Choosing the Appropriate Pension BenefitMarch 15, 2016 9:40 am
Pensions come in all shapes and sizes, and understanding how they fit into your long-term financial plan is essential when planning for retirement. Some pensions offer cost of living adjustments (COLAs), can have varying ages of retirement and vesting schedules, as well as different payout options. Unfortunately once you choose your payout option and begin taking your benefit, the decision is usually final.
Things to consider before making the irrevocable decision:
What does it mean to take your pension as Joint and Survivor as opposed to Single-Life?
- The single-life option will be the highest monthly benefit you can receive as it is based solely on your life expectancy. After you pass away, the benefits will stop.
- The joint and survivor option is based on the life expectancy of both you and your spouse. Most plans will allow you the choice of 50%, 75% or 100% of the benefit being paid to your spouse when you die, however other plans may offer different choices. The higher the benefit you elect to leave to your spouse, the lower your monthly benefit will be. Although the benefit may be lower, it does guarantee two steady streams of income over both your life and the life of your spouse.
Can you afford to take the reduced benefit?
When preparing for retirement, I recommend to all my clients that they first gain a firm understanding of their expenses. I’ve had people say “I can easily live off of $150,000 pre-tax in retirement” while they are currently earning over $300,000. That’s not to say it is impossible, but without looking at a budget or cash flow breakdown, it is hard to prove whether it’s actually feasible. The other aspect that needs to be determined is your retirement income. Sources of income may include social security benefits, distributions from your retirement or brokerage accounts and other savings. Once you have identified all expenses and sources of income, you can then run scenarios to see how taking a reduced benefit under the joint and survivor option would affect your long-term financial goals.
Is your spouse reliant on the income?
The decision as to whether or not your spouse would need the survivor income isn’t just a pure numbers crunching exercise as their standard of living should also be considered. If your spouse were to lose you, he or she might sell the big home, downsize into a condo and be able to live off of the proceeds and other sources of income. Maybe you’re the world traveler and your spouse’s discretionary expenses would drop dramatically if something happened to you. There could also be a life insurance policy that will be paid out and cover their expenses if you pass away. On the flip side, your spouse may be dependent on the guaranteed income coming in for various reasons. Outstanding debt, large non-discretionary living expenses and a costly lifestyle are just a few reasons to opt for the joint and survivor option on your pension.
How does leaving a legacy fit into the picture?
Leaving a legacy isn’t usually at the forefront of one’s mind when deciding on pension payout options. Providing for a spouse is usually taken into account but going a step further and identifying how your decision could impact a future legacy should also be considered. If you can afford to take the joint and survivor benefit, it can be beneficial in preserving the assets you leave behind.
For example: Jim and Judy are retired and both get social security benefits as well as Jim’s pension, which he has taken as single-life. If something were to happen to Jim, this would leave Judy with only the higher of the two social security benefits as her income. If Judy is unable to live on just the one social security, she might need to drain their retirement accounts faster than desired or even tap into the equity of her home if necessary. This could potentially reduce the legacy left after Judy passes significantly.
There are many other variables to consider such as inflation, longevity, investment returns, cost of living adjustments on the pension if any, long-term care planning and more. Taking the time to weigh all of your options will always give you the best outcome. You should also utilize your financial advisor and have them run different scenarios using your various pension options so that you can make an informed decision. As I said before, once you begin your benefits, there’s no going back.
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Megan’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.