Retirement decisions can be daunting. If you make the wrong decision you often times cannot change the decision later. The decision of how to take your pension payments is one of those decisions. Just this past week I was working with a client facing retirement and was trying to decide whether to take a single life payment plan in her pension or a joint and surviver payment option for her pension. The decision was between getting paid $3,026 every month for the rest of her life, or getting paid $2,784 for the rest of both her and her husband’s lives. The risk of which option to choose exists because nobody knows exactly how long they will live.
In their situation, a pension maximization idea makes sense. The pension max idea works like this. Figure out what lump sum is needed to create a lifetime single annuity payment for the spouse who does not have the pension and get a permanent life insurance policy with the pension holder as the insured for that death benefit amount. Then, choose the single life payment option. In this case it would take a lump sum death benefit of $540,000. Let’s review the following extreme scenarios of what would play out. Spouse 1 is the spouse that has the pension and spouse 2 does not.
Scenario 1: The couple lives a long life and dies at the same time. If they die at age 85, they would have received $726,240 from the pension, $540,000 would be paid out to the beneficiaries, and they would have paid $260,000 for the premiums for the life insurance. The net outcome would be $1,006,240 of wealth generated. If instead they took the joint and survivor annuity payment, they would have received only $668,160 instead. If they live to age 100, the resulting numbers are $1,387,920 with the single life annuity and life insurance versus $1,169,280 with the joint and survivor annuity options. In this scenario it makes sense for the couple to choose the pension max strategy instead of the joint and survivor payment option.
Scenario 2: Spouse 1 and Spouse 2 die right away. If they choose the pension max strategy, they would have the life insurance, and their beneficiaries would receive the $540,000 death benefit. If they chose the joint and survivor annuity option, they would receive $0. Clearly the pension max strategy is the better option here.
Scenario 3: Spouse 1 dies right away and Spouse 2 lives a long time. The surviving spouse will create a life annuity with the death benefit that mirrors the joint and survivor annuity payment. Therefore the resulting payout is the same. The difference between the two is that the surviving spouse doesn’t necessary have to annuitize the death benefit proceeds and could instead have the flexibility of receiving the money how they choose, making the pension max strategy the preferred option.
Scenario 4: Spouse 1 lives a long time and Spouse 2 dies right away. If spouse 2 dies right away, spouse 1 could either cancel or keep the insurance. If they cancel the insurance, she would have received $726,240 from the single life option and $668,160 from the joint and survivor option at age 85, and $1,270,920 with the single life option and $1,169,280 with the joint and survivor option. She could also choose to keep the insurance, in which case you would add another $280,000 of total wealth created at age 85, or $117,000 of wealth created at age 100. Therefore again the pension max strategy is preferred.
In each scenario above, it is better to take the single life option and have the life insurance in place, than to do the joint and survivor option and not have it in place. However, this recommendation is not for every person. It only works if the clients have an abundance of cash flow and the $13,000 annual premium doesn’t affect their lifestyle. When I ran a retirement analysis for this couple, they never run out of money. They will even have a couple million dollars to pass on to their two children. A time when the pension max strategy might not be the best option is if the couple has no desire to pass money on to any beneficiaries or organizations. They will have less money to spend during their own lifetime due to the high premiums if they were to both live a long life.
The trick in the pension max strategy is to have the foresight at a young age and lock in the lower premium costs. If it is locked in as a 40-year-old, the premium would only cost $4000 a year instead of $13000. If the client is unable to afford the premium costs now, it is important to at least get some convertible term insurance in place while the client is healthy and insurable. This policy can then be converted to permanent when cash flow allows for it. If you need help figuring out if a pension max strategy is in your best interest, just reach out to your financial advisor and have them run the numbers for you.