When it comes to making important decisions, everyone likes to have options.
This is especially true as one nears retirement and the time to choose the pension option that’s most appropriate for you and your family is quickly approaching. Not only will the decision you face have wide ranging repercussions -as it will determine the income you’ll receive for the rest of your life as well any survivor’s benefit-but it is irrevocable.
Benefit payment options
Pension plans provide a benefit to the retired plan member that continues to the surviving spouse for life (normally as a reduced amount) once the retiree passes away. This is commonly referred to as a “joint life” pension. Most plans, however, offer retirees a number of additional payment options, one of which is a “single life” pension. These do not pay a pension to the surviving spouse. Since single life pensions pay benefits over just one lifetime, the monthly payments to the pensioner are higher than if the pension is guaranteed for two lifetimes. However, because single life pensions provide an income for just one person, they effectively disinherit the pensioner’s spouse in the event of the pensioner’s prior death.
Because most plan members with spouses aren’t willing to accept that risk, the single life pension isn’t really an option. Instead, most individuals opt to build in a risk management component by selecting a joint life pension. That is, they accept a smaller income in exchange for the certainty of knowing their spouse will receive an income in the event of their death. The “premium” they agree to pay for this certainty, therefore, is a reduced monthly pension.
Accepting a smaller income appears to be the only choice for most people approaching retirement. Further, some plans literally prohibit married retirees from choosing a single life pension-they offer them only one choice, the joint life pension.
With careful planning, however, you may be able to opt for the larger benefit that comes with a single life pension while resting assured knowing your spouse will enjoy a comfortable lifestyle in the event of your death. The right life insurance policy, purchased at the appropriate time, can provide the best of both worlds.
How does this “pension maximization” concept work? It’s quite simple. Upon the death of the pensioner, proceeds from their life insurance policy are invested to provide an ongoing income for his or her spouse. It’s the knowledge that cash is certain to be made available to provide income for the surviving spouse that allows a pensioner to choose a single life pension. This income may exceed the survivor’s pension that would have been available to them through a joint life pension.
In addition, there could be some capital remaining upon the death of the surviving spouse to share with loved ones or to form part of their charitable legacy.
Should the pensioner’s spouse die first, the pensioner still retains complete control of the insurance policy. The pensioner may choose to cancel the policy or designate other beneficiaries.
You may not necessarily need to purchase additional life insurance coverage to implement this strategy. The coverage you bought once upon a time to serve another purpose could be used to maximize your pension. If your existing coverage is term insurance, however, it may be necessary to convert it to some form of permanent coverage.
So what is the ideal time to consider pension maximization? One thing’s for certain -if you wait until you’re within a few years of retirement, it’ll probably be too late. The ideal time to implement the strategy is at least 20 years from retirement, as that’s typically when it’s most affordable.
Understanding the Costs of Certainty
Given the choice between a single life pension and one that provides a survivor’s benefit, most people opt for the latter. As we see in the illustration below, however, choosing the selfless option often forces retirees to accept a smaller monthly income.
The illustration is based on a hypothetical, 45-year-old male, with a 43-year-old spouse, who anticipates retiring at age 65. Should he opt for a single life pension, his pension income is projected to be $3,200. Should he opt for a joint-life pension, his income will be $2,637.1
Through the use of life insurance, the pension maximization strategy can allow you to opt for the significantly higher pension income that comes with a single life pension and provide you with peace of mind knowing your spouse will be taken care of in the event of your death.
The cost effectiveness of the strategy depends on several things, includ-ing the cost of the life insurance, the investment return needed to produce the survivor’s pension and the availability of indexed benefits through the company pension plan.
REFERENCE
1. The projected pension figures provided are for illustra-tion purposes only.
Lorne Dubros, CFP, is senior financial con-sultant with Inves-tors Group Financial Services Inc. He can be reached at lorne. dubros@investors-group. com or (416) 491-7400.
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Pension Option
Single Life pension
$2,637 Joint & Survivor pension
Cost of certainty $3,200 $563
Monthly Pension
