I wrote about this topic earlier in Pension Options, but I’ve recently come across a few cases involving it and thought I should update/expand on the concept.
As a reminder, this concept applies to individuals who are participants in a defined benefit pension plan. Granted, that is a pretty small universe these days, as most companies have switched to 401(k) plans or other type of defined contribution plan.
The mandated default retirement option for married individuals in defined benefit plans is the joint and 50% survivor option, where the participant receives a reduced sole survivor benefit (the reduction varies by plan and age of the participant and spouse, but 10% seems to be about average) and the spouse receives half of the participant’s benefit, provided he or she survives the participant.
The difference between the sole survivor benefit, which a married participant cannot take without the notarized consent of the spouse, and the joint and 50% option, is nothing more than a premium on an life insurance policy that will pay one half of the 50% J&S benefit to the spouse, provided he/she survives the participant.
Since we’re dealing with life insurance, it makes sense to check the marketplace to see if better options are available. And if the participant is healthy, better options usually exist.
The obvious question is what amount of life insurance policy is needed to replace at least the 50% J&S option? There are several methods that can be used to estimate the amount, but the one I use is a single premium immediate annuity (SPIA) proposal. That is, using SPIA software, calculate the lump-sum required to produce the desired income.
For example, say Mary’s (age 60) sole survivor benefit is $5,000/month, her 50% J&S benefit is $4,500/month, and her spouse’s (John, age 60) benefit is $2,250/month (provided he survives her). The lump-sum required to be deposited into a current SPIA that produces $2,250/ month for as long as a 60 year-old male lives is $466,868. If Mary owned that amount of life insurance, or if she could procure it for less than $500/month (the difference between the sole survivor benefit and the 50% J&S benefit), then it would make economic sense to do so.
The premium for a 20-year term policy for that face amount would be less than $2,000/year. Since the sole survivor benefit exceeds the 50% J&J benefit by $6,000/year, as a family unit, John and Mary would be ahead by $4,000/year using this method.
This is a simplistic overview of the concept and other factors need to be considered, but there exists a potential opportunity for a participant in a defined benefit pension plan to significantly increase his/her retirement income.
Please call or email if you would like additional information on this topic, and thanks for reading.