Wednesday, December 20, 2017

Pension Max Is A Bad Bet.

Over the years  I get questioned about what is the best option to take their pension. I try to give them advice and also encourage them to contact the UFT pension consultants so that they can evaluate all the options.   However, many educators near retirement are contacted by some insurance companies and financial advisers who work for and with insurance companies who have proposed an alternative to taking a joint pension annuity.  This is known as "pension max".   To my knowledge neither the UFT or independent financial advisers push this alternative and for good reason.

The premise of pension max is that the retired educator can take the maximum pension payout and take the difference between the maximum payout and the 100% joint annuity payout and buy a life insurance policy for the spouse.  Since the 100% joint annuity payout averages about 80% , depending on the ages of the spouses,  of the maximum payout, the idea of pension max is attractive at first blush.  However, as you go deeper into the pension max scheme you can see it only benefits the insurance company seeking the product while putting the surviving spouse's income at risk..

Let's assume that the recently retired educator receives a maximum payout of $50,000.  Had he took the 100% joint annuity option, he would only get $40,000 but if he dies, his spouse will continue to receive the $40,000 annual payout until she passes away.  Here is why pension max is a bad bet.

First, if he takes the maximum payout of $50,000 and buys a $500,000 life insurance policy for his spouse with the $10,000 he saves by taking the maximum payout.  His spouse would theoretically receive $40,000 annually from the  life insurance policy once the retired educator dies  This is about an 8% return and while higher than most life insurance policies these days of low interest rates, its close to what most pension funds try to achieve.  The problem is that the $10,000 is really $7.000 since the money is subject to Federal, State, and City taxes.  That means the $7,000 only buys a $350,000 life insurance policy on himself and for his spouse to receive the $40,000 annually,  The life insurance policy would have to average an annual  return of 11.3%!   Not likely achievable.  Realistically, the spouse would have to reduce their annual payout to $32,000.  Therefore, pension max would result in a decrease of $8.000 annually, assuming a generous 8% payout..

Second, there is no guarantee that the insurance company will maintain the interest rate or that the insurance company will continue the life insurance program. Moreover, most life insurance companies charge a surrender fee and maybe other fees that further diminish the payout.

Finally, the 100% joint annuity is reliable and safe while the pension max relies on the financial strength of the company and the stock market.  In other words pension max is a death gamble that can leave your spouse with years of little income if the country goes through another recession or the company has financial issues, not a gamble I would take. Tha,t's why pension max is a bad bet


Anonymous said...

I went for my final UFT pension consult last week and was told my now free prescription plan would be $488 per month when I retire and that the UFT would reimburse me $390 once a year. I have HIP - so if I retire July 1st, I'm assuming I'd have to pay that until I could switch my plan to something less expensive like GHI in October? I'm really confused and am thinking of going to a private consultant. Any info is appreciated.

Anonymous said...

An insurance salesman is coming with free lunch to try selling cancer insurance and life insurance. Who invited this guy?

Anonymous said...

Sir Chaz thank you for this very informative article. Your words can save people lots of money.

Anonymous said...

There are a couple of flaws with the logic - first, if you get the proceeds of the insurance policy, you can either use the capital as part of the return or, if you die before you use up all the money, it can go to your heirs. A pension ends on death and no benefits pass to your heirs. Secondly, I am not as confident as you are on the certainty of our pension. Any competent financial planner would suggest that a reasonable person should not count on receiving their pension. Just ask the Detroit pensioners and eventually those from Illinois as well.

NYCDOEnuts said...

This isn't the first and won't be the last scheme that private equity companies try to use on teachers who are nearing retirement.

If you think about for a second, civil servants are the only types of employees left who have a guaranteed monthly pension benefit to look forward to. This means we have money in retirement and it makes us ripe for schemes like this.

And this is a scheme. If you were a teacher, it is not a good idea to divert (as much as) 20% of your retirement income to the private financial sector for after life concerns. In fact, as you showed here, all of the life insurance we'll ever need is in that 7.5% compounded interest and the choice of beneficiaries offered by the TDA, in combination with the pensuon and medical benefits we will have. As my old DR Marc Korashan used to say, 'if a financial advisor suddenly calls you out of the blue within 5 years of retirement, don't pick up the phone'.

R Gold said...

I know people have used Ira.Bernstein for a consult

Unknown said...

Depending on your circumstances, the max pension works. For instance, I have been retired 7 years. I am in tier 1. I have no dependents/spouse. My adult sons are my only survivors. Have the no survivor pension option. My TDA has not been annuitized. I have no life insurance. But I did go to Ira Bernstein to complete my retirement papers and he also wrote letters to TRS for me to get monies owed me. I had a gap in service for childcare/changing from NYS to NYC and other circumstances. His seminars are informative. His NYC office called once. I told them I was not interested in investing with them. Never heard from them again. Waited until 70 to collect SS. So, with pension and SS have more money monthly than I did while working. Now, Fed govt tells me to take a yearly withdrawal from TDA.....they want their taxes. Fun money. One year bought convertible. Fun. SHIP pays for some of the medical/dental expenses not covered by medicare and GHI and Cigna in retirement. We have a good deal, just make sane , logical decisions.