11 Great Tips to Help You Make a Great Choice

Pensions have been getting a lot of attention in the news lately.  While many pension plans, as well as the companies and municipalities which fund them are solvent, many are falling short on the amount of assets needed in order to sustain the benefits promised to the covered employees over their life expectancies.

Many companies have moved to 401Ks and away from pensions.  However, many workers approaching retirement are covered by pensions.  If you are covered by a pension, the choices you make related to your decision of how to take your payout are not as clear cut as they may seem at face value.

Before we review methods to maximize your pension options, it is important to note that some pensions provide no benefits to your spouse if you should die prior to receiving your pension benefit.  Check with your employer and see what the rules are regarding this matter.  If you determine your spouse would not receive benefits should you die before drawing them, it is suggested you obtain term life insurance to cover this – if only for a few months or years - until you are signed up to receive your pension.

Here are some key points to include in your consideration of the payout option in order to optimize your pension benefits.  First, let’s address a lump sum option.  Next, let’s explore monthly benefit options.

LUMP SUM:  Not all employer pension plans offer this option.  If your plan offers a lump sum benefit in lieu of guaranteed lifetime income, it can be tempting to make a cash grab for that large sum of money.  Make certain you keep the following factors in mind when considering this choice.

    1) Do the math.  For a fair and safe comparison, multiply the lump sum by a safe rate of return assumption.  A factor of 4% rate of withdrawal on a balanced portfolio is prudent.  (Naturally, we can hope for a greater return – but, 4% is a prudent measure.)  Determine how that sum compares to the monthly pension payments offered.  Here’s an example:

    Lump sum offered:  $750,000
    4% withdrawal:  $30,000 per year - $2,500 per month
    Joint and 100% survivor pension offered:  $2,600

Keep in mind, you are comparing a potential withdrawal from an investment portfolio versus a “sure thing” from a pension.  This strategy requires an extremely disciplined approach both in the investment style and income plan. And, if your investments have negative returns you run the risk of running out of income before you run out of life.

Fortunately, there is a way to take the uncertainty out of a lump sum decision. Methods exist which allow you to take the lump sum, invest it and create your own “pension” with a guaranteed lifetime income option. Even if you have poor investment returns, you are guaranteed income for life. (Typically, there is an additional fee for lifetime income guarantee).

For many, this is a wonderful approach to securing both the lump sum pension and a guaranteed lifetime income.

Generally, investments that provide guaranteed minimum withdrawal benefits are a type of annuity investment.  It must be further noted that all annuities are not the same.  Due diligence in selection is highly advised.

    2) Naturally, you would want to roll the benefit into a private IRA to avoid taxation on the entire lump sum.  Once in the IRA, you will be taxed only on the amounts you withdraw.

    3) Do your research on the solvency of the pension plan and the company.  Financial insolvency of the pension plan may jeopardize the future of your payments.

    4) When reviewing the employer’s projection of the lump sum offered, please know that often these numbers are a moving target as the calculation utilizes the prime interest rate.  As you know the prime interest rate moves up and down.  As interest rates move up, your lump sum goes down.  As interest rates go down, your lump sum goes up.

    5) Required Minimum Distribution rules (RMD) will apply to the IRA requiring you to take distributions no later than 70 ½.

    6) New standards of investing should be utilized to minimize risk in your portfolio.  The same investments, strategies and thinking that got you to retirement won’t get you through retirement.  An unprotected portfolio could have losses that would substantially impact the amount and longevity of your income stream. 

    7) When opting for the lump sum you can have peace of mind that if you and/or your spouse should die before your life expectancy, at least your heirs would get the benefit of the remainder of your lump sum.

In conclusion, if you choose to take the lump sum after carefully considering the factors above, it is possible to have your cake and eat it, too. Investment products available today enable investments in the stock market with underlying guaranteed income for life.

MONTHLY PAYMENTS:  All pension plans offer monthly income options.  Here are important considerations when selecting your income option:

    1) Lifetime income option for the retiree only is generally undesirable for those who are married.  However, there is a formula to consider when making the lifetime income only versus joint and survivor income choice.

Subtract the joint and survivor income amount from the lifetime income amount to determine what the survivor option will cost you.  Example:

   Lifetime income only                    $3,100    
   Joint and 100% survivor income    $2,525
   Monthly difference                        $   575 x 12 = $6,900 per year
Can you purchase a permanent life insurance policy that costs $6,900 per year or less for a death benefit amount that would generate $2,525 per life for your spouse’ life expectancy? 

This option can work quite well as it affords an income tax free benefit for the spouse;  if the spouse dies before you the policy and premium payments can be cancelled or you can transfer the death benefit to other heirs. 

A few cautions about this approach:  Never make your pension choice until you are fully insured and the life insurance policy is in place.  And, it is strongly suggested term insurance should not be used for this purpose.  Permanent life insurance (whole, universal or variable) should be utilized.

    2) If you choose a “life only” benefit option, will your spouse still be eligible for employer sponsored medical coverage?

    3) Does your plan offer a “Pop-up” provision?  This choice enables you to elect the joint and survivor benefit and if your spouse dies before you do, then your monthly benefit will “pop-up” to the “life only” benefit amount.  In my opinion, this can be a great choice for many people.

    4) If you are considering an option which is less than 100% survivor benefit for your spouse, please conduct a thorough “widow/widower” analysis.  I call it a “sudden death” analysis.  Run through the numbers and determine the exact amount the surviving spouse would have as income each month.  Please keep in mind that only one social security check survives the death of a spouse – and for teachers covered under KTRS – no spousal social security benefits are available.

As you can see, there are many factors and formulas to put to the test in determining the optimal pension election for you.  I love helping people navigate through these important retirement income planning decisions.  Need help?

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Copyright © 2017 – Jane B. Smith, CFP®.  All rights reserved.

This material is for use with the general public and is designed for informational or educational purposes only. It is not intended as tax or investment advice and is not a direct recommendation for your retirement savings. LFS-1925264-101717