How to Determine if a Pension Maximization Strategy is Feasible

A pension maximization strategy is not for everyone. The pension maximization plan is clearly advantageous if the extra pension benefit payable under the SL annuity option (as compared with the joint benefit payable under the standard J&S annuity option) is large enough to pay the premiums for a sufficient amount of life insurance. But this is not always, or even usually, the case. This is especially true when you factor in the considerations discussed in the “Disadvantages” section earlier in this chapter.

The survivor benefits payable from a retirement plan are determined using actuarial methods and factors similar to those used to determine life insurance benefits. Assuming for argument’s sake that all the assumptions used in the calculation of benefits for each alternative are identical, it is clear that the cost of the life insurance in the pension maximization plan would have to be greater than the cost (the difference in the payout under the single life or J&S annuity) of the insurance feature of the J&S annuity from the plan. As was described above, the pension maximization plan offers greater flexibility and more attractive features than the J&S annuity option, but this flexibility and these features must cost something.

The real question is whether the advantages and flexibility of the pension maximization plan warrant the additional cost. The monthly pension benefit payable under the SL annuity option will typically range from 10 percent to 25 percent greater than the normal joint benefit payable under the J&S annuity. Among the factors affecting this differential is the difference in the spouses’ ages, the participant’s age at retirement, and the selected survivor benefit payable under the J&S option. The differential will be larger if the survivor is paid 100 percent rather than only 50 percent of the joint benefit. Additional factors have an effect as well, such as whether or not the pension plan subsidizes one option at the expense of the others. Although each of the pension payout options is usually roughly equivalent on an actuarial basis, it is not uncommon for the underlying actuarial assumptions to favor one option over the others. Most often the normal joint and 50 percent survivor benefit annuity is the actuarially-favored option.

If the participant is insurable, a carefully designed pension maximizing plan can put the surviving spouse in a better position than just relying on the pension plan’s survivor benefit and also provide the couple with a more attractive overall package of flexible options. Given the greater flexibility and the many advantages, a pension maximization plan may even be a desirable choice if the insurance premiums somewhat exceed the pension payout differential. But a bad design, or failure to follow through with the plan, can jeopardize the spouse’s financial security in old age.

Learn about the tax implications of pension maximization strategy here.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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