“Retirement income planning” is lingo used in the financial industry to help clients determine their retirement possibilities. It is uttered by most advisors/brokers/insurance salesmen as a general offering, even when very few actually have the needed knowledge. Unfortunately, I’ve found that retirement income planning is rarely done properly across the broad industry, with more bad advice given than good.

My article last month on the gamble related to “When Is the Best Age to Start Claiming Social Security? provides some big-picture insights to help educate and assist clients actually dealing with Social Security elections for retirement. This month, I wanted to bring up another gamble: pension plan annuity elections.

Pensions come in varying options, which are mostly at the employer’s discretion in terms of what to offer within their company’s original plan document. Some of the most common options are: lump sum, single-life annuity, 100% joint survivor, 50% joint survivor and/or options with pop-up provisions. A client’s choice as to which option to take is dependent on a multitude of factors such as: future risk, future income needs, age of retirement, client life expectancy, joint-spouse life expectancy, estate planning objectives, current life insurance coverage, insurability, long-term care assumptions,and retirement income lifestyle needs – just to name a few. 

For purposes of this article, I’m using a generic example, based on an undisclosed pension plan from a Fortune 500 company:

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In this example, the company doesn’t offer a lump-sum option, but does offer various other options for both survivorship and non-survivorship benefits. If the company offered a lump-sum distribution option, the amounts would have been somewhere in the $400k to $500k range. Regardless of the details for each, the main point for clients relative to retirement income planning is the current and future income/cost/total estate benefit effect for each survivorship versus non-survivorship option elected.

As you likely noticed, any survivorship option chosen above directly forces a reduction in the retirees’ benefit received, in comparison to the non-survivorship option (single-life annuity). For example, the 50% joint-survivor option would be reduced by $300/month ($3,000 – $2,700 = $300) which is the pension plan’s internal cost for providing a 50% spousal-survivorship coverage benefit ($2,700 x 50% = $1,350). 

Here are a few important questions regarding pension planning that every advisor should ask their client before making pension election recommendations:

  • Is the client insurable with enough life insurance coverage to provide a survivorship benefit cheaper than the above pension plans costs for the survivorship option? 
  • Are they okay with NO inheritable benefit from this pension asset to their estate/children/grandchildren, if by chance they and their spouse decease soon after retiring, or before they meet their life expectancies?
  • Do they view their pension benefit like an asset, which they worked for and own a right to benefit from, rather than just a retirement income stream?
  • Do they care about that asset being passed to future heirs in an inheritable form?
  • How much retirement income will they actually need?
  • Will this pension option increase or decrease their 401(k) or retirement asset withdrawals? If so, are those withdrawals prudent, sustainable, etc.?
  • Do their pension election objectives align with their “big picture” financial and estate planning goals?
  • Is taking a lump sum best for them if given that opportunity? Do they understand the inherent risks of investing a lump sum for the next 25 to 30 years, versus a pension election option in annuity form?
  • If they take the lump sum, will they be able to achieve the same monthly income cash flow as one of the pension options above, without risk of running out of money before they die?
  • How long do they think they will live—shorter or longer than their life expectancy? How does that answer compare to their family history of parents’ and grandparents’ lifespans?

I could fill pages and pages with more questions, depending on each family’s specific goals and objectives – not just at retirement – but also based on their future 10, 15, 20 and 30 years before retirement. My point is very similar to my previous thoughts on Social Security.

No matter which pension option a client chooses, the reality is “it’s a gamble of a lifetime,” so don’t take retirement income planning lightly, because “plans don’t always go as planned.” Most of my clients prefer to gamble where they have higher probabilities of winning rather than losing. However, getting to that point of confidence or understanding takes a lot of analysis and discussion, because the gamble is real and usually permanent.

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