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Pension Maximization

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My spouse is about to receive a pension. We’ve heard of “pension maximization.” What is it?

If your spouse is participating in a traditional pension plan (also known as a defined benefit plan), the benefits must normally be paid in the form of a “qualified joint and survivor annuity” (QJSA). A QJSA is an annuity that pays a dollar amount (usually monthly) to your spouse while he/she is alive, with at least 50% of that amount continuing to you after your spouse’s death.

However, if you consent in writing, your spouse can waive the QJSA and elect instead to receive a single-life annuity. With a single-life annuity, payments are made over your spouse’s lifetime but stop upon his/her death. For example, if your spouse receives just one payment after retirement and then dies, the single-life annuity would end and the plan would make no further payments.

So why would you agree to waive the QJSA in favor of a single-life annuity, knowing that payments will stop at your spouse’s death? The main reason is that the single-life annuity generally pays a significantly larger pension benefit than the QJSA. That’s because the payments are designed to last for a smaller number of years — one lifetime instead of two. Pension plan participants who want to maximize their monthly retirement income are often tempted to choose the single-life annuity for this reason. However, most pensioners are also concerned about providing for their spouses if they should die first.

“Pension maximization” is one technique for solving this dilemma. The way it works is that your spouse elects, with your consent, to waive the QJSA and receive the pension benefit instead as a single-life annuity. You and your spouse then use the additional pension income to purchase insurance on your spouse’s life, with you named as beneficiary. If your spouse dies first, the pension payments will stop, but you’ll receive the life insurance death proceeds free from federal income taxes. The idea is that by coupling the larger pension payments with the purchase of a life insurance policy on your spouse’s life, you both may be able to increase your total income during retirement, while also providing for your financial future if your spouse dies first.

Is pension maximization right for you? There are a number of factors to consider. Is your spouse insurable? If not, pension maximization is not a viable strategy. How much will the life insurance cost? (If your spouse is relatively young and in good health, the insurance premiums may be much more affordable than if he/she is older and/or in poor health.) How much more does the single-life annuity pay than the QJSA? The larger the benefits under the single-life annuity, the more you’ll have to pay the premiums for the life insurance policy. (Also make sure to factor in any cost-of-living adjustment the pension plan may provide when analyzing your payment options.) How healthy are you, and what is your life expectancy? What are the tax consequences? (Death benefits from life insurance are free
from federal income tax, while pension benefits are typically fully taxable.) If your spouse dies first, can you manage a large lump-sum payment?

The pension maximization technique is not for everyone, but could be worth considering as you and your spouse evaluate the pension benefit options. (Note: Any guarantees associated with payment of death benefits, income options, or rates of return are based on the claims-paying ability of the insurer. Policy loans and withdrawals will reduce the policy’s cash value and death benefit.)

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