Our Lockheed Martin clients in the Syracuse and Owego plants often ask for our recommendation on how to elect their pension payment.
Take the hypothetical example: John works at Lockheed Martin in Syracuse and his life only pension benefit is $5,000/month, or $60,000/year. At the other extreme, his 100% survivorship benefit is $4,000/month, or $48,000/year; a $12,000/year difference between the benefits.
When trying to determine the most appropriate pension benefit, keep in mind that they all yield a similar end result because they are based on actuarial tables for life expectancy. We have explained the pros and cons of a few options below:
Option 1: Take Life Only Benefit
This is a relatively risky option as it leaves John’s spouse vulnerable to John passing away early on in retirement. This option is typically not recommended unless clients have significant assets and/or other sources of retirement income.
Option 2: Take 100% Survivorship Benefit
This option is more common than life-only as it provides protection for John’s spouse in the event he predeceases her, especially early in retirement. However, this option has little value if John and his spouse pass away around the same time or John’s spouse predeceases him (assuming no pop-up provision).
Option 3: “Pension Maximization” Strategy
A less common, but interesting strategy, is using life insurance coupled with the life only benefit to provide protection for John’s spouse. Here’s some background to set the stage followed by an explanation of the strategy:
We like to think of the 100% survivorship option as an insurance policy. If John elects the 100% survivorship option, he is essentially purchasing a $12,000/year insurance policy (difference between life only and 100% survivorship option) with an unknown, declining death benefit for his spouse.
For example, the 100% survivorship option would provide a large death benefit if John were to pass away early (say, 5 years into retirement) and his spouse lived a long life. He would have “paid” $60,000 of insurance premiums ($12,000/year x 5 years) and his spouse would receive $960,000 of pension payments if she lived for 20 years after John’s early death. Not a bad return on investment!
Alternatively, if John elects the 100% survivorship option there are two scenarios to be aware of. First, if John’s spouse predeceases him early in retirement, the $12,000/year “premium” is lost entirely for the remainder of his life. Second, let’s assume they both live long lives and die together at age 90; John would have paid 30-years of survivorship “premiums” ($360,000) in “premiums” and received no death benefit for those payments. In both scenarios John would have been much better off if he elected the life only option.
The obvious problem is that death ages are unknown and benefit elections can only be made once. The best we can do is develop a strategy to protect the surviving spouse in the event of an untimely death. This would favor electing some sort of survivorship option; acknowledging the “worst-case” scenario of John predeceasing his spouse early in retirement is possible, although unlikely.
The “Pension Maximization” strategy using life insurance works as follows:
Instead of choosing a survivorship option, John elects the “life only” option and purchases life insurance to protect his spouse if he were to predecease her. Example: As previously stated, the difference between life-only and 100% survivorship option is $12,000/year. John would choose the “life only” option and then purchase a life insurance policy with the $12,000/year difference between the benefits. This provides the same pension payment as the 100% survivorship option after the insurance premiums are paid. This strategy has a few advantages:
- Flexibility – If John predeceases his spouse at any time in retirement, he can simply cancel the insurance policy and his realized benefit will “pop-up” to the full life only amount. Additionally, if his spouse predeceases him late in retirement, he might choose to keep the policy and leave the death benefit to his heirs. These options are not available with the traditional 100% survivorship election.
- Statistical significance – There is a higher probability that John and his spouse will pass away within ~5 years of each other. Recognizing this probability, the life insurance strategy would be ideal. If John were to pass away at age 90 and his spouse at age 91, she would receive the entire insurance policy death benefit (say $1,000,000) and could live on the funds for 1 year, then leave the remainder to heirs. Alternatively, if John had chosen the 100% survivorship option, his spouse would only receive one year of survivor pension payments and would have nothing to leave to their heirs after all the years of “paying” survivorship premiums.
As financial planning nerds, we enjoy exploring all these unique strategies to determine what’s best for each client. As a fee-only advisor, we don’t sell insurance (or anything for that matter), but we can help clients price insurance policies and help them make the best decision for their personal situation. Feel free to reach out if you have questions about your pension from Lockheed Martin or any other employer!