Any client lucky enough to have an employer-provided pension will face one key decision when it comes time to retire. Should they take payments as long as they live, or choose the joint-and-survivor option to keep the payments coming to a spouse who outlives them?
In many cases, the joint-and-survivor option is selected for them automatically. Their spouse has the right to waive that benefit within 90 days, however - and they should.
Your client's impulse will probably be to accept the joint-and-survivor payments. After all, they love their spouse and want to provide for them. Let's talk about why that's actually a bad choice in terms of overall retirement planning.
Let's say your client accepts the joint-and-survivor pension payments. Because that pension has to last through both spouses' lifetimes, the monthly payments are going to be smaller than they would if they only had to last through your client's lifetime. Survivor payments are usually between 50% and 100% of the retiree's benefit. To budget for those continued payments, the pension provider will pay out less money every month than they would for someone who opts out of the survivor payments. For example, if the full benefit were $1,500 per month, the pension provider would probably pay about 75% of that benefit, withholding about $375 per month to set aside for a surviving spouse.
But what happens if the spouse dies first? Your client's monthly payments have already been permanently reduced. Every reduced payment they received in anticipation of their spouse outliving them is money they can't ever get back. Using the sample dollar figures above ($1,500 per month reduced by $375), your client would lose $45,000 over 10 years if their spouse passed away first. Even if their pension had a provision to return them to the full monthly payment amount after the spouse's death, they're never going to get that $45,000 back. Plus, if your client remarries, the new spouse is not usually eligible for any survivor benefits. Isn't there a better way to go about this?
Let's look at an alternate scenario. Let's say your client and his spouse opt out of the joint-and-survivor pension payments. Your client now receives a larger monthly benefit. He takes part of that benefit and buys a whole life insurance policy, naming his spouse as his beneficiary. That policy will pay a tax-free death benefit to his spouse when he passes away. That benefit will be equal to, if not greater than, the survivor benefit that would have been available through the pension. As long as your client is healthy enough to qualify for life insurance, this is a great way to maximize their retirement income.
This scenario also works in the event that the spouse passes away first. If that happens, your client has two options:
- Name someone else as a beneficiary, such as a grandchild.
- Surrender the policy and use the surrender value as supplemental retirement income.
An additional bonus is the cash value that accumulates while the policy is in force. Before anyone passes away, your client and his spouse will have cash value accumulating on a tax-deferred basis. Unlike the survivorship pension option, the life insurance option will cover a second spouse if your client remarries - as long as he or she updates that beneficiary list!
Do you have clients in their 40s or 50s who are married, currently employed, and eligible for an employer-sponsored pension? If so, they're great candidates for this solution. The time to talk to them is now, before they hit retirement. For sales help and illustrations, contact our Brokerage Sales Support team at 800-823-4852 or email us at [email protected].
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Disclaimer: Any tax information provided in this article is not intended to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed on the taxpayer. Always seek advice from an independent tax advisor.