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Knowledge is power

What Is Pension Maximization and How Does It Work?

Most pension plans offer a single-life annuity (single-pay) option and a joint-life annuity (survivor benefit) option. A single-life annuity will provide a larger monthly payment, but it will only make payments to the pension earner. If the original pension earner passes away, the pension payments will stop.

A joint-life payout provides a reduced payment to the pension earner and their spouse. If the spouse outlives the pension earner, they will continue to collect payments from the pension until they pass away.

Most joint-life annuity pension plans offer a much smaller monthly payment than a single-life annuity pension. Pension maximum involves determining whether or not a life insurance policy can provide a comparable replacement income for your surviving spouse for less than the monthly reduction of selecting a joint-life annuity plan.

Additionally, there are several type of life insurance policies available in today’s market. A thorough examination should be undertaken to select the one that works best for your family.

How Do I Determine Which Pension Strategy Is the Best for Me?

To help you determine if purchasing life insurance for pension maximization is the best option for your situation, we’ve created these 5 Easy Steps. Most pension plans will advise you of pension options at least 6 to 12 months before a planned retirement date.

1. Determine the Monthly Difference Between Your Pension’s Joint-Life and Single-Life Plan 

To calculate this number, subtract the pension’s monthly joint-life payment from the single-life payment.

As An Example:
Single-life pension = $2,550
Joint-life pension = $1,700
$2,500 (single-life) – $1,700 (joint-life) = $850 (monthly cost of joint-life plan)
Monthly cost of joint-life or survivorship pension plan = $850

2. Determine the Annual Income Your Joint-Life Pension Offers 

Multiply the joint-life pension the plan offers by 12 to determine the annual benefit a spouse would receive.

$1,700 (joint-life pension option) x 12 (number of months in the year) = $20,400
Annual Income Offered by the Joint-Life Pension (before taxes) = $20,400

3. Determine the Amount of Money Your Spouse Would Stand to Receive from Your Pension 

To calculate this number, subtract spouse’s current age from 95 or 100 (depending on family longevity).

Spouse’s current age = 60
95 (life expectancy) – 60 (current age) = 35 years

Next, multiply this number by the annual income your spouse would receive from the joint-life pension plan.

35 (years) x $20,400 (annual income from joint-pension plan) = $714,000 (before taxes)
Lastly, multiply this number by 0.65 or 65% to account for income taxes.

$714,000 (joint-life pension before taxes) x 0.65 (income tax multiplier) = $464,100
Approximate joint-life pension benefit after taxes = $464,100

$464,100 is the amount of money you would need to replace for your spouse if you selected the single-pay pension plan and passed away the following day. (Remember, the death benefit from a life insurance policy is untaxed unless your estate is worth more than $11,200,000.)

4. Determine the Cost of a Life Insurance Policy with a Face Amount that is Equal to the Amount of Income Needed to Replace for Spouse 

Review the available life insurance products; term and universal life to name a few. Keep in mind; all quotes are subject to insurability requirements.

5. Compare the Cost of a Life Insurance Policy to the Cost of Selecting the Joint-Life Pension

If the monthly cost of a life insurance policy is less than the amount you’d sacrifice each month by selecting the joint-life or survivor-life option to protect your spouse, we recommend maximizing your pension with a life insurance policy.

If the cost of the life insurance is higher, or if you’re uninsurable due to a serious health condition, we recommend choosing the reduced pension payout with the spousal or survivor-life benefit.

Overlooked Benefits that Pension Maximization Can Offer

1. If Spouse passes away before retired employee, they can cancel the life insurance at any time with no penalties. The retiree also has the option to change the beneficiary listed on their policy. In comparison, if you chose a reduced pension with a joint-life benefit, you can’t go back and change your election.

2. If Spouse outlives retired employee, they will receive the death benefit from the life insurance policy upfront and untaxed. This allows the options of reinvesting the money or paying off any outstanding debts with high interest rates.

3. Spouse will have complete control over the money left behind by deceased retiree’s life insurance policy. This will allow leaving any additional money behind to the family member(s) of their choice. Unlike a pension, a life insurance policy can create an inheritance for your loved ones.

4. The longer the retiree lives, the larger the surplus of replacement income the life insurance will provide to spouse. (Remember, the life insurance policy is designed to pay the full amount spouse would stand to gain from the pension if retiree passed away tomorrow.)

5. The couple can reduce the amount of their life insurance policy in the future, if needed. This will allow them to save additional money each month on the cost of their life insurance coverage. And with life insurance, you have the ability to receive the death benefit as a lump sum, or over time, similar to a pension or annuity.

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