You may have heard that some retirees look toward pension maximization as a strategy to get the most out of their pension – both for them and for their spouse. Pension maximization has some clear benefits, but it might not be the solution for everyone. Let’s explore how this strategy operates in the real world, and how you can determine whether or not it’s right for you.
What is Pension Maximization?
When you take your pension, you may have several election options:
Lump sum
Single life annuity
50% joint and survivor
100% joint and survivor
Life with 10 years certain
If you choose to leverage a pension maximization strategy, you would take the single life annuity (or life only) option. By accepting your full pension over the course of your lifetime – you don’t receive any spousal benefits directly through your pension.
However, to ensure that your spouse is still protected, you would purchase a life insurance policy rather than accessing reduced survivor benefits through your pension. The goal here would be to increase the monthly benefit you receive from your pension more than the cost of a life insurance policy that would provide a death benefit to your spouse in the event that you passed away first.
Wondering how this works in practice? Let’s take a look.
If the single life payout is $2,800 a month, the 100% joint and survivor payout option may be reduced to $2,100 a month to provide your spouse with $2,100 of monthly survivor benefit.
However, if you took the single life annuity payout at $2,800/month, and were able to find a life insurance policy with a premium of less than $700/month that could generate income for your spouse of over $2,100/month after you died – you’re maximizing cash flow now and setting your spouse up for financial success if you pass away.
In fact, you may even be able to find a policy that’s monthly premium is notably lower than what a reduced joint and survivor pension benefit might be – which will save you money in the long run.
Benefits of Pension Maximization
There are several upsides to a pension maximization strategy using life insurance. Here are some of my favorites:
Immediate death benefit protection for your spouse. Through your life insurance policy, your spouse will have death benefits that your single life annuity option won’t provide them.
You receive the maximum monthly income from your hard-earned pension. Your pension likely plays a large role in your retirement income – maximizing it can make a huge difference in your cash flow.
You may be able to find a life insurance policy with premiums that are lower than the difference between a single and joint and survivor pension benefit. This would actually save you (and your spouse!) money in the long run.
You provide yourself an avenue to leave the funds from your life insurance to someone other than your spouse if you outlive them. This is a fantastic option for people who aren’t necessarily sure that their spouse will outlive them, and still want to be able to provide an inheritance to their heirs through their life insurance if they live longer than their spouse.
Drawbacks of Pension Maximization
Of course, this isn’t to say that pension maximization is for everyone. There are several potential drawbacks that you and your spouse need to take into consideration before moving forward with this financial strategy. These drawbacks include:
Potential loss of spousal benefits through your pension. Some pensions offer medical or other benefits through their joint and survivor options. Choosing a single life, or life only, option may cancel these out.
Not a big enough death benefit. Make sure that your life insurance policy will offer your surviving spouse enough to cover the income you received from your pension. You wouldn’t want taxes, or miscalculating your life insurance payout amount, to get in the way of providing them the income they need after you die.
Insurance policies lapse – pensions don’t. A life insurance policy to provide your spouse with a death benefit is a great option, but it’s also forgettable. Insurance isn’t a set-it-and-forget-it thing. You need to make sure that your policy doesn’t lapse – and remembering to follow through with renewing your policy if you’re busy, or struggling with your health, can be tough. You don’t want to pay for a policy during retirement only to have it lapse and not pay anything to your spouse.
Do Some Comparison
Before making a decision about whether or not pension maximization is for you, it can be helpful to do a side-by-side comparison of your pension benefit options, and a potential life insurance policy cost and payout. Run multiple scenarios where you outlive your spouse and where they outlive you. It also needs to be taken into consideration with other assets that you have to determine that it’s the right option.
Look at the different monthly benefits of each pension election option, and how they might be impacted by taxes. Then, look at the monthly premiums for different life insurance policies, and how a death benefit would be paid out to your spouse or heirs if you pass away before them.
Knowing that you and your spouse are both taken care of, while still getting the most from your pension, can give you peace of mind as you head into retirement. Does the process of determining what pension strategy is right for you feel overwhelming? Reach out, as I’ve helped clients go through this exact process. As a fee-only financial planner who specializes in working with retirees, I’d be happy to run projections of each of these scenarios for you and your spouse as part of an ongoing comprehensive financial plan.