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.
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