“Chase your passion, not your pension.” This quote by motivational speaker, writer and consultant Denis Waitley is well known, and thankfully many of my clients have been able to chase their passion and their pension at the same time. You could say they got to have their cake and eat it too!
Although the number of private sector workers with a pension plan has decreased significantly over time, there are still employers who offer them. I often meet with pre-retirees with pension plans from the federal, state and local governments, and individuals from the private sector who were grandfathered into their pension plans.
In this article, when I use the term “pension plan,” I’m referring to the employer-funded, defined-benefit plan. This is an employer-sponsored retirement plan in which the employee knows in advance how much he or she will receive in retirement based on a formula. This formula will often consider factors such as salary history and amount of time spent with a company. Benefits are typically guaranteed for life and may or may not adjust for cost-of-living increases. These pension plans are different from the defined-contribution plans, the common 401(k) or 403(b) in which employers are not involved after their contribution and the benefit an employee receives in retirement is based on market investment returns.
Pension plans are generally paid out in one of four ways: life-only, life with period certain, life with joint payout, and lump sum.
Life-only: The benefit will be paid out only during the employee’s lifetime. This gives the highest payment possible; however, it will not leave a benefit to the spouse.
Life with Period Certain: The benefit is paid for the employee’s lifetime or for a specified period of time. This means that if the employee’s pension was guaranteed to pay for 10 years, then the payments would come for 10 years regardless if the employee dies during that time or not. If the employee dies, the payments would go to someone else for the remainder of the guaranteed time period. If the employee did not die during the 10-year period certain phase, he or she would continue to receive payments for life. There would not be a benefit to leave to the spouse.
Life with Joint Payout: This ensures that the employee’s spouse will continue to receive a benefit even after the employee dies. With this payout plan, the employee is paid a benefit during his or her lifetime, but after the person dies, payments will continue to their spouse for life. The spouse’s payment usually ranges from 50% to 100% of the employee’s original pension payment. The higher the beneficiary payment to the employee, the lower the payment to the surviving spouse.
Lump Sum: This is a one-time payment from the pension administrator to the employee. A lump sum gives the employee more control to spend or invest his or her money as desired. The previously mentioned payment plans offer monthly distributions for life, but this one does not, so it is vital that the individual works with a retirement planner and decides how to invest the money to ensure it will provide an income for life. It’s also important to name a beneficiary who will receive any money that remains after the employee and spouse are gone.
Traditionally, employers manage their own pension plans, but recently we’ve seen them start to outsource their defined-benefit plans to insurance companies. Employers are good at servicing clients, but they are not professionals in managing pensions, so many of the best companies have outsourced their pensions to insurance companies that know how to actuarially build product. I always suggest my clients talk to their pension administrator to find out who is managing their pension plan; is it managed internally or is it outsourced? And what payment options do they have available to them?
Choosing whether to take the monthly distributions or lump sum payment is an important decision and should only be made after considering many factors such as Social Security benefits, life insurance, health concerns, life expectancy, etc. Retirement goals also need to be factored in. For example, if leaving a legacy is important, it’s good to know that most monthly distribution payment plans do not leave an inheritance to beneficiaries beyond a spouse.
In fact, life-only pensions are structured in a way that if an employee takes even one payment and then dies, the pension is gone. However, if the employee had taken a lump sum and invested it into an annuity or used a portion to fund a life insurance policy, an inheritance would have been left for the person’s children or whomever the employee wanted to name as beneficiary.
Another option is the pension maximization strategy: purchasing a life insurance policy and then taking the life-only option on the pension to maximize an employee’s monthly payments. At the person’s death, the pension is gone, but the heirs gain the life insurance policy tax-free. The amount of life insurance to purchase is based on several factors, including the difference between your life-only option and your life-with-beneficiaries option.
As mentioned earlier, there is no right or best solution for everyone; it will depend on various factors, but choosing monthly pension payments without considering all options is not recommended. You want to know you have made the best choice for you, your situation, and your retirement goals. We like to help our clients retire with more than just money, which means we want you to have confidence in all aspects of your retirement goals (such as leaving an inheritance to your heirs) in addition to your retirement income.
You can learn more about Jason at www.jasonlabarge.com.
Jason LaBarge, Managing Partner at Premier Planning Group
115 West Street, Suite 400, Annapolis, MD 21401 443-837-2542
Premier Planning Group is an independent firm with securities offered through Summit Brokerage Services Inc., Member FINRA, SIPC. 443-837-2520
The cost and availability of life insurance depends on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable by having the policy approved. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition, if a policy is surrendered prematurely, there may be surrender charges and income tax implications. The opinions contained in this material are those of the author, and not a recommendation or solicitation to buy or sell investment products.