So, You Want to Have Your Retirement Cake and Eat It, Too!

Last month, we saw how Jack’s wife faced an uncertain economic future following his death because of the retirement income choices he had made with the expectation that he would outlive her.  Unfortunately, Jack’s plans did not work out as he expected.

We also saw that his employer had provided options that could have allowed his widow to have an income if she outlived him; but, these choices would have caused them to have a significantly lower monthly retirement income.  What Jack really wanted was a plan that would allow him to have his cake (the maximum monthly retirement income) and eat it (the maximum retirement income for his widow), too.

Knowing Jack, had he been told that such a plan existed, he would probably  have responded that when it sounds too good to be true, it isn’t true.  What Jack did not know was that such a plan does exist and it is not too good to be true.  The plan is often referred to as “Pension Maximization”.

Let’s assume that Jack’s options are as follows:

•    Life Income – this option pays the highest monthly income at his retirement; BUT, that income ends when he dies.  We will assume that this option provided an income of $1,000 per month.

•    75% Partial Benefit – Jack will receive a monthly pension of $750 per month.  At his death, his wife would continue to receive a monthly check in the amount of $250.

•    50% Partial Benefit – Jack will receive a monthly retirement income of $500.  At his death, his wife would continue to receive the same $500 per month.

Pension Maximization allows Jack to choose the Life Income option with a contractual guarantee that his wife will receive a lump sum of money that can be used to create a monthly income.  How can Jack do this?  He can do this through the miracle of life insurance.  Here’s how it works …

Jack will purchase a life insurance policy with a death benefit that, when invested conservatively, will generate a $1,000 per month income for his wife.  To determine the required death benefit, Jack will divide the annual income goal ($12,000) by the interest rate that can be obtained on a conservative investment (for simplicity, we will assume a 5% interest rate).  Expressed as an equation, it looks like this …

12,000 / .05 = 240,000

This equation tells us that Jack will need to purchase a $240,000 life insurance policy.  At his death, his wife takes the lump sum of money and places it into an investment that yields 5% interest.  This will then give her the same monthly income that they enjoyed while Jack was alive; and, if she never invades the principle, will provide a legacy that she can pass on to their children when she dies.

The key to Pension Maximization is to plan ahead.  The younger a person is when they start this plan, the less the life insurance costs.  To demonstrate the difference that starting early can make, I checked with an A+ (Superior) rated life insurance company and found that if Jack, a non-smoker in good health, had purchased a $240,000 whole life policy at age 45, his monthly premium would have been $325.015.  Had he waited to purchase the policy until age 65 and assuming that he was still in excellent health, he’d have paid $780.42 each month.  Clearly, planning ahead offers tremendous advantages.

What Do You Mean I Don’t Get My Husband’s Retirement Anymore?

I got a call last month from the wife of my friend “Jack” telling me that Jack had died; and, asking if I could help her with making sense of his affairs.  She felt overwhelmed.  Jack left no will and she was learning that she was in for a rough financial road ahead.  She was afraid that she might not have enough income to remain in her home.
Jack worked hard all of his life; made what he believed were good choices.  To ensure that he and his wife could really enjoy their golden years, he took the highest income possible from his retirement, a “lifetime” income, so that they could travel; see and do things that they’d always dreamed of.  Little did he realize that in doing so, he was sowing the seeds for a financial problem for his wife!
Last week, Jack’s wife got a letter from his former employer informing her that, because he had selected a “lifetime” income from his retirement plan, the monthly retirement check he’d been receiving was being terminated.  The income had been provided for his lifetime only and ended at his death!  While it had provided them with a very generous income while he was alive, she would receive nothing in the future!!  Needless to say, she was both shocked and afraid.  She wanted to know why Jack’s employer had not given him other income options.  What she did not realize was that they had.  Because his wife had been undergoing health issues at the time of his retirement, he never anticipated that she would outlive him.  Consequently, he made his selection in the belief that he was making her last years as full and enjoyable as possible.  He always anticipated that he could fend for himself when she was gone.
Retirement plans offer various choices as to how income will be received; and, people can plan for retirement well ahead of their last year of work.  Let’s take a brief look at the options Jack had in his retirement plan and how a different selection might have provided an income for his wife following his death.
• Life Income – this is the option Jack chose.  It pays the highest monthly income at his retirement; BUT, as his wife learned, that income ends when he dies.  To illustrate the other options, we will assume that this option provided an income of $1,000 per month.
• 75% Partial Benefit – had Jack elected this option, his monthly income would have been reduced by 25%.  Consequently, he would receive a monthly pension of $750 per month.  At his death, his wife would continue to receive a monthly check in the amount of $250.
• 50% Partial Benefit – by choosing this option, Jack would have agreed to receive a monthly retirement income of $500.  At his death, his wife would continue to receive the same $500 per month.
• Lump Sum Benefit – At first glance, it’s easy to ask how taking a lump sum payment would have enabled Jack’s wife to receive an income after his death.  However, the fact is that this money could have been invested in a manner (i.e., a portfolio of dividend paying stocks, interest paying bonds, or an annuity) that would create an income for them both.
Each of these  options has advantages and disadvantages; and, no option is perfect for all situations.  When planning for retirement, it’s important to examine all options and carefully consider how each option might impact you and your loved ones.