Retirement: Income Protection Review

At retirement, many retirees are faced with making a difficult decision that could negatively impact their future financial security and that of their spouse.  Deciding how a pension benefit will be paid out for the remainder of a retiree’s life is an important and critical decision.  There are two ways a pension can be paid.

One choice is to receive the maximum retirement check each month for as long as the retiree lives, with the condition that upon death, the retiree’s spouse gets nothing.  Another choice is to receive a reduced retirement check each month, with the condition that upon the retiree’s death, the spouse will continue to receive an income.

These retirement income decisions will determine the amount of pension income received for the rest of a retiree’s life.  A generally irreversible decision, many people unknowingly purchase the largest death benefit they will every buy and one over which they have no control.

Joint and Survivor Annuity Payout Requirement

If a person is married, federal law requires that, in order to protect their spouse, they must elect a “joint and survivor” fixed annuity payout option for their pension benefits.  This guarantees that the surviving spouse will continue to receive at least one-half of the pension income.

This concept may seem sound at face value, however, a person has to pay for a joint and survivor annuity payout option for several reasons.  First, the pension benefit is reduced for as long as the retiree lives.  Next, if the spouse dies before the retiree, the pension benefit cannot be restored to its unreduced amount.  Finally, all pension payments cease when both retiree and the spouse die, leaving heirs with nothing.

Pension Benefit Option Examples

When deciding which pension option is best, referring to the three most common benefit options using a hypothetical example helps to clarify each choice.

Life Income Option

A life income option definition is often described as life insurance.  However, it can actually be seen as the opposite.  If a retiree receives their pension benefit under the life income option, they will receive the maximum life pension payment.  However, when the retiree dies, the surviving spouse receives nothing.  

For example, a retiree receives a monthly pension benefit of $2,000.  Upon the retiree’s death, the monthly pension benefit paid to the spouse is $0.  If the spouse dies before the retiree, the monthly pension benefit remains unchanged at $2,000.

Joint and One-Half Survivor Option

With the joint and one-half survivor option, a lower lifetime pension payment is received.  However, unlike the life income option, if the retiree dies, the surviving spouse continues to receive a lifetime pension benefit based on the joint and survivor annuity formula equal to 50% of the pension benefit received prior to the retiree’s death.

For example, a retiree receives a monthly pension benefit of $1,700.  Upon the retiree’s death, the monthly pension benefit paid to the spouse is 50% of the monthly pension benefit or $850 per month.  This amount is paid to the spouse each month until death.  If the spouse dies first, the monthly pension benefit remains at $1,700.

Joint and Equal Survivor Option

With the joint and equal survivor option, a retiree receives a significantly lower lifetime pension payment.  However, the surviving spouse will continue to receive 100% of the pension benefit if the retiree dies.  If the spouse dies first, the retiree continues to receive the lower lifetime pension benefit amount until death.

For example, a retiree receives a monthly pension benefit of $1,500 a month, which is about 75% of the full pension benefit amount.  If the retiree dies first, the spouse will continue to receive the $1,500 until their death.  If the spouse dies first, the retiree will also continue to receive $1,500 until death.

If reducing the monthly pension benefit by up to 25% does not sound appealing, there is an alternative—life insurance.

A Potential Retirement Income Protection Solution Using Life Insurance

Federal law allows a pension plan participant to waive the “joint and survivor” annuity payout requirement, with the written consent of the spouse.  This means that, with spousal consent, the maximum life income annuity payout at retirement can be received.  With a retirement income protection solution, life insurance is purchased today to replace the pension income lost at death, assuring that a spouse has an adequate source of income after the retiree’s death.  This also means that if the spouse dies first, the retiree does not have to continue with a lower monthly payment amount.

There are risks associated with retirement income protection funded life insurance:

  • Income after retirement must be enough to ensure that the life insurance policy premiums can be paid and that coverage will stay in force for the retiree’s lifetime.  If there is not sufficient income to pay the insurance premiums, the spouse may be left without sufficient income after death.
  • If a pension plan provides for cost-of-living adjustments, upward adjustments in the amount of life insurance will be needed to replace the cost-of-living adjustments after the retiree’s death.
  • If a company pension plan continues health insurance benefits to a surviving spouse, will selecting the life income option to leave the spouse without sufficient health coverage after the retiree’s death?

All of these options are complex and should not be considered without the help of a qualified financial expert.  Comparing income, determining the effect of a joint and survivor, a joint and one-half survivor, or a life income option can yield very different results.  

Adding life insurance to the mix can tip the scales from one option to another based on the overall income expected to be received by the retiree and spouse.  Insurance concerns, whether life or health insurance, should also be considered before making any decisions regarding a pension benefit payout option.  

Protecting income before, during, and after retirement should not be done without a thorough evaluation of all options involved.  A skilled financial planner can help a potential retiree with this life altering decision.

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