This is the third article in a three-part series on pension election decisions.
Today, I will look at a strategy to maximize your pension. As the name suggests, pension maximization can help you to get the most out of your pension payment. It takes a bit of calculation and careful planning. Here's how it works:
First you determine the difference between the single life and joint survivor payment monthly payouts. Based on your situation - mainly your age, health and lifestyle (e.g. smoking status, gender, exercise level) - you determine how much insurance you can purchase with the difference between the higher and lower payouts.
Based on the calculation that you just did, determine if you can purchase with that cash difference a sufficient amount of permanent life insurance on yourself to provide a cash flow near the level of income that would be lost to your spouse if you should die and your pension then ceased.
In most cases, and assuming that you are insurable, the cash difference you calculated (after any taxes that may be owed on that cash difference once distributed from your retirement plan if used to pay for the life insurance benefit) should be more than enough to purchase the life insurance needed.
Secure the life insurance coverage prior to electing your pension payout option and name your spouse as the beneficiary. (Note that term life insurance does not work well for this concept, since it will eventually expire or become prohibitively expensive.)
You then select the Single Life regular payment option at retirement - receiving the maximum monthly pension payout for benefit of you and your spouse as long as you live.
If you predecease your spouse, the life insurance death benefit would then be paid to your spouse, replacing the monthly pension income that you were receiving during your lifetime. This payment can be a tax-free lump sum or structured as a monthly income to your spouse for the remainder of her life.
Some possible benefits of pension maximization include the following:
• You and your spouse receive the highest cash flow from your pension while you both are living.
• The life insurance could, in some instances, provide a larger cash flow to
your spouse than the former pension payments that were received while you were living. (This would be more likely if the insurance had been purchased several years before your planned retirement.)
• The life insurance option within the pension maximization strategy may not be subject to claims of creditors against you or your estate. (You should consult with your attorney for proper structuring to preserve all benefits.)
• Your spouse's death could precede yours - in which case, you'd have received a reduced monthly income for the rest of your life if you had taken the joint payout option.
• Under pension maximization, if your spouse should die before you, you'd have the option of keeping the insurance and naming a new beneficiary or canceling the insurance and receiving the accumulated cash value - tax-free unless and until the amount of your surrender value exceeds the premiums you've paid.
• Any life insurance proceeds remaining at the death of the surviving spouse/beneficiary could pass to other family members.
• You could diversify your "insurance risk" by making sure that the carrier that sells you the insurance policy is different from the insurance company paying your annuity payments under the company plan's policy.
Generally, the younger you are when you purchase the life insurance element of this concept the better pension maximization works, since you lock in the premium rate based on your age at time of purchase and because your health would likely be better at a younger age as well, which allows for a better rate. However, this concept may work as well even if purchased at retirement time. Your financial advisor can help you determine if pension maximization works for you.
WHAT HAPPENS IF YOUR COMPANY FILES FOR BANKRUPTCY?
There are two common forms of bankruptcy. In Chapter 11, a company stays in business while it reorganizes its finances. In Chapter 7, a company goes out of business and liquidates all assets. In Chapter 11, pension and health plans are often - though not always - continued, while these plans are terminated in Chapter 7.
In either case, if the plan is a standard defined benefit retirement plan subject to ERISA, the PBGC guarantees "basic benefits" earned before your plan's termination date.
I don't think anyone should make a decision in isolation about how to receive your pension benefits. Preparing for retirement requires a comprehensive planning process. Be sure to include your tax, legal and financial advisors in making this very important decision.
They can estimate the cost of your retirement, analyze your income sources and choose an appropriate investment strategy to meet your goals and family situation.
• William Creekbaum, MBA, CFP, a Washoe Valley resident, is senior investment management consultant of Morgan Stanley Smith Barney LLC. He can be reached at William.a.creekbaum@mssb.com or 689-8704.