You worked many years to earn a pension, but you face a tough decision at retirement – choosing a distribution plan. Your decision could cost you thousands of dollars and take a chunk out of your children’s inheritance.
You could end up making a trade-off on your pension – deciding whether to take their full pension benefit and expose their spouse to a loss of benefit at their death, or taking less than their maximum benefit in exchange for continuing benefits after they die for their spouse.
At the time of retirement, if you’re entitled to a pension you’ll have to choose an option for pension distribution. There are two common options: the Single Life Option and the Joint & Survivor Option.
The Single Life Option
The single life option allows you to receive the highest possible monthly income throughout your life. The only problem is that your benefits will be paid ONLY as long as you are alive. When you die, your pension benefits die with you. That's fine if you’re single, but what if you’re married? Are you going to leave your loved one with no monthly income from your pension?
The Joint & Survivor Option
On the other hand, the joint and survivor option pays a reduced monthly pension (typically 50% to 85% of the single life benefit) for as long your or your spouse is alive. This option guarantees a payment for your surviving spouse. But what happens if your spouse dies first? Unfortunately, you will continue to receive the reduced income and you ultimately lose the gamble.
Most people select the Joint & Survivor Option because they do not want to leave their spouse without income.
Fortunately, there is another alternative that many people don’t realize is available to them: pension maximization.
Pension Maximization
The concept is fairly simple: if you’re healthy and the cost isn’t prohibitive, you purchase a sufficient amount of life insurance on yourself, naming your spouse as the beneficiary. The death benefit will replace the lost pension benefit if you die first. At retirement, you opt to take the single-life benefit option in order to receive the maximum benefit, using a portion of the additional pension funds – usually much less than the difference between the amount for a single versus a joint and survivor benefit – to pay for the life insurance premiums
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Byron Udell is founder, president and chief executive officer of AccuQuote. With more than 23 years of industry knowledge, Udell is widely acknowledged as one of the nation’s foremost life insurance and annuity industry experts. His expertise is often called upon by the national media, including CNN, Forbes, Money, Kiplinger’s, The Wall Street Journal, The New York Times, and many others to comment on various life insurance issues.In addition to his law degree (JD), Udell has earned the Chartered Life Underwriter (CLU), Chartered Financial Consultant (ChFC), and Certified Financial Planner (CFP) professional designations.
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Leave it to a life insurance salesman to push life insurance. The truth is that combining a single life annuity with life insurance to create a Joint & Survivor annuity cannot be as efficient as simply selecting the Joint & Survivor annuity to begin with. This is especially true once you work in the extra fees and expenses that insurance companies will add to the cost of the life insurance that the pension fund will never charge.
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Peter - thanks for your comment. I believe that every situation is unique. And yes, there are times where choosing the joint & survivor option makes sense. For instance, when someone is uninsurable. However the extra fees and expenses are minimal as compared to the income you and your spouse will lose when choosing the joint and survivor option.
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When choosing the Joint and Survivor option the participant has no control given different situations. They also do not have any source of emergency fund or investment opportunities. When done right, with the strongest company, Northwestern Mutual, this makes perfect sense.
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Every retirement situation is different. I have prepared analysis for many clients; some where pension maximization obviously does not work and many where it obviously nets the client thousands of dollars per year. For that select couple where the retirement age is right, their health is good and there is a sufficient difference between the single life and joint and survivor benefits, pension max is a great tool.
In addition, life insurance proceeds are income tax free. If the surviving spouse then uses those proceeds to replace the lost pension benefit by using a single-premium immediate annuity they are allowed to use the exclusion ratio when calculating the taxable income. Using pension maximization they can receive a dollar for dollar replacement of income, of which up to 85% is non-taxable. The pension income will always be 100% taxable.
I've just completed an analysis for a client where the difference between the single-life annuity and joint and survivor annuity is nearly $19,000/yr. Utilizing a combination of term and guaranteed death benefit permanent insurance we are able to replace the pension income with under $13,000 of premium, guaranteed.
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I love the concept of pension maximization and have seen where it works great and seen where it doesn't work. My question is why do so many people wait until they retire to try to utilize this strategy? Won't it work better purchasing permanent insurance when you are young and then taking the higher option at retirement?
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