A recent article in FedSmith (3 Reasons for Federal Employees NOT to Do a “Pension Max”) outlined the things that can go wrong when utilizing a life insurance policy to replace your federal annuity survivorship benefits. For balance, let’s take a look at how a properly implemented plan can save you money, provide flexibility and give you control of that survivorship benefit.
The “Pension Max” strategy typically applies to married federal employees and usually only works if you are under the Civil Service Retirement System (CSRS). If you are married, the two components to consider for your surviving spouse are whether they will need a portion of your annuity to continue to live the same lifestyle if you (the federal retiree) passes away first and whether they will need access to your Federal Employee Health Benefits.
Generally, the answer to these two questions is yes. Which poses another question – how do you efficiently create a plan that provides benefits for the spouse, at the lowest cost, leaving you with the most control?
As a married, CSRS employee approaches retirement, they have two clear choices for providing survivorship benefits. The first is to simply take the reduction to their annuity and provide their spouse with 55% of their gross annuity should their spouse end up as a survivor (hopefully many years down the road). This is the easiest way to accomplish survivor benefits, since if the federal retiree passes away first, the surviving spouse sends the death certificate to OPM and they immediately begin receiving the 55% (or whatever amount you elected) from OPM. No muss, no fuss.
Unfortunately, this is also the most expensive way to provide survivor benefits.
The second option is the one known as “pension max,” short for pension maximization – defined as making the most of your survivorship benefits. This is a more complicated way to provide those survivorship benefits, but it offers some unique benefits that the survivorship benefits from the annuity simply cannot supply.
- Pension max is less expensive than the alternative. The cost of the survivorship benefits within your federal annuity increases every time you get a cost of living increase (we can hope there’s a time when COLA’s return for retirees!). Yes, the survivor’s benefit increases, as well, but over a period of 20 years, it’s common for the federal employee to have paid in well over $100,000 to cover the cost of survivorship. The cost of the permanent life insurance is fixed. You purchase a permanent policy that guarantees the death benefit will not change as long as you pay the fixed premium amount on time. The purpose of the policy is not to grow cash value; you’re simply looking for the highest guaranteed death benefit with the lowest guaranteed premium. Because the premiums remain the same over the life of the policy, the overall cost is lower.
- One thing that allows pension max to work for CSRS employees is that they have flexibility in electing survivorship benefits for their spouse. They can leave as little as $1 up to a maximum of 55% of their annuity. They must leave something (yes, even the $1 counts) to provide FEHB to the surviving spouse. This gives you the opportunity to keep health benefits for your spouse at a low cost AND utilize pension max. Most federal employees leave their spouse enough to cover the cost of the health insurance, which constitutes an average deduction of about $20/month. When you deduct the cost of keeping enough survivorship to maintain the health insurance from what full survivorship would have cost, you have the amount of premium you can spend on life insurance.
- Depending on the difference in your and your spouse’s ages, you may run a greater risk of your spouse passing away first. In all cases, we do not get a guarantee on life expectancy. What happens if you provide full survivorship through your annuity for your spouse and they pass away first? All the money you have paid toward survivorship is gone – OPM wins! If you have children, grandchildren or other heirs you like better than OPM, you may not want this to happen. If you were using the life insurance option, at that point, you could change your beneficiaries (or you might have already designated them as contingent beneficiaries). Someone you name will get a leveraged, tax-free death benefit for all of the money you’ve paid in. In other words, your contributions don’t just evaporate.
- By using pension max, you maintain control over the policy and your survivorship options. While the federal annuity gives you the simplest means of providing survivorship, the life insurance gives you the most control. Understanding that not everyone wants that control, let’s look at what that control really means. Your surviving spouse inherits a lump-sum, tax-free death benefit. They won’t get a monthly check from OPM. They have to set up their own income, which can be done either through the life insurance company or your financial advisor. The good news – they get to determine how much income they want and it is distributed to them in a tax-efficient manner since the life insurance proceeds were inherited income-tax free. The could also decide they’d like to take a lump sum for part of it and, say, pay off the mortgage and take the remainder in monthly payments. If they need more income for a month or two along the way, they’re in control of how the funds get used. AND, any funds that are remaining at the spouse’s death go directly to their beneficiaries.
- One of the frustrations of many CSRS retirees is that they cannot leave survivorship benefits to anyone other than a spouse. Live-in partners cannot be covered. Same-sex domestic partners cannot be covered. Children, siblings, nieces, nephews…cannot be covered. Although you cannot provide any of these heirs with health benefits, through pension max you can at least provide them with a survivor benefit.
Pension max is not right for everyone, but you owe it to yourself and your family to understand your options, do the analysis and find out of it makes sense for you. If you’d like a copy of “Guidelines for Choosing a Survivor Benefit,” send an email to this address with “Pension Max” in the subject line, and your free copy will be emailed to you.