Pension Maximization

Big Gamble on a Promise of Plenty

It sounds s-o-o-o very good. Imagine being able to reap a maximum pension during your lifetime knowing that when you die, your spouse will receive a benefit equal to what he or she would have received had you selected a survivor annuity. Sounds almost too good to be true. Know what? It is.

It's called Pension Maximization, and it's one of the more recent retirement planning schemes directed at prospective retirees. Pension max works like this:

John who is 65 and has 35 years of teaching experience wants to retire. He can choose from six retirement income options within the State Retirement System. Since Mary is five years younger than John and has not worked outside the home, John wants to make sure she is well provided for should he die first. He looks at his options carefully.

Of his six options, only Plan One with no survivor annuity offers John a full pension of around $21,000 a year. Four other payment plans provide for Mary when he dies, but reduce his monthly pension 9% to 17% depending on whether she receives the same amount or half the amount of his pension.

But a financial planner tells John of a way that he and Mary can have it all.

The Pension Max Strategy
What the Financial Planner Isn't Telling You
Investigate. Calculate.
Survivor Options: Public Pension vs. Insurance Policy
To Say It Quick....
Our Perspective
Pension Maximization Worksheet

The Pension Max Strategy 

The strategy is for John and Mary to select the $21,000-a-year maximum pension option and then take out a $100,000 cash value life insurance policy. At John's death, the $100,000 insurance proceeds, if invested, will yield an annual income about the same that Mary would receive under Plan Four.

According to the financial planner, who also sells insurance, John can help pay for the premiums on his $100,000 policy from the additional $1,852 a year income he saved by opting for the maximum Plan One benefit instead of Plan Four. Look what John gains after only 10 years: The $1,852 a year additional pension has produced a gain of $18,520. After 20 years, his pension gain is $37,040! Plus, Mary has a guaranteed $100,000 upon John's death.

The planner points out the other "advantages" of pension maximization:

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Is it too good a plan to pass up? Here's what the financial planner (insurance agent) isn't telling John:

High Commissions

An insurance policy of the pension max type isn't designed to provide an income to John. However, agents and their companies stand to gain 70% or more in commissions, policy fees, and underwriting charges from John's first year premiums. Even the proceeds may incur commissions should Mary buy an annuity at John's death. The larger the policy, the higher the premiums, commissions, and policy costs. Your State retirement has neither commissions nor profit margins to satisfy.

Forfeited Interest

Interest is paid only on the policy's cash accumulations, not on the premiums the company receives from John. Cash value is the money left after commissions, administrative, mortality and other charges are deducted.

Shrinking Dollars

Cash accumulations in John's policy may not equal the premiums he pays for many years. On a $100,000 policy after 20 years John could shell out $102,240 in taxed premiums with a guaranteed cash value of just $57,286 (see table below).

Moreover, if John lives as expected, the value of the policy benefits Mary will receive tomorrow is less than the value of the money he pays in premiums today. Thus, the loss is double edged. To know whether future benefits are worth today's cost, ask your agent to do a present-value analysis. We did, and the revealing lifetime income results are shown below in Exhibit 1.

Ignores Assets and Needs

Pension Max proposals typically omit assets and savings plans (such as a 401(k), 457, or IRA) already in place, overlook the effect of taxes, and ignore individual circumstances. A one-size-fits-all pension max policy may conceal potential signs of danger.

Uncertain Longevity

Mary's life expectancy is 5 to 10 years longer than John's which increases her financial needs. Moreover, she is 5 years younger than John. If John dies at age 85, Mary may live another 5 to 10 years. Should John die very early, say at 66, Mary may be looking at 25 to 30 years in which she'll have to be financially independent. See the following exhibit:

Exhibit 1: The Black and White Shortfall of Pension Max

A look at John's and Mary's benefits under
two different situations illustrates the lifetime income truths
a pension max proposal may never reveal:

No Income Guarantees

There is no guarantee that Mary can realize the kinds of returns on her $100,000 insurance proceeds to ensure an adequate income for the rest of her life. Because the economy is unpredictable, Mary may find herself earning much less than she had counted on, perhaps prompting ill-considered investment decisions.

No COLAs

Even were Mary to secure an adequate return, today's inflation would erode the value of her insurance income in a very short while. There are no cost-of-living adjustments on interest income. If John wants the equivalent of a cost-of-living augmented retirement, he must buy either a larger policy or one with an escalating death benefit. Either one costs more.

Inflation Pressures

After paying premiums, John and Mary will have to scrimp by on even less than if they had chosen Plan Four. In the first 15 years inflation of only 6% will erode their already reduced income to just 41 cents on the dollar. When financial pressures finally force John and Mary to slash expenses, one of the first considerations will be the $5,112 a year John is paying for insurance. If he drops the policy within five years (near average), it loses up to 90% of its guaranteed face value. And Mary loses her financial security.

Unpredictable Economy

If John were to buy an interest sensitive policy and interest rates fall; OR if his policy has a "vanishing premium" and interest rates fall; OR if at his death investment returns on Mary's proceeds fall; the plan may utterly fail. Ask the agent to show you what happens under each plan if interest rates decline.

A State retirement survivor option, even though it pays less per month, guarantees to pay it, with cost-of-living increases for all of John's life and all of Mary's life, even if she should outlive John by 40 years.

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Investigate. Calculate.

Investigation is the key to making correct financial choices. Any retirement plan should look at many factors, including the assets a spouse will need beyond retirement, the liquidity of those assets, supplemental savings or investments, indebtedness, health and potential longevity, insurability, and perhaps most importantly, the impact of inflation.

To evaluate the retirement options best for you, ask yourself these questions:

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When You Choose a Survivor Option

What does your public pension offer that an insurance policy doesn't?

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To Say It Quick....

Our Perspective

You've earned your State retirement benefit.
You'll receive it as long as you live, as will your spouse if you so choose.
Beware of forfeiting this continuing benefit to pay for a promise of spousal
security that will cost more and deliver less or nothing at all.

To calculate and compare your exact financial position under a pension maximization proposal versus a State retirement plan, use the following worksheet:

Pension Maximization Worksheet

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