Learn about various ways to protect your money in your later years
When it comes to choosing the best course of action for retirement, the options can be overwhelming. Most retirement plans today do not offer the guarantees once provided in traditional defined benefit plans such as pensions. For teachers, government and public employees, pension plans offer a defined monthly income guaranteed with various payout options to choose from. Retirees elect which payout option they want before they are ready to retire. A retiree can choose from the following payout options:
Single life only — This payout option ends at the retiree’s death and does not continue to a spouse or beneficiary. This option provides the highest payout.
Joint/Survivor — The retiree and spouse or a loved one would take less money while alive to continue to receive a monthly income after the retiree’s death. There are often options for what percentage the retiree would like to continue (i.e 100 percent, 75 50.
Lump Sum Payout — The lump sum payout allows the retiree to cash out and take full control of the retirement dollars available. We do not see this option commonly taken because there are no guarantees you can manage your money better with better returns than the pension fund.
Most of our clients choose the joint payout option to ensure their spouse or loved one continues to receive payouts after death. The dollar amounts and age difference are the biggest factors when considering this alternative.
A substantial number of our clients found choosing the life only option coupled with a pension maximization plan most beneficial. A pension maximization plan is a cash flow analysis that uses life insurance to determine whether a retiree’s pension dollars can be stretched to provide the same or more net income to their surviving loved one. If done correctly, this plan can provide more income before and after the retiree’s death. To properly evaluate the options one must look at future income needs, life expectancy, and other objectives.
Recently we had a government employee of 25 years, Bill, come to us asking which option he should choose. Bill, age 60, planned on retiring at 65 and was in good health. The single life payout option gave him $6,000 per month but didn’t pass anything onto his spouse, Betty, who is also 60. The joint/survivor option paid them $4,900 per month and would continue to Betty after Bill’s death. Because they are both age 60 and in good health, it is likely Betty will outlive Bill by several years based on life expectancy.
If Bill and Betty took the joint option, they would receive $1,100 less each month ($13,200 annually) starting at age 65. If Bill passes at current life expectancy of age 82, the couple would’ve paid $224,400 to ensure Bill’s monthly benefit of $4,900 passes to Betty. If Betty lives a normal life expectancy of age 87, she would receive $4,900 for an additional five years or $294,000. The joint survivor option is comparable to an expensive insurance policy where $224,400 was paid to leave a benefit of $294,000 for Betty. Bill and Betty felt it was ridiculous to pay that much for that potential payout.
Rather than sacrifice $1,100 per month using the joint survivor option, Bill chose the life only option giving him and Betty $6,000 per month. Consequently, with proper help and analysis from us, Bill was able to receive the $6,000 per month and purchase a $500k life insurance policy for $621 a month, which would go to Betty tax free at his death. Invested conservatively, Betty will receive the $6,000/month, most of which is not taxable. In addition, when Betty dies, the remaining unused amount of death benefit would go to their heirs tax-free.
When considering a pension maximization option, your financial professional should tailor this to your needs by taking into account life expectancies, the dollar difference between payouts, health/insurability, tax brackets, and whether health insurance is tied to the pension.
Brian Harrigan and Bob Price are the owners of Executive Plan Design. Contact them at (408)767-2572.
Latest posts by Bob Price and Brian Harrigan (see all)
- Your Retirement … with Brian & Bob: Applying mediation in financial planning can be beneficial - August 3, 2019
- Your Retirement … with Brian & Bob: There are major differences in retirement plans regarding spouses - July 6, 2019
- Your Retirement … with Brian & Bob: Are you planning to fail or failing to plan for your retirement? - June 7, 2019