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.