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