A Tale of Two Widows

Jane and June Smith are sisters, Jane turning 58 years old in 2017, while June turns 60 in that same year. They are married to two brothers, Jim and John Smith, who turn 61 and 63, respectively, in 2017. Jim and John work for the same company.

Each Smith family has the following financial profile:

One day the call comes in to both Mrs. Smiths telling them that their husbands have been killed in a freak accident at work.

After Jane recovers a bit from the shock of the news, she asks June to come over so they can discuss their new financial situation. When she arrives, Jane says, “What will I do now? I don’t have any idea how I will pay my bills or how much I can spend!” June says, “Didn’t you get that retirement analysis that Bob, our new financial planner, wanted to do for us?” Jane replies, “No, what are you talking about? We never talked with him because we got too busy.”

June says, “Bob showed us how, with one small change in how we handle our money, we would be able to increase our sustainable retirement spending by about $14,000 a year, after federal income taxes, even in the event of a tragedy like this. So, we did it.”

“I wish I had made time to see him.”

“You can fix that.”

“How? It’s too late now!”

“No, it isn’t. Wake up. WAKE UP!!!”

Jane bolts upright in bed. “What a terrible nightmare!” She looks across the room to the bathroom door and sees light under the door, along with the sound of the shower that Jim is taking before work. So much for her plan of sleeping in today.…

After kissing Jim goodbye and sitting down to a raisin muffin for breakfast, she texts June:

Jane: “Hi, got an hour to talk this morning?”

June: “Sure, your place or mine?”

Jane: “Mine.”

June: “I’ll be over at 9.”

When June arrives, Jane says, “Remember when you explained what that new financial planner did for you? Well, I just had a nightmare about our husbands being killed in a freak accident and my not having done whatever it was that he told you to do. The only detail I remember is that you were able to increase your projected sustainable retirement spending by about $15,000 a year (after federal income taxes) by following his suggestions. Obviously, my unconscious was trying to tell me I should have paid more attention to what you were telling me. Please explain it to me again, and this time I promise I’ll listen carefully.”

“Sure, glad to. He has a new kind of financial planning software that takes assets, salary, pensions, age, sex, any existing life insurance, and health into consideration when making a conservative projection of how much after-tax spending you can afford to do per year in retirement, even if one spouse dies at the worst possible time. It takes about 15 minutes to gather the data, then he runs some ‘optimizers’ to see if there’s a way to improve the results by making some changes in your insurance and/or annuities. In our case, with the assumptions he put in for expected returns on our investment portfolio and our cash holdings, it turned out that we had to make only one change to the way we were handling our money to get a big improvement in the worst-case scenario, as you correctly remembered.”

“Ok, I’ll call him today to make an appointment for him to show me exactly how it works.”

…

We’ll pick up this conversation a bit later. But first we need to look at one of the most important sources of retirement income for many Americans. Social Security as a Mainstay of Retirement Income

As with current retirees, one of the largest sources of retirement income for the Baby Boomer generation will be from Social Security payments, as explained in an article in the “Social Security Bulletin”:

“Similar to current retirees, Social Security will account for about two-fifths of the projected family income at age 67 and will be received by almost all baby-boomer retirees. Supplemental Security Income will be received by 5 percent of current retirees and only 2 percent of baby-boomer retirees. The projections also suggest that baby boomers are less likely than current retirees to have enough postretirement income to maintain their preretirement living standards. The financial planning literature often recommends having enough postretirement income to replace 70 percent to 80 percent of preretirement income; however, over two-fifths of baby-boomer retirees will replace less than three-quarters of their preretirement earnings and almost a fifth will replace less than half of their preretirement earnings.”

(From https://www.ssa.gov/policy/docs/ssb/v65n3/v65n3p1.html,
emphasis added by author)

However, even this insufficient income is subject to a risk of loss that is currently uninsured in most cases. This is the risk of premature death of one spouse of a married couple; when one spouse dies, the remaining spouse’s income is reduced by the loss of one payment. The exact proportion of income lost by this event varies but is generally in the range of one-third to one-half of the original income.

This problem is widely recognized by personal financial advisers, and was discussed in detail in a 2012 GAO publication entitled “RETIREMENT SECURITY: Women Still Face Challenges” (http://www.gao.gov/assets/600/592726.pdf). Here is a passage entitled “Widowed After Age 50” (pp. 30–31):

“Not only did women’s total household assets and income decline substantially with widowhood, but the effects were more pronounced for women than for men. For example, while men’s income fell 22 percent after widowerhood, women’s income fell by an even greater amount — 37 percent. The effects were larger for women living in younger households than women living in older households. Specifically, women in households where all members were age 64 or younger experienced a 31 percent decrease in assets and a 47 percent decrease in income. Adding to these effects, widowhood was a much more common experience for women than men in our sample. In fact, women were at least twice as likely as men to become widowed between any two survey periods. Consequently, 70 percent of women age 85 and over were widowed compared to only 24 percent of men age 85 and over.”

However, just realizing that the problem exists, while necessary, is not sufficient. What we need is a solution to the problem of the “significant financial decline” at widowhood. Fortunately, there is a method to prevent this disaster in many cases. Let’s see what it is and how it works.