The life insurance option has its costs and risks. By far the biggest risk with the pension maximization plan is that the life insurance premiums will not be paid and the insurance will not be in force if the insured plan participant dies first. Since there is no J&S benefit being paid due to the election to take the single life benefit instead, this potentially leaves the surviving spouse without sufficient income with which to live. In order to mitigate the risks associated with pension maximization, the following should be considered:
- Buy enough death benefit on the plan participant sufficient at the insured’s death to purchase an after-tax life only immediate annuity payout for the surviving spouse to replace the same after-tax income as the foregone J&S pension benefit.
- In determining how much death benefit to purchase, assume the worst case scenario, which is that the plan participant dies the day after retiring. The reason for this is that the cost to purchase a life only immediate annuity for a sixty-five year old surviving spouse would be considerably more than to purchase one for a seventy-five or eighty-five year old surviving spouse. If the life insurance contract is flexible enough, it may be possible to periodically reduce the death benefit over time in order to make the life insurance premium less costly.
- To minimize the risk that the life insurance death benefit will not be in force when needed, use conservative products and assumptions. Ideally, the death benefit should be guaranteed for the insured’s life (or at least to the insured’s age 100).
- Have the plan participant purchase the life insurance well before reaching retirement age. A pension maximization plan that is implemented some years before retirement will generally cost less than one that is implemented later. In general, the premium cost for an adequate amount of life insurance in a pension maximization plan that is implemented entirely when your client reaches retirement will be greater than the differential between the single and joint life annuity payouts from your client’s pension. Whether the additional features and flexibility of the life insurance are worth the additional cost while the couple both live depends on what they want their plan to accomplish.
- Pension maximization should be employed only by those couples who are financially disciplined enough to see the plan through. Often, if the plan is implemented early enough, this risk can be reduced or eliminated altogether by paying enough up-front to entirely fund the life insurance policy at or soon after retirement.
- Ideally, pension maximization should generally only be employed by those couples who have sufficient other assets, so that the surviving spouse could tap those assets for retirement income in the event that the life insurance policy were to lapse prior to the insured’s death.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM