Pension Maximization

By William F. Devereaux Sr., CSA

1/3 of the U.S. population is due to retire in the next decade.

History

In 1974 I was part of a financial planning team in Clarkston, Mich. specializing in working with employees of the public school systems and state and local governments. During this time there was an economic downturn in the area that resembled the current situation in America. As the auto industry suffered a major recession, all of the area suffered. There was a local joke: “Would the last person leaving Michigan for the jobs in the Sun Belt, please shut off the lights.”

Employers were faced with the need to “cut costs” in any way possible. One of the methods widely used was to increase class size. This put great strain on the staff. Many of our clients approached us to see if there was a way for them to retire early.

Thousands of hours were spent analyzing this complex situation. I developed the concept of “Retirement Option Planning — Pension Maximization”©: the most sophisticated software in the industry for individuals retiring with pension benefits. Eventually it became the driving force of a national pilot program of one of America’s premier insurance companies.

The software’s complex 287 step algorithm is the only pension maximization software that I am aware of which analyzes life insurance needs in every year of retirement to be comparable to what a retiree’s survivor would receive in pension income. All other approaches to pension maximization attempt to take a “snap shot” view of the life insurance needs at retirement and offer a solution.

The most current life mortality tables, IRS tax tables and pension cost of living adjustments (COLA) are incorporated into the evaluation making it the most comprehensive pension maximization study available. After years of restricted use to select life insurance agents and financial advisors, my reports are now available to the general public.

The problem

The problem an agent faces when working with a senior is: how to provide an adequate amount of life insurance, at an affordable price, to allow the client to offer the security to the spouse and also have the advantages of the higher pension. Security, flexibility and income must be weighed objectively.

Jane Bryant Quinn wrote an evaluation of pension maximization concept. You can buy her book at Amazon.com http://www.amazon.com/Making-Most-Money-Bryant-Quinn/dp/0684811766 (pages 1019-1022). It offers an excellent method of evaluating pension maximization proposals. I agree with most of the points in her evaluation. The Society of Actuaries www.soa.org has investigated this approach through the years. William’s Actuarial Service certified my pension maximization software a number of years ago.

This is a proven technique if properly used. Thousands of clients have benefited from this approach. My years of study have resulted in the program I use today. It essentially creates a “reversionary annuity” utilizing off-the-shelf life insurance products available today from many top rated companies. Pension maximization is a “win-win” for the client and the advisor when done correctly.

Case study

John is a teacher in a public school. He has 30 years of credited service earned from his state retirement system. His average final compensation for this calculation is $65,000. He is retiring at age 64. He is a non smoker in good health and is looking forward to many years of retirement with his spouse Jane who is 56 years of age and is also in good health. They have two grown children and four grandchildren. All are healthy and have no special needs to consider.

State plan

John went to his personnel office and learned that the state pension he has earned has several options:

The Single Life Option — Full pension will pay him $54,366 a year initially. The plan has a built in 3 percent annual compounded Cost of Living Adjustment (COLA) that will nearly double his pension over the next 24 years to $ 98,191 per year (Rule of 72). The plan is payable for as long as John lives, but does not provide any income for Jane upon his death.

The state pension plan also has several options that will provide a benefit to Jane if John dies first. After a discussion with Jane and his advisors they determined that since Jane has no pension she will need the income from his pension to live on if he dies first. They decide on the Joint and 2/3 option.

The $9,348 reduction he incurs will provide for Jane only. Note: In many plans the reduction is permanent even if the beneficiary were to die first.

State   Plan John   & Jane Both Alive John   Survives Jane   Survives Cost   of Option
Full   Pension $   54,366 $54,366 $ 0 $ 0
Joint   & 100 Percent Spouse Benefit $   45,018 $45,018 $   30,024 $   9,348

Analysis

The web site www.pensionmax.com has a further discussion of this case study. There is a video presentation of the pension maximization concept, this sample study and links to all of the state pension plans and Social Security.

The “Pros” of taking the state pension plan option are:

  1. The state plan assures them of a defined income for their lives.
  2. They do not have to worry about investing in later life.
  3. The post retirement health insurance will continue to be available to Jane if John dies first but she may be required to pay the premium to the system. She is several years from being eligible for Medicare. Note: As the plans go forward there is no guarantee that this benefit will always be there. Some plans have to re-evaluate this situation.

The “Cons” of taking the pension plan option are:

  1. Both Live — 10 years. They have incurred an extra $25,000 in cost (Reduced income vs. insurance premium). By year 35 the difference grows to $135,648.
  2. John dies first — year 11 of retirement. They have incurred additional cost. Jane’s income has grown to $40,375 and is fully taxable. Estimated after tax net income would be $35,938 per year to meet her needs. Annuity income from pension maximization approach would net her $38,902 after taxes on the same gross income. She has less spendable income from the state plan.
  3. Jane dies first — year 11 of retirement. They have incurred unnecessary reduction of income, while they both lived, that is not recoverable. In many plans John will continue at the lower income level for the rest of his life. In some plans he is not able to change beneficiary if he were to remarry. My mother was the victim of this. After my father died she remarried a man who had selected the survivor option, his first wife died, he married my mother, he died and my mother got nothing.
  4. All too often the second person dies shortly after the first death. In the event this happens there is no money paid to anyone else.
  5. When I started doing this work in the 1970s, inflation was not much of a concern. In subsequent years we saw double digit inflation. As a result clients often found a need for additional income. Pensions do not have the capacity to provide additional money to cover emergencies or opportunities that may arise. The cash value of life insurance in a pension maximization policy is therefore prudent use in the event situations may dictate.

In all my years of working in this field I have yet to experience any other possible scenario. In all five cases the pension maximization approach is superior to the pension option if properly designed and maintained.

There are no cookie cutter solutions that always work. The future is not predictable. The best we can do is to analyze each individual situation and based upon our best evaluation make a recommendation that will be most likely to best meet the present and future needs of our clients.

Feel free to use the free resources at www.pensionmax.com in your efforts to help seniors decide what is truly in their best interest. If you wish to purchase a custom report it is also available on the site for $29.99.