Retirement signals the time for making a
number of critical decisions. For individuals eligible for pension benefits,
one of these decisions will involve determining the most beneficial pension
option. The choices may include a lump sum benefit and some type of annuity.
Two main types of annuity options available through a pension plan include a
single life only annuity (which pays a benefit over the life of the retiree,
but stops when the retiree dies) and a joint and survivor (J&S) annuity
(which pays a benefit over the combined lives of the retiree and spouse).
The
monthly benefit in a J&S annuity is less than it would be under a single
life option, because the benefit potentially will be paid over two lifetimes
instead of just one. For example, a retiree who would receive a monthly pension
benefit of $1,700 under a single life annuity might receive $1,300 under a
J&S option. Some think of a J&S annuity as a type of “insurance,” with the “premium” for the
continued benefit to the spouse being the reduction in the monthly benefit
amount (in this case, $400 each month).
A
retired couple may find that deciding between a single life only and a J&S
annuity is difficult. If a J&S option is selected and the spouse dies
before the retiree, the surviving retiree will continue to receive the reduced
benefit amount, even though no benefits will ever be paid to the spouse.
Conversely, when a retiree covered under a single life annuity dies, the
pension stops to provide any continuing benefits to the surviving spouse.
A
financial planning tool called pension maximization may provide some retirees
with a way to enjoy the higher monthly benefit of the single life annuity, yet
with financial protection for the spouse in the event of the retiree’s death.
The basic concept of pension maximization is this: Choose the single life
annuity, and use some portion of this larger monthly benefit to purchase a life
insurance policy that could be used to generate income for the spouse after the
retiree’s death. If the spouse dies
first, the retiree can change the beneficiary on the policy, or simply cancel
the policy and pocket the money formerly used for premiums. Furthermore, if the policy had any cash
value this money could be used for another purpose.
Is
pension maximization the right strategy for you? Several factors should be
considered in answering this question—
• Insurability.
The retiree must be able to get a life insurance policy. For those in poor
health, this may not be an option. It
is critical that the retiree secure sufficient life insurance before
making their pension choices.
•
Financial means and discipline. The
retired couple must be conscientious about making premium payments on the life
insurance policy to ensure that it does not lapse. Thus, the income generated
by the single life annuity (and other income sources) must be adequate to cover
your living expenses, plus the cost of the life insurance premiums.
• Other
income sources. What assets and investments does the retired couple have
outside the pension plan? Does the spouse have a separate pension plan or
retirement account?
•
Pension plan COLA. Pension plans with
a cost-of-living adjustment (COLA) increase the benefit amount over time for
inflation. This valuable feature can make the J&S option more attractive.
•
Ancillary pension benefits. Sometimes
any additional benefits for a spouse—such as medical coverage—are forfeited if
a single life annuity option is chosen.
The
retiree considering pension maximization should consult with a qualified
financial and/or tax advisor to obtain a detailed analysis that considers tax
consequences and inflation. Only through such an analysis can one obtain a good
picture of the “cost” of the J&S option and the amount of insurance needed
to replace the survivor benefit if the single life option is chosen. That said,
pension maximization offers the advantage of a higher monthly pension benefit
for the lifetime of the retiree, coupled with insurance protection for the spouse.
For many, it represents a smart financial planning strategy.
