Could Pension Maximization Work for You?
Updated: Nov 8
If you are among the rare few with a retirement pension, congratulations! You have a benefit that is becoming increasingly rare. With the 401(k) plan becoming the workplace retirement plan of choice, people hold more responsibility for their financial futures than ever.
Knowing you have a pension gives you the comfort of knowing that, once you retire, you are scheduled to receive monthly income payouts for life. Your income payment will be based on your salary and your length of employment. Just like with annuity payout options, the lifetime payout option you select with your pension plan will have a direct bearing on how much income you receive. Survivor’s Benefit, Yes or No? Let’s say your retirement day has dawned and you are going to meet with your pension plan administrator. You will be asked a very important question. Which distribution option do you choose: “single life” or “joint and survivor” distribution? Single life refers to the option that pays you pension benefits until you pass away, therefore paying during your life alone. The joint and survivor distribution pays your monthly pension to you while you are alive, then pays that benefit to your spouse until their passing.
If the joint and survivor option seems the obvious choice to ensure your spouse is taken care of, there are other factors to consider. Selecting the joint and survivor option means that you will receive a lower pension payout from the beginning. Why? Because the payment is calculated on the assumption that payouts will continue for a longer period. The payouts would cover not only your lifespan, but that of your spouse as well. The Differences in Action So, how might this affect you in real-world dollars and cents? Let’s look at a scenario involving two couples. Joan and Arthur are a married couple. She is 60, he is 70. Arthur has a pension at work. He decides on a single life distribution for their monthly payments. A sum of $650,000 will be divvied up for their income payments, with their payouts starting in year one. Based on a single life distribution choice, they will receive $35,475 a year from his pension. Now, say that Arthur chose a joint and survivor distribution instead. While Joan would continue receiving lifetime income when he passed away, the monthly payouts will be smaller. With a joint and survivor distribution, Joan and Arthur would be paid $26,125 – almost a $10,000 step down from the aingle life distribution. Age is also Important This brings up another important point. Couples’ age differences also play a role in the sum of income payouts.
The wider an age gap both spouses have, the bigger the difference will be in payouts from single life and joint and survivor distributions. And when couples are closer in age, the smaller the difference will be in payouts. Here’s another example for illustration. Another couple, Peter and Sandra, are both 70 years old. Sandra has a pension at work. And the nest-egg sum to be divvied up is again $650,000, with income payments starting in year one. Just as before, assume that a single life distribution from Sandra’s pension would pay out $34,475 a year. But now with Peter and Sandra being the same age, the gap between payouts shrinks. A joint and survivor distribution would bring $32,038. A payout difference of roughly $2,000 might not be much of a deal breaker for some retirement investors. The Option of Pension Maximization Knowing that the highest pension payout comes from choosing single life, an innovative income strategy has emerged: the pension maximization strategy. Pension maximization is designed to provide pensioners with the highest payout and then provide income for their spouse upon their passing. With pension maximization, a retiree chooses the higher payout of single life and then purchases a life insurance policy with a considerable death benefit for their spouse. Their partner will receive the death benefit proceeds should the pension holder die first. From there, the surviving spouse has the option to purchase an immediate annuity that can function as lifelong income, just as the joint and survivor option would have. Is a Pension Maximization Strategy Right for You? Your circumstances are unique. They should be carefully considered before deciding your pension payout strategy. Consulting with a financial professional can help you explore your options and determine which strategy might be best for you.
Some questions for you, your spouse, and your financial professional to consider:
What is the difference in payouts between your two options?
How healthy are you and your spouse?
How healthy is your pension plan?
What other assets will you rely on for income streams?
What are both of your Social Security claiming strategies?
What are you and your spouse’s ages?
When do you both plan to retire and start drawing retirement income?
Should your spouse predecease you, would you want your children to become beneficiaries?
The first and second questions are intertwined. If you are in good health, you will have more time to collect the larger monthly income that is derived from single life. If your health is questionable, having less time to draw the higher amount may make securing your spouse’s guaranteed income with the joint and survivor option your top priority. Your spouse’s health becomes a factor in another way. Upon your passing, your pension can only be paid to your spouse, not to your children. If your spouse is likely to pass away before you do, taking the higher payout and having a life insurance policy with the flexibility to change beneficiaries (from your spouse to your children, for example) could address your legacy goals. Other Important Questions in a Pension Maximization Strategy Your health isn’t the only consideration. The health of your pension plan could be a weighty factor in deciding between your payout options. There have been many headlines over the last decades about companies closing and shutting down their pension plans. Even some public-sector pensions have generated troubling headlines around their ability to keep up with their pension payouts. There is some relief in knowing private pension plans are at least partially insured by a government agency, the Pension Benefit Guaranty Corporation (PBGC). It was established in 1974 by the Employee Retirement Income Security Act (ERISA). The PBGC was created to step in should an employer’s pension fund go bankrupt. While the PBGC makes payments to retirees, it doesn’t pay the entire amount that the former employee is due.
The PBGC reported that, in 2018, it:
Protected approximately 37 million workers in 25,000 private pension plans.
Paid $5.9 billion to nearly 1.5 million retirees in more than 5,000 failed plans (an additional 560,000 workers will receive benefits when they retire)
Assumed responsibility for more than 28,000 people in 58 newly failed single-employer plans
These statistics show that pension plans can fail. Learning about the health of your own plan can influence your decision on which payout to select. It should be noted that “the PBGC can only pay a maximum benefit of about $60,000 per year.” Nor does it guarantee “it will pay the full benefits promised to a retiree by their employer,” according to analysis by financial writer Wendy Connick. Putting Your Retirement Income Security in Place If your retirement is within 10 years, now is a good time to explore your own situation, your pension plan options, and other parts of your retirement income puzzle. That includes retirement income strategies that could help maximize not only your lifetime pension income, but also the retirement lifestyle you and your spouse enjoy. If you need personal guidance, a financial professional can help you explore various pension maximization strategies and other income-generating options. Our financial professionals at JenniferLangFinancialServices.com stand ready to assist you. To request a personal appointment, contact us today. We're happy to help!