Wednesday, November 21, 2012

Retirement and Life Only Pensions: Part 1

When it comes to retirement planning, most people just want to provide for their loved ones.  In this blog series, we’ll discuss some ways you can make sure they’re taken care of.

A life only pension is a pension that is designed to pay out for the rest of your life only. These benefits apply whether or not you’re married. If you take a life only pension from an institution and you are married, have a significant other or children, “life only” means it will pay only for the rest of your life and that's it. If you pass away the next day or you never collect, it will be absorbed back by the institution and nothing will be paid to your spouse, children and/or heirs.

Historically, some employers offered life only pensions to their employees.  Financial planners would recommend the employees take advantage of them if it made sense economically. To determine this, they would look at a life insurance policy as a benefit supplement and set it up either before or at the time of retirement.

Let’s compare two scenarios:

  • In scenario A, John is receiving $1,000/month from his pension and uses that full amount to live on each month. When John passes away, there is no benefit whatsoever to his wife, Abby, or their children.

  • In scenario B, John is also receiving $1,000/month from his pension.  However, he only uses $700/month to live on. He uses the additional $300 per month to fund a pension replacement program that benefits his spouse, Abby, and their children after his death. When he passes away, there is a benefit to their Abby and their children.

Before we discuss these specially designed life insurance policies, let’s explore what pension maximization means and how it affects you.

Pension Maximization
Pension maximization was part of the Employee Retirement Income Security Act (ERISA)1 laws that were modified in 1974. Traditionally, a retiree would receive a monthly pension in the form of a single life annuity, which would pay out to the retiree as long as they were living. Once they passed away, their spouse and/or children received nothing.

Next, joint survivor pensions were established. This type of pension was set-up so that when the primary retiree passes away, the spouse can receive anywhere from 0% to 100% replacement of that monthly pension income. 

In our example, instead of John taking $1,000/month for a single life only pension, he could choose the 100% joint survivor option and receive $700/month which would pay out for as long as he or Abby is living.

With this came the life insurance product pension maximization. In the previous example, by going from $1,000/month to $700/month, the pension will essentially pay for John’s life insurance. The problem remains that if John and Abby both die, there is nothing from the pension that would be passed on to any children or heirs.  However, with life insurance, there is the option for something to be passed to the children/heirs.  This is why it’s so important to compare life insurance options and life only pension plans.

In the next part of this blog post (link to next post), we’ll discuss life insurance policies, your government life only pension and how these can affect your retirement planning.

"The Employee Retirement Income Security Act" United States Department of Labor;

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