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Pension Max: A Primer

Wednesday, February 6, 2019 7:42

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Been working with a client on how best to handle her upcoming retirement income options, and realized that the most comprehensive post I ever did on this was actually at my old Answers.com gig.

So, since that’s been memory-holed by TBTB, here’s a reprise:

*Summary

One of the challenges when planning for one’s retirement is balancing benefits with the risk of death. Pension Maximization is a useful tool for solving this dilemma.

*Intro

In planning for retirement, we often have choices about how we’d like to receive our post-employment income. Typically, these pension plans will offer various dollar amount levels based on how long we expect to live, and how long we’d like to receive that income. The challenge is that we don’t know for sure how long that might be.

*Choices, choices

So your retirement plan offers you, for example, two choices. Under Plan A, you receive $1,000 per month for as long as you live. At your demise, though, the payments stop.

Or perhaps you’d like to make sure your spouse continued to receive some income after you’re gone. In that case, perhaps you’d like Plan B, in which you receive only $500 a month, hut your widow or widower would continue to receive a benefit after you’re gone.

But what if there was a way to have the best of both options, high income in a perpetual stream? There is, and it’s called Pension Maximization, or Pension Max.

*When do I choose?

The first challenge is that Pension Max requires some advance planning and forethought. It wouldn’t do to wait until one actually retires, because at that point all the choices have been made. Ideally, one would start considering options years beforehand.

*What are my options?

This will vary from plan to plan, company to company, but generally fall into one of two broad categories. The first is called the Single Life option. Under this scenario, you’d receive the highest monthly income because the plan is paying only you, and you’ve agreed to have payments stop at your death. This might make sense if one is single, or if one’s spouse has sufficient income to make up for any shortfall.

The other category is called the Joint and Survivor option and, as its name implies, covers both your own life as well as your spouse’s (or other designated beneficiary). The benefit to this method is that at least a portion of the retirement income continues on after your death, although at a reduced level. The major drawback is that the cost of doing so is a significantly smaller retirement income than the Single Life method.

*So what’s “The Third Option”

Under the Pension Max method, one chooses the Single Life retirement income option, and then buys a life insurance policy to guarantee that the surviving spouse continues to receive the income that will be cut off at one’s death. It’s not a terribly complicated arrangement, but does require a certain amount of math.

*How does it work?

Let’s assume that your Single Life option income amount would be $4,000 a month, or $48,000 a year. Let’s further assume that the plan administrators use 75% as their survivor’s benefit cost. That is, if you elect the Survivor Benefit option, you’d only receive $3,000 a month, or $36,000 a year. That’s a cost of $12,000 a year. Over the course of even 20 years, that’s a net reduction of almost a quarter of a million dollars.

Under the Pension Max option, you’d take a fraction of that lost income and use it to purchase a life insurance policy sufficient to produce an income stream equal to the Single Life option even after you’ve died.

*Conclusion

Making informed and economically rational choices in planning for retirement income can be challenging. Using Pension Maximization to insure the greatest possible retirement income stream for both you and your surviving spouse can make it easier.

*Callout

According to the Employee Benefit Research Institute, two-thirds of American workers expect to have to work during retirement.

Source: http://insureblog.blogspot.com/2019/02/pension-max-primer.html

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