insurance proceeds are paid out in the wrong percentages and outright to minor children and grandchildren. The improper bequeathing or disposition of one’s assets is one of the most frequent and serious of all estate planning errors. There is nothing in the law that says that heirs – particularly children- must inherit equally. Children typically have different financial needs. With respect to minor children, in most states, the state will tie up life insurance proceeds paid to minor beneficiaries and make it more expensive or time-consuming for a minor child to use the proceeds. For minor children or grandchildren, it is therefore recommended that the life insurance policy owner establish a trust as beneficiary for the benefit of minor children or grandchildren. Upon the death of the policy owner, the life insurance proceeds would be paid into the trust in which a trustee would be in charge of the trust assets, including the life insurance proceeds, for the benefit of the minor children or grandchildren.
  • All the insurance (FEGLI) and/or private life insurance is owned by the insured. Federal employees who do not anticipate at their death that the value of their gross estate will exceed the Federal estate exemption (currently, during 2020 the exemption is $11.58 million) need not worry about their estate being subject to the Federal estate tax. But they may live and die in a state in which there is a much lower state estate tax exemption, particularly in the order of $1 million to $3 million. In that case, the employee should talk to an estate attorney in order to determine ways to avoid inclusion of the life insurance proceeds in the gross estate of the life insurance policy owner upon his or her death.
  • Not realizing that FEGLI becomes progressively more expensive as an employee gets older and throughout retirement. Many Federal employees, particularly those employees close to retirement, are not aware that FEGLI becomes increasingly more expensive as the employees get older, especially after age 59. There are employees who will need life insurance coverage for at least a portion of their retirement. These employees are encouraged to check out individual life insurance policies offered by a private life insurance company, whether it be term or permanent life insurance. Ideally, they should do this within five to 10 years of their retirement date. This is because the insurance premiums will be more expensive the older they are and apply for the insurance. Also, from a medical underwriting standpoint, an applicant for life insurance has a better chance of qualifying for the insurance the younger they are.
  • Understanding the advantages and disadvantages of using life insurance as a supplement to, or as a substitute for, a spousal survivor annuity benefit – the concept of “pension maximization”. The Federal government’s survivor annuity benefit, either for a CSRS-covered or for a FERS-covered employee, is a form of insurance. At retirement, married employees can choose either to receive a full annuity with no provision for a spousal survivor benefit or to provide for a spousal survivor benefit and accept a reduction in their own annuity. The monthly reduction to a CSRS or FERS annuitant’s annuity amounts to a premium paid for a spousal survivor benefit. The spousal survivor annuity could be equal to as much as 50 or 55 percent of the gross annuity the annuitant was receiving at the time of his or her death. This spousal survivor annuity will continue with cost-of-living adjustments for the rest of the surviving spouse’s life.                                                                                                                                         Some employees choose – with their spouse’s written and notarized consent – to take a full CSRS or FERS annuity, forgoing a spousal survivor benefit and, using the monthly amount saved by not electing a survivor annuity benefit,  purchase a life insurance policy on themselves and name their spouses as beneficiaries. At their death, their surviving spouses as named beneficiaries will receive a lump-sum payment of the life insurance proceeds. The life insurance proceeds are then invested so as to ideally provide the surviving spouse an income for life (with no guarantee this will happen).

There are a number of potential problems associated with “pension maximization”. First, the retiring employee and soon to be annuitant would have to be insurable. Any significant health problems could result in the employee being denied life insurance coverage. Second, by not providing a spousal survivor annuity benefit, a surviving spouse who is not a Federal employee will lose his or her health insurance offered through the Federal Employees Health Benefits (FEHB) program upon the death of the annuitant. Third, term insurance policies are usually issued for no more than 30 years. If a retiring employee qualifies for a 30-year term life insurance policy but then dies after the 30-year period has expired, there is no more life insurance coverage and the surviving spouse receives no life insurance proceeds. Cash value or permanent life insurance is another option. However, buying a permanent life insurance policy in one’s late 50’s or early 60’s could mean a very unaffordable premium. Finally, term life insurance has no inflation protection. If over a period of 15 to 30 years there is a great amount of inflation and the cost-of-living significantly increases, then the face amount of a life insurance policy may result in an inadequate amount of life insurance proceeds to provide sufficient income for the surviving spouse. Federal employees are highly encouraged to consider all of these potential problems associated with “pension maximization” before electing it as a substitute to giving a full CSRS or FERS survivor annuity benefit to their spouses.

Federal Employee Life Insurance

Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While the employees of Serving Those Who Serve are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.

Life Insurance, Options for Coverage