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How Can I Maximize My Pension Benefits?

How Can I Maximize My Pension Benefits?

March 13, 2024

What is Pension Maximization? 

Pension maximization is a strategy to maximize a person’s pension income benefit through life insurance. Instead of decreasing your monthly payment to include spousal benefits, you would take the higher single life payout and use a portion of the difference to purchase a life insurance policy. That policy's tax-free death benefit would be used to fund your spouse’s benefit when you pass away.

When you start completing the paperwork for your Benefit Payments, you may get overwhelmed. Without having a crystal ball for you and your beneficiary, there's no way to know if you're making the correct decision. If you are a public sector employee in the State of Maine, chances are you paid into Maine PERS, which has over 8 options to choose from (see the names of them below).  More on each one is provided in this brochure:  Benefit-Options-Brochure.pdf (mainepers.org)

  1. Lump sum 
  2. Top Option and or Full Monthly Benefit / Single life Annuity 
  3. Substantial Income for you and your Beneficiary or 100% joint and survivor  
  4. Supplement the Income for a Beneficiary
  5. Income for a Beneficiary based on a Selected Percentage
  6. Immediate Lifetime Income Supplement to a Beneficiary 

If you choose to leverage a pension maximization strategy, you will take the top monthly benefit option throughout your lifetime. However, you don’t receive any spousal or benefits for your beneficiary directly through your pension. However, to ensure that your spouse is still protected, you would purchase a life insurance policy rather than receive a lower monthly benefit through your pension. The goal here would be to increase the monthly benefit you receive from your pension by more than the cost of a life insurance policy. The tax-free death benefit would provide your spouse with enough monthly income if you passed away first.   

Example

Jim is 64 and could receive a pension of $5,000/month for his life only or $4,000/month for the joint lives of his wife Debbi and him (100% survivor benefit). With this option, He’s giving up $1,000/month ($12,000/year) to ensure his wife gets $4,000/month for the rest of her life if he passes away before her.   But if Debbi passes away first, Jim still gets $4,000/month and is essentially still paying for the no longer needed benefit.

Jim could get a $750,000 20-year term life insurance policy for less than $500 monthly.   $750,000 could provide $4,000/month for just over 19 years with a 3% return.  With this strategy, he receives his $5,000/month pension and pays less than $500 monthly for life insurance, saving him $500/month ($6,000 per year).  If Debbi passes away, Jim would still receive $5,000/month, but he could cancel the life insurance (or use it to provide for another family member).

Jim's life expectancy is 84.3 years, so he may pass away within 20 years (the length of the insurance policy). Life expectancy, however, is a 50-50 proposition. 50% of people live less, but 50% live longer. Jim has a 20%- 25% chance that he’d live past age 90 and a 9%- 10% chance he’d live past 95. 

Pros & Cons

A good scenario would be that Jim lives 15-20 years before he dies. Jim’s pension would stop, but Debbi would receive $750,000, which could last her another 19 years. Jim would enjoy the extra income but also know that his wife is protected. 

However, there are two bad scenarios.

  1. Jim dies early.  Debbi must make the $750,000 last if Jim passes away too early.  She risks outliving the money.
  2. Jim dies much later.  If Jim lives past the end date of his life insurance (and doesn’t renew because premiums would be extraordinarily high at that point), there would be no protection for his wife.  Debbi would lose the $4,000 pension and not have new assets to replace it. 

However, if Jim and Debbie had been saving $500 a month for 20 years( the amount they would be saving by going with the top option), a 4% return would give them $178,668, or a 6% return would give them $220,713. They also would free up another $500 a month after 20 years. 

Term insurance was used in the example because it is the cheapest.  Permanent insurance could be used too, as it would eliminate the ending date associated with term insurance.  Permanent insurance is much more expensive, though.

Pension maximization does not have to be an either-or proposition either.  A retiree could protect a 50% spousal benefit through his pension and use life insurance to cover the rest.  Pension maximization is a flexible strategy.  It can be an excellent option for some people, but not so good for others. 

When looking at whether this strategy makes sense, many factors come into play:

  • Is the retiree healthy and insurable?
  • What are the retiree and spouse's ages and projected life expectancy?
  • What is the difference between the single pension payout and the joint life payout?
  • What is the rest of the couple’s financial situation like?
  • Do they have other investments or assets? 
  • Are medical benefits tied to the retiree’s pension benefits?
  • How comfortable is the couple with the strategy?
  • If they paid into PERS, will their spouse be affected by the government pension offset when receiving the monthly benefit  

Each of these factors can significantly impact whether pension maximization should be considered or not.

If you are within a few years of retirement and have questions about whether or not pension maximization is right for you, please get in touch with us.