Spokane Journal of Business

Pension-maximizing options allow income flexibility

Some insurances can be structured to secure payout, protect family members

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Do you have a defined-benefit pension plan? We’re not talking about 401(k)s or 403(b) deferred compensation accounts. We’re talking about an actual life-income pension that gives you a guaranteed income in retirement for the rest of your life.

Often, these pensions are provided to those working in the government sector. They also still are offered by some larger corporations as well.

Pension maximization is an insurance and financial planning technique, an alternative to taking a reduced pension while alive so your pension continues to be paid to your spouse when you die, and there are some compelling advantages for the right person. If done properly, it can save you literally thousands of dollars and give your beneficiaries much better flexibility, options, and tax advantages.

Just before retirement, you will face an important decision, but it’s best to address this now, as early as possible. Don’t wait till the last minute. More on that later.

You will choose either the single-life option, which pays out the maximum possible monthly income and stops after your death, or a joint-and-survivor option that will pay a reduced benefit to you during your retirement and a continue a benefit to your spouse after you’re gone. Gamble and choose the wrong one, however, and it could be costly.

Let me illustrate: If you choose the single-life option and die unexpectedly a month into retirement, your pension stops and your spouse gets nothing. For that reason, most people instead select one of the joint-and-survivor options. But it can backfire.

For example, let’s say the single-life one pays you $6,000 per month. And let’s say you have three different joint-and-survivor alternatives.

The first one is called “Joint and Survivor, 100 Percent Replacement.” It pays you $5,000 per month while alive, a $1,000 reduction to you, and when you die, your spouse keeps getting the same $5,000 per month. The “Joint and Survivor 66 2/3” option, will pay you $5,300 per month and pay your spouse 66 2/3rds of that, or $3,529, after you die. The last option, “Joint and Survivor 50 Percent” will pay you $5,500 while alive and your spouse 50 percent of that, or $2,750 after you’re gone.

Let’s say you and your spouse want the 100 percent replacement option, which has a $1,000 reduction. If you live for 20 years, that protection will have cost you $240,000.

This scenario is what the pension-maximization concept will be competing against.

The whole point of you doing this was to protect your spouse. But what happens if your spouse dies 20 years before you do? What do you have to show for your $240,000? Nothing. And you aren’t allowed any contingent beneficiaries, so it may feel like you took the pension reduction in vein.

When helping my clients with these decisions, I try to get them to recognize that if they take a reduced joint-and-survivor option, they are in fact buying an expensive life insurance policy from their pension with some significant disadvantages for them and their beneficiaries.

I tell them to pretend their employer only provides a pension for them, but nothing for their spouse. Would they be concerned for their spouse? If so, what would they do? They likely would shop for some life insurance.

I then draw a line down the middle of a page and tell them we’ve narrowed it down to two life insurance companies, A and B. On the left, in column A is a plan that works exactly like a joint-and-survivor option.

In column B, I describe what you could get with a true, personally owned, permanent cash-value life insurance policy, purchased on the open market.

In column A, you’re getting an expensive life insurance policy, through which you can only choose your spouse at the time of retirement as your beneficiary, with no contingent beneficiaries allowed. Your spouse will be limited to a monthly pension annuity payment, with no lump-sum payments allowed. The payments will be 100 percent taxable and you must die for it to payoff, because it has no cash value.

Would you pay $1,000 per month to buy a life insurance policy that looked like that? Maybe only if you were uninsurable and this was the only company who would take you.

On the other hand, here is what you get for your $1,000 with life insurance company B. You get a permanent cash-value policy, through which you can choose as many primary and contingent beneficiaries as you wish. That life insurance ordinarily pays a lump-sum, tax-free benefit, although some of it can be converted into a guaranteed lifetime income annuity stream, just like a joint-and-survivor pension.

Your beneficiaries also can invest part of it they wish, so one portion is growing while they’re living on the remainder. The life insurance from company B also can have a cash value that can be accessed by you along the way for opportunities or emergencies or to recoup your costs if your spouse predeceases you.

Provided there is enough cash value built up, it can even be used to cover your insurance costs, allowing you to stop paying premiums at some point, or in ideal situations, even let you start taking tax-free distributions to supplement your retirement. Modern policies can also have what are called “Living Benefits,” or “Accelerated Death Benefit Riders” that allow you to access all or some of the death benefit while alive, if you are terminally ill or have a chronic illness or need long-term care.

Pension maximization and buying your own life insurance isn’t without its faults and disadvantages, however. You must apply, take a medical exam, and get approved. So it’s best to start planning for this as early as possible, even if you think you’re a long way out. Don’t wait till the last minute to apply. You run the risk of not qualifying, and your rates will be more expensive as they’re based on age and health. Conversely, there are no medical qualifications to taking a joint-and-survivor option from your pension.

Also, with buying your own life insurance policy comes responsibility. You must be sure to pay your premiums on time and not lapse it. There are many companies and policies to choose from, some with better ratings for financial strength and claims-paying ability.

Also, some contracts have better guarantees built in than others, so you’ll need to do some research. Better yet, it can be complicated, and you have a lot on the line, and there are no do-overs, so find a life insurance specialist who really understands the ins and outs of pension maximization, and have them research everything for you. To be clear, this is not your basic do-it-yourself online term-life quote.

Done correctly, using pension maximization can be a powerful technique to help you to get the maximum income from your pension, while still taking care of your loved ones in the most flexible ways possible.

Todd Radwick, president of Radwick Financial Group LLC, of Winthrop, Wash., is an insurance and financial adviser and a 23-year industry veteran. He can be reached at 509-996-3425, radwickfinancial.com, and todd@radwickfinancial.com

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