U—Pension Maximization

Upon retirement under a qualified pension plan, married workers and their spouses are often faced with making a difficult decision regarding the desired payout election. Basically one of two elections may be made: (1) to take a reduced monthly income with a survivor income benefit providing for payments during the lifetimes of both the retiree and his spouse; 2 or (2) to take an increased monthly income for the lifetime of the retiree without provisions for a survivor income
benefit. Although plans differ, typically when the survivor income benefit is elected there is a reduction of 25 to 30 percent. The reduction will depend upon the survivor option selected. For example, if a straight-life benefit pays $2,100 per month, a joint and full survivor benefit might pay $1,600 per month, whereas a joint and one-half survivor benefit might pay $1,800 per month to both retiree and spouse and $900 per month to the survivor. Typically these
options are said to be “actuarially equivalent,” in that at retirement they annuitize the value of the retiree’s pension benefit according to actuarial tables.

CURRENT PENSION PLAN. For example, assume that the election under the current pension plan involves a choice between a retirement benefit of $1,600 per month to both husband and wife, or $2,100 per month for the retiree only. This difference of $500 per month can be viewed as the “cost” of securing a survivor benefit for the retiree’s spouse. The election must be made prior to retirement and under most plans it is irrevocable once retirement begins.

The retiree and his spouse are faced with a dilemma! If the survivor income benefit is elected they will receive only $1,600 per month. And, if his spouse dies first, he will continue to receive only this reduced monthly income. On the other hand, if he elects to receive $2,100 per month and dies before his spouse, no further payments will be made to the surviving spouse.

PURCHASE OF LIFE INSURANCE can provide an alternative means of providing for the surviving spouse. If life insurance is purchased upon retirement, it may be possible, depending upon the particular plan of insurance, for the increased monthly after-tax income to pay for this coverage. Note that the full increase in retirement income will not be available for making premium payments, since these payments must be made with after-tax retirement dollars. On the other hand, if the surviving spouse takes an annuity payout of the tax-free death benefits, less of each payment will be subject to income tax than postretirement survivor benefits received under a noncontributory pension plan (i.e., less death benefits will be required to provide the surviving spouse a given after-tax income).

It is generally better to obtain the insurance some years prior to retirement, when premiums are lower and the worker is more likely to be insurable. In either case, the amount of insurance should be sufficient to provide an income in replacement of the survivor benefit that was not elected.

Although life insurance can be an effective way to plan around the difference in benefits between life only and survivor benefits, it is important for the retiree and his or her spouse to carefully consider the options as well as specifics of the life insurance policy being considered. You generally have only one opportunity to make your pension election.

AFTER RETIREMENT the contract insuring the retiree provides great flexibility. If the retiree dies first, then the death benefit can be used to pay a lifetime annuity to the surviving spouse. If the spouse dies first, then accumulated cash values are available to the retiree. If taken as a lump-sum, cash values in excess of net premiums paid would be subject to income taxation. Alternatively, the retiree might obtain additional income by exercising a settlement option under the contract by receiving existing cash values as an annuity.By either terminating the contract, or placing it in a “paid-up” status, the retiree could then stop premium payments and retain his full retirement income of $2,100 per month.

It is important, however, when working with qualfied plan assets to consider the possible impact of the Department of Labor (DOL) Fiduciary Rules. Although the recent DOL Fiduciary rules have been invalidated, there are still fiduciary standards that apply in the advisor-investor content.