Advantages of Using Pension Maximization

The principal advantage of a pension maximization strategy is planning flexibility as compared with the J&S annuity survivor benefit from a qualified plan.

The insurance feature of the J&S annuity has several unattractive elements. First, with this type of insurance the plan participant will generally have to continue paying the monthly premium (receive the lower J&S benefit payments rather than the higher SL benefit) even if the spouse dies first and the survivorship insurance is no longer necessary. Unless the plan has a pop-up feature, where benefits payable to the participant jump or pop-up to the SL annuity amount in the event the spouse predeceases the participant, the participant will continue to receive the lower J&S benefit after the spouse’s death. Typically, all else being equal, the joint benefit paid on J&S annuities with a pop-up feature is less than the joint benefit paid on normal J&S annuities. Either way, the couple must pay for the survivorship benefit by receiving lower joint benefits; it’s just a matter of timing when the premiums are due.

A second unattractive element of the insurance feature of the J&S annuity is its lack of flexibility. Essentially the only option or choice a couple has with respect to the pension’s survivor benefit is to select the survivor benefit ratio, that is, the percentage of the joint benefit that will be payable to the spouse in the event the participant dies first. The default ratio is 50 percent, but most plans will permit the couple to elect ratios of 66⅔ percent, 75 percent, or 100 percent. Of course, as the survivor benefit ratio goes up, the joint benefit typically goes down, effectively increasing the premium for the survivorship benefit.

Furthermore, a pensioner generally has no rights to: (1) accelerate benefit payments if the need arises; (2) choose an alternative or substitute beneficiary if the spouse predeceases the participant; or (3) wait to select what type of benefit payout pattern will be paid to the surviving spouse if the participant dies first.

In contrast, the pension maximization plan is often attractive because a life insurance policy on the participant offers considerably more planning flexibility than the implicit insurance within the pension’s J&S annuity.

If the spouse dies first, the participant has several alternatives as to what to do with the life insurance policy.

First, he may continue to pay premiums, keep the insurance in force and name a new beneficiary, perhaps a child, grandchild, or even a favorite charity.

Second, he can suspend premium payments and effectively increase spendable retirement income. This is essentially a home-made equivalent to the pop-up feature described above.

However, the participant still has several additional options with respect to the insurance coverage that are not available under the J&S annuity. If the policy has cash value, the participant may elect to keep the policy in force under either the reduced-face-amount fully-paid-up whole-life option or the full-face-amount term-life option. Alternatively, if life insurance is no longer needed or desired, he or she may surrender the policy and take cash value as a lump sum or under one of the many nonforfeiture (essentially annuity) options all life insurance policies must offer.

A life insurance policy also provides more flexibility than the J&S annuity with respect to the options available to the surviving spouse. Where the J&S annuity provides only one option—a life annuity for the spouse at some pre-specified proportion of the joint benefit—the life insurance provides many options as to how the proceeds may be distributed to the surviving spouse.

Although a couple may initially anticipate that a life annuity will be the best way to distribute the life insurance proceeds to the surviving spouse, circumstances may change. For example, if the spouse is not in good health, some form of higher-benefit, limited and guaranteed term annuity may be more suitable than a life annuity.

Alternatively, the couple may take a wait and see approach by setting up a trust to receive the life insurance proceeds. The trustee may be given discretion as to how to distribute the funds to best insure the surviving spouse’s financial security. In such cases, payments could be accelerated to meet special needs, such as large medical expenses. Such flexibility is virtually never available under the pension’s J&S annuity benefit.

Finally, a life insurance policy provides more flexibility to handle special or changing needs while both the participant and spouse are alive. For example, if the health of either partner begins to fail, they may borrow cash values from the policy to help pay medical expenses. If the policy has a chronic illness or long-term care rider, they may be able to accelerate the death benefit or have access to a pool of benefits to help meet chronic illness and long-term care expenses. No such acceleration provision is generally available from the J&S pension option.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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