Pension Max
The Problem
At retirement, married pension plan participants typically must make a choice. They can choose to take:
- The maximum monthly income for the life of the retiring employee only (e.g. $1,000 per month); or
- A substantially reduced pension for the lifetime of both the retiring employee and his/her spouse (e.g. $800 per month).
Many employees and their spouses feel compelled to take the reduced lifetime income1. Unfortunately, once selected this option may not be changed.
Consider the Potential Costs
- If spouse lives but a short time, the surviving retiree faces a lifetime of reduced pension benefits.
- If both live a full life and die within a year or so of each other, little benefit is ever realized after 20 years or more of reduced pension.
- In no case do children or other heirs inherit any benefits.
The following examples illustrate the potential lifetime cost of the survivorship benefit:
Example 1 – Full Survivorship Benefit on Pension Plan | ||
With No Survivorship | With 100% Survivorship | |
Anticipated monthly income at retirement (age 65) | $1,000 | $800 |
Cost of survivorship election | $200 per month for both spouses1 remaining lifetimes | |
Joint life expectancy at 65 2 | 25 years x $2,400 = $60,000 total potential cost |
Example 2 – 50% Survivorship Benefit on Pension Plan | ||||||
With No Survivorship | With 50% Survivorship | |||||
Anticipated monthly income at retirement (age 65) | $1,000 |
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Cost of survivorship election | $100 per month for both spouses1 remaining lifetimes | |||||
Joint life expectancy2 at 65 | 25 years x $1,200 = $30,000 total potential cost |
1 Caution: In some cases, eligibility for continuing the surviving spouse’s group health care is dependent on choosing the survivor option.
2 Based on IRS Annuity Table VI – Ordinary Joint and Last Survivor. Assumes both spouses are the same age. Conclusion
Pension survivorship options equate to very expensive term life insurance that may never pay a benefit.
A Solution – Alternative Funding
Purchase permanent life insurance prior to retirement in an amount that would provide the survivor or other heirs with a similar monthly income benefit. Then still take the maximum monthly pension benefit.
For example, to provide $800 per month for 25 years (assuming a 5% growth rate on the remaining balance) would require an initial lump sum or life insurance death benefit of approximately $137,000. Of course, the 5% return is not guaranteed, so, if desired, a guaranteed lifetime payout available from the insurance company could be used.
Advantages to Alternative Funding
- Premiums can be paid when income is higher, before retirement, from discretionary income.
- If the retiree and spouse die simultaneously or if the spouse dies first, their children or other heirs may receive the insurance death benefits. Typically, no additional benefits would be payable from the pension plan. If the spouse dies first and the retiree does not have any other beneficiaries deserving of the proceeds, the retiree can surrender the policy for its cash surrender value.
- You can tailor additional benefits based on the policy used.
- For example:
- Using a policy designed for cash value can provide a return of premiums should the spouse die before the retiree.
- Long Term Care benefits can be added.
- Policy can be designed to be fully paid up in a certain time frame.
- A large part of the death benefit proceeds payable in monthly installments will be income tax free. Normally, pension income is fully taxable.