What To Take Into Account When Considering Pension Maximization

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Pension Maximization, commonly referred to as simply Pension Max, is a concept that has been around for years. Over time it has had more than its share of fans and detractors.

Its proponents see it as a way to benefit retirees and their spouses by boosting income in their retirement years. Its detractors see it as a scam to siphon off a retirees needed income into questionable financial products. As is often the case with many planning concepts, there is no right or wrong.

In many cases, Pension Max will be beneficial to a client; however, careful analysis is required. Determining what income needs are required and where Pension Max fits is more than a numeric analysis; some issues cannot be quantified. This article will consider these issues and look at some unusual approaches to Pension Max.

What is Pension Max?

Under a pure Pension Max analysis, a retiree elects the largest payout option from his or her employers pension plan, using some or all of the increased funds to purchase life insurance to handle a survivors income needs.

In a classic Pension Max, a retiree elects a single life payout, typically the largest payout option. Although such an election leaves their spouse without income in the years following a retirees death, the retiree replaces the lost pension through the purchase of life insurance. The insurance is often purchased with some of the increased pension income. The survivor would live off the income-tax-free death proceeds to enhance income in the years following the retirees death.

An example from the early 90s shows why Pension Max might be so attractive. In an example from 1992, a retiree was offered a single life pension payment of $2,000 per month or a joint and 50% survivor benefit of only $1,218 per month. By electing a strategy providing for two lives, the retiree took a $782 cut in retirement income. After death, the survivor would be further reduced to only $609 per month. All of these amounts would be subject to income tax.

With a Pension Max approach, a client would elect the higher $2,000 per month single life approach and purchase life insurance to provide the survivor with tax-free life insurance proceeds sufficient to boost the post-death retirement income over $609 per month under the joint life pension option.

Determining if Pension Max is appropriate for your clients calls for a careful analysis.

This same example, now nearly 10 years old, also suggested that during the pre-death years cash value from the life insurance policy could be used to supplement income during the retirement years. If the retiree died, the spouse would be cared for. If the spouse died first, the retiree would be able to continue the larger single life payout while retaining the life insurance death benefit for other heirs.

In the years following this example, a number of items happened that discouraged Pension Max marketing. Pensions, and the annuities supporting pension payments, became more competitive, so the wide discrepancies between single and joint life pensions became less dramatic. In the example from 1992, the survivor benefit was barely 30% of the single life. Now it is more typically 66%.

Retirees also became more cautious of using life insurance cash values during their living years, Qualified Domestic Relations Order made it more difficult for retirees to make unilateral decisions, and financial planners adopted a bias that was more investment-focused.

Nevertheless, in many instances a pension difference might still call for the use of Pension Max.

Where does Pension Max make sense?

There are many things to consider when looking to do a Pension Max analysis:

Quantitative analysis: Many software programs are available that allow advisors to do a quantitative analysis. This includes comparing the pension payout, or projected pension payout, and determining the amount of life insurance necessary to replace the lost pension at the retirees death. A thorough analysis would include a present value comparison of: a) the stream of single life payout less the life insurance premiums paid, and b) the stream of reduced joint life payments. The earlier such a strategy is adopted, and the lower the cost of the life insurance, the more attractive Pension Max will be.

Planning before retirement: As noted above, Pension Max works best if the strategy is adopted before retirement. Although many retirees might defer pension payout planning, and consideration of this strategy until they are about to retire, the younger the client, the better. A healthy 45-year-old can purchase life insurance at a lower cost than a retiree 20 years older.

Although planning years before retirement requires projections and may involve working with the employers HR department, earlier planning results in more leverage obtained from the life insurance. In todays economy, where executives may change employers several times, it is also more difficult to determine a final pension. Nevertheless, if reasonable projections can be done at a young age, Pension Max may be more viable than at retirement.

Policy design: Hand in hand with planning early comes policy design. In Pension Max cases, the desire is to receive as much death benefit with as little as possible by way of retirement dollars. Often thinly funded UL-based products may be the most appropriate. The trade-off may be a large cost with these products in the later years, particularly if a client also taps the policy cash values in retirement.

In some cases, it may make sense to design a policy that endows at age 100 or later.

In other cases, carrying an analysis into a couples 80s may be all that is needed. At that point a couple may believe they received enough benefit from the increased single life pension that a loss of future pension dollars will not be a problem.

Along those same lines, some individuals may prefer to use a 20-year term product, again dropping the life insurance in their 80s.

The health of the retiree: If a retiree is ill, the cost of the insurance may make a Pension Max strategy too expensive to pursue.

Age differences between spouses: As with many planning concepts, Pension Max works in a particular situation on a case-by-case basis. In a situation with wide discrepancies in ages, even with a reduced pension after the retirees death, a younger spouse may recoup more by way of survivors pension benefits than could be received from the death proceeds payable by insuring an older retiree.

Tax brackets make a difference: The lower the surviving spouses tax bracket, the higher the resulting after-tax proceeds from the pension. As a result, the lower the survivors tax bracket, the less attractive tax-free life insurance proceeds will be.

Risks to the spouse: If a Pension Max strategy is adopted, after a retiree dies the spouses pension benefits are cut off. A client, however, can change the insurance policy, beneficiary, etc., effectively cutting off the spousal consent. At that point, the spouse has waived rights in the pension. For that reason, many insurance companies recommend an irrevocable beneficiary election or the use of an irrevocable trust to provide the spouse with an element of protection.

Benefits are another risk to consider. In some cases, the spouses ongoing medical care may be dependent on continued participation in the pension. If spousal benefits terminate when the single life pension terminates, the added cost of medical care may work against a Pension Max approach. In other cases, a spouse might find their benefits integrated with Social Security; here life insurance would not affect other benefits.

Pension Max with First-to-Die Insurance

What about two-income-earner families? As dual-income baby boomer families approach their retirement year, a Pension Max analysis in its classic form on one retiree may not be complete. In many cases, a two-earner family might require an advisor to perform a Pension Max analysis on both of the family earners.

Why is this important? Just as with one spouse making a pension election, in this situation both spouses may have pension elections. By doing a separate Pension Max analysis for each spouse, an advisor can tell the couple whether Pension Max makes sense. To the best of my knowledge there is no software that does this analysis for two income earners at the same time. An advisor determining that a Pension Max strategy could work should recommend the highest amount of insurance, as first-to-die coverage, calculated to cover any losses due to unexpected death.

Pension Max can be an attractive approach for many clients. Its not for every client. Determining when it is appropriate calls for a careful analysis. Advisors should be certain to have all of the facts and issues addressed when approaching a Pension Max strategy. A clients other advisors may be quick to attack a Pension Max strategy, so advisors recommending this approach need to be certain that they can make a clear case.

In many cases, Pension Max will be attractive, but advisors should not view it as a stand-alone marketing niche. Instead, they should consider Pension Max as one part of an overall retirement analysis. In some situations it will fit; in other cases, a different approach may be better.

Mark A. Teitelbaum, JD, LLM, CLU, ChFC, is second vice president, advanced marketing, at Phoenix Life Insurance Company, Hartford, Conn. He can be reached via e-mail at Mark.Teitelbaum@phoenixwm.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, August 13, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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