Key Things Planners Should Consider With a Pension Maximization Alternative

First, the spouse has rights to survivor benefits from the pension plan unless he or she expressly waives those rights in writing.

The normal form of pension benefit for married couples is a J&S annuity with a survivor benefit ranging from 50 percent to 100 percent of the joint benefit. In addition, a spouse is entitled to a preretirement survivorship benefit if the plan participant should die before normal retirement age. This preretirement survivorship benefit is essentially the same as the survivorship benefit the spouse would have received under the normal J&S annuity if the plan participant had retired or terminated service on the day of death. If a couple wishes to elect any other form of benefit, such as the SL annuity, the spouse must give informed and written consent (witnessed by a notary public or plan administrator) waiving his or her rights to the survivor benefit under the normal J&S annuity. In general, a spouse should never waive his or her rights to survivorship benefits without guarantees that he or she will receive comparable nonforfeitable benefits in some other way. These benefits are typically assured by an insurance policy on the participant’s life. The spouse or a trust set up for the benefit of the spouse should be the owner and named beneficiary of the policy.

Second, be sure you know what benefits the pension will pay under the SL annuity and the J&S annuity options.

The pension administrator must give a Summary Plan Description (SPD) to every plan participant. The SPD should describe all the options and participant rights under the plan. If necessary, the plan documents themselves can be reviewed to clarify the participant’s and the spouse’s rights. In addition, no later than within ninety days of retirement, the plan administrator must present retirees with a statement describing their options under the plan. Since it is advisable to begin planning sooner than ninety days before retirement, the participant may ask the plan administrator to estimate monthly benefits under various options before the ninety-day period. The key factor is the relative difference between the single life and joint life payouts.

The differential between the SL and J&S annuities may be affected by whether the spouse is permitted to waive his rights to preretirement survivorship benefits and, if permitted, when he so elects. Typically, if the spouse waives rights to a preretirement survivor annuity, the value of the post-retirement J&S or SL annuity benefits are correspondingly increased. Therefore, it is often best to implement the pension maximization plan before retirement, especially if the plan permits the spouse to waive preretirement survivor benefits as well as post-retirement survivor benefits. The sooner the election to waive preretirement survivor benefits is made, the larger, generally, will be the upward adjustment of the post-retirement benefits. Once again, a spouse should generally not waive his rights to preretirement survivorship benefits until adequate insurance has been secured on the life of the plan participant.

Third, be sure to fully account for all of the benefits associated with the pension plan.

Some pension plans include specific cost-of-living adjustments (COLAs) or have a policy of making occasional ad hoc inflation adjustments to pension benefits. If the pension plan includes these adjustments, the couple’s pension maximization plan will need a greater amount of insurance to provide benefits comparable to those offered by the inflation-adjusted pension.

In addition, employer-provided post-retirement medical benefits are sometimes tied to participation in the pension plan. In such plans, if the couple selects a J&S annuity, the company continues to pay certain medical benefits for both the participant and the spouse for as long as either one lives. However, if a couple selects the SL annuity from the pension plan, the spouse’s medical benefits would typically cease upon the participant’s death. Before proceeding with a pension maximization plan, check with the employer’s benefits counselor to see how post-retirement medical benefits, if any, will be handled.

Fourth, a pension maximization plan is more likely to be a feasible alternative if some life insurance is already in force on the life of the participant before retirement. Often, the reasons for keeping life insurance in force change over time. For example, many people purchase life insurance to protect dependent children or to help finance their children’s educations if the primary breadwinner dies. However, as the parents approach retirement age and the children leave the nest, these needs may diminish. Life insurance that was originally acquired for these kinds of purposes may then be used to help finance a pension maximization program. In such cases, the additional insurance required to fund the pension maximization program and its premium cost may be relatively low or zero.

Fifth, a pension maximization program is more likely to be feasible if insurance is acquired before retirement.

Keep in mind, the premium cost for insurance increases with the age of issue. The sooner an insurance program is implemented, the lower the average cost of coverage. Premiums must also be paid sooner, so there is an opportunity cost for setting up the program earlier rather than later. However, if a couple has legitimate life insurance needs before retirement, the purchase of life insurance with the anticipation of funding a pension maximization program at retirement becomes much more feasible.

One very important retirement reason for purchasing life insurance before retirement is to supplement the spouse’s preretirement survivorship benefits from the pension plan.

Typically, pension benefits and correspondingly, the spouse’s survivorship benefits, will increase with the length of participation in the pension plan. If a participant dies before normal retirement age, contributions to the plan or benefit accruals for his or her account will be smaller than if the participant had survived to normal retirement age. Consequently, the spouse’s survivorship benefits generally will be less than if the participant had survived to normal retirement age. However, the spouse’s needs will actually be greater, since he will be younger and have a longer life expectancy than his life expectancy at the participant’s normal retirement age. This deficiency can be corrected through the use of life insurance. If the participant survives to retirement age, at least a portion of the insurance needed for a pension maximization program will already be in place and have been partially or completely funded.

Sixth, a pension maximization strategy is more likely to be feasible if the participant is a female.

Despite some narrowing in the difference in longevity between men and women, women still exhibit longer life expectancies than men, on average. This enhances the feasibility of a pension maximization plan in two ways. First, private insurance uses sex-based mortality tables that are more favorable for females. Therefore, for a female the premium cost for life insurance purchased outside a pension plan will generally be less than that for a male, all else being equal. Second, since males of all relevant ages, on average, survive for a shorter period of years than females of the same age, less insurance is required to provide the same expected total survivor benefits until death for a male than for a female.

Seventh, a pension maximization strategy is more likely to be feasible if the participant’s spouse is not in good health.

A J&S annuity is generally a poor “insurance” choice if the participant’s spouse is less healthy than average for a person of his or her age. The greater the likelihood the spouse will not live as long as average for his or her age, the less insurance the pension maximization plan requires to assure a sufficient survivor benefit. For example, assume a participant-husband is in normal health, but the beneficiary-wife has advanced heart disease and is expected to survive, say, at most ten years. In this case the amount of insurance needed to provide survivor benefits for ten years in the event the husband predeceases the wife is considerably less than the amount needed for the normal duration of life for a healthy woman at normal retirement age.

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

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