Several serious decisions need to be made as retirement approaches. One of these decisions might involve deciding what pension benefit option is most beneficial. Most pension benefits have a choice of a lump sum benefit or an annuity option. There are two main types of pension plan annuity options: a joint and survivor (J&S) annuity, which provides a paid benefit over the lives of both the retiree and the spouse, or a single life-only pension, which provides a paid benefit covering only the life of the retiree and ceases upon death.
Various aspects of the two main types of pension plan annuity options can create a problem for the retiree. A monthly J&S annuity benefit is substantially less than benefits from a single life option, as the benefits potentially cover the lifetimes of two people vs. just one. In other words, a retiree who receives just $1,300 with a J&S annuity might receive around $1,700 per month under a single-life annuity option.
The retiree will also continue to receive this reduced J&S annuity amount of benefits even if the spouse dies before the retiree. On the other hand, if a retiree receiving a single life annuity payment fails, the pension is halted to supply the surviving spouse with any continued benefits.
The entire process can be like choosing between the lesser of two evils. But, what if you could have your cake and it eats too?
Many retirees take advantage of pension maximization, a financial planning tool to provide a means of receiving a higher monthly payment, like the single life annuity, while still having the perk of financial protection for the spouse.
Pension maximization is achieved by choosing the single-life annuity pension option. The retiree then takes a portion of the higher monthly payment to buy a life insurance policy that can generate income for the spouse when the retiree dies. Suppose the spouse passes away before the retiree. In that case, the retiree can always cancel the life insurance policy and keep the money used for the premium, change the deceased spouse from being the beneficiary on the policy and name someone else, and use any cash value of the insurance policy.
Is Pension Maximization the Right Strategy
You should consider your lifestyle factors and personal circumstances when determining if pension maximization is a strategy that will work or benefit you. Ask yourself these questions to help you decide:
- Am I insurable? For pension maximization to work, the retiree must be able to qualify and purchase a life insurance policy. It is wise for retirees to already have a life insurance policy before weighing their pension options, as this can be a determining factor. Those with certain preexisting conditions or poor general health may find it challenging to secure life insurance.
- Do I have the financial leeway to afford to pay the premium on a life insurance policy? Consider whether the single-life annuity and other income sources will support your living expenses and pay policy premiums. If you doubt you will have the discipline or monetary means to pay the life insurance premiums. You might want to consider a different option.
- Do I have other potential sources of income? Of course, other income sources and whether or not the spouse is eligible for their pension plan is also an important consideration.
- Do I have ancillary pension benefits available to me? Extra help, such as medical coverage for the spouse, might be forfeited by opting for a single life annuity option.
- Do I have a pension plan with COLA available to me? Suppose the retirees’ pension plan has a cost-of-living adjustment, where benefits are adjusted with the increase or decrease in the cost of living. In that case, a J&S pension option might be more attractive than pension maximization.
Making an Informed Decision
A qualified tax adviser or financial adviser should be consulted for anyone considering pension maximization. They will be able to provide you with detailed analysis, apprise you of any tax consequences, and offer advice on how much life insurance should be purchased with pension maximization.