Jason Fisher The pension maximization strategy is a dying breed since qualified pension plans have become scarce with the rise of defined contributions plans, like 401(k)s.
However, for those in their pre-retirement years now, using a pension max is still a very real possibility as you age forge your retirement plan.
The method making the most out of the pension a retiree will receive based on his choice of the type of retirement benefit he will get.
It is not without some financial risk, requiring a thorough analysis before this irreversible decision.
In summation, a pension plan is where a retiree chooses the maximum benefit from his pension, where a portion of it is earmarked for a life insurance policy.
This life insurance policy then creates the “survivor” benefit, and potentially more, once he passes.
The Benefits of Pension Maximization Plans
This strategy offers couples several advantages.
The pair receives the maximum benefit which they can enjoy together for the rest of their lives.
And as long as they purchased enough coverage, the spouse will continue to live at the same economic level as she has prior to her spouse’s passing.
Both the couple and the single spouse will maximize their income.
With the purchase of a permanent life insurance policy, usually a guaranteed universal life, the couple has the benefits of this policy.
- They can take out loans against it.
- The cash value will accumulate.
- And they will also have the added income from the annual dividends, assuming they are paid.
And if the retiree should die, the spouse has immediate funds available from the life insurance benefit to pay expenses and debts, while replacing the nest egg for future retirement funds.
The spouse will have to pay income tax if she receives a pension benefit after the retiree’s death.
On the other hand, if her income replacement comes from a life insurance benefit, she will get these funds tax-free.
If the coverage is adequate, she’ll be able to build a guaranteed income for the rest of her life, which meets or exceeds what her spouse was receiving.
Choosing Life Only vs. Joint and Survivor Benefits
The crux of the pension maximization strategy rests with the choice of benefit and the purchase of life insurance.
When an individual nears retirement, he will be faced with a decision regarding his benefit.
He can choose a life only option in which he will receive the maximum amount of his retirement benefit.
There is no cost to the retiree, though the spouse will receive nothing when he dies.
The other option is to choose the joint and survivor benefit.
This choice will reduce the amount of the benefit the retiree receives during his lifetime.
However, it will guarantee his spouse 50 percent (or more) of his benefit after he passes, and for as long as she lives, too.
He can also elect for his spouse to receive 100 percent of his benefit, which will lower the amount he receives during his lifetime, in most cases, but the amount he receives monthly may be even further lessened.
Criteria to Make It Work
To get the most out of pension maximization, the retiree should have a pension plan which will pay a fixed income each month, for as long as he lives.
Some plans may differ.
The guarantee of funding is essential to make this strategy work best. It will deliver the greatest benefit if the retiree can secure the most affordable premium.
You also need a permanent life insurance plan, where the death benefit would be enough to supply a future income to the surviving spouse, for as long as she lives, which is equal or greater than what she may have received from the join and survivor benefit plan.
The Role of Life Insurance
This is where life insurance comes into play.
Instead of the spouse collecting on the retiree’s benefit, the couple chooses the life only option.
To ensure her future financial security, they purchase life insurance to make up for the monies she won’t receive upon the retiree’s death. The couple should purchase the amount of coverage necessary to cover her needs.
There are several conditions which apply to this strategy.
- First, the retiree must be in good enough health to be insurable.
- Second, the couple must be able to afford the insurance so the spouse can receive the benefit upon the insurer’s passing.
Purchasing the life insurance well before his retirement age is a smart plan to guarantee a more affordable premium.
Risks of A Pension Max
Pension maximization carries risks if the retiree fails to do the necessary pre-planning. Much of it exists from not crunching the numbers.
The strategy only makes sense if it does indeed maximize the income of both the retiree and the surviving spouse. Likewise, the insurance coverage on the retiree must be adequate to meet the future financial needs.
Of course, it is essential the surviving spouse maintains the premiums on the life insurance to prevent it from lapsing.
This means she must have adequate resources to cover it, which usually are a portion of the pension benefit. It’s worth noting drawing from the policy before it pays out will lessen the death benefit when the time comes.
It’s crucial the retiree determines whether his choice of benefit affects his spouse’s medical coverage.
Some retirement plans may stipulate eligibility requirements for the surviving spouse to continue to receive benefits.
The retiree should determine these stipulations prior to making a choice of his benefit.
Another risk concerns the retiree.
He must be insurable if the couple chooses the life only option. Remember, the choice of pension benefits is irreversible.
This is why it makes good sense to purchase life insurance on the retiree well before he actually leaves the company.
It probably goes without saying the cost of life insurance should not exceed the amount the couple is saving with this plan, or it’s a net loss and shouldn’t be acted upon.
It’s essential to choose this route well before retirement to maximize the strategy’s potential. If a decision is delayed, the retiree runs the chance of paying more for life insurance and losing income.
And one cannot discount the risk of losing one’s job before retirement age.
It’s far wiser to plan ahead than to fail to plan at all.
Also, it’s important the life insurance policy stays adequately funded.
The retiree may consider adding a guaranteed insurability rider to his life insurance policy so he can increase coverage if necessary without the need for additional underwriting to secure it.
This way the benefit remains flexible in case his family’s circumstances change.
Taking Care of Heirs
Neither retirement option offers heirs, such as dependents, any benefit.
However, if the couple buys life insurance, they can name children as beneficiaries.
Both the spouse and the heirs have the added financial security of a life insurance policy as a source of emergency funds should the need arise. Also, the cash value or dividends may cover the cost of the premiums for further savings.
The strategy offers a win-win for the heirs.
Even if the spouse dies before the retiree, they can still receive a death benefit from the life insurance policy.
The entire family is protected when opting for a pension maximization strategy. The retiree then has the peace of mind knowing his family will be financially secure long after he has passed.
Choosing the Joint and Survivor Benefit
For the case of argument, the joint and survivor benefit eliminates some of the risks associated with pension maximization.
The surviving spouse has a guaranteed source of income from the reduced benefit.
However, like the retiree, the spouse will have to pay taxes on this money. Unless she has savings elsewhere, she won’t have a source of emergency funds.
A pension maximization strategy offers an excellent option for a retiree to get the most out of his benefit while ensuring his surviving spouse has a guaranteed source of income when he passes.
A couple can enjoy the financial benefits as long as they do the necessary homework to ensure enough insurance coverage for the surviving spouse’s future financial needs.
The strategy has many variables which need to be considered before implementing this plan.
Factors such as the pension benefit requirement, the health of the retiree, and current financial situation all play a role in determining if it is an appropriate choice.
To truly maximize one’s pension, the individual should consult an insurance professional for guidance.
