Making Your Money Last

A Pension Strategy That Could Backfire

Taking a life-only pension payout and buying life insurance to protect a spouse comes with risks.

Couples who qualify for an employer pension need to make a big decision before they retire. Should a retiree take a life-only annuity, which provides the highest monthly payout but ends when the pensioner dies? Or choose a joint-and-survivor benefit, which offers a lower payout but one that continues after the retiree dies for as long as the spouse is alive?

If the employee due the pension is likely to die first, the joint pension is usually the best route. But some insurance agents may try to steer you to a strategy known as "pension maximization." It works like this: Take the higher life-only payout and use all or part of the extra income to buy life insurance. If you die first, your pension ends but your spouse will get a death benefit that supposedly will be enough to generate at least the same income she would have received under the joint pension. If she dies first, you cancel the insurance and continue to take the higher payout.

However, this strategy may not work out as planned. It’s essential to examine the numbers closely before you sign away your rights to a joint pension. "If the goal is to have steady income for life, why jump through all these hoops?" says Rebecca Davis, legal director of the Pension Rights Center.

Mark Maurer, president of Low Load Insurance Services in Tampa, Fla., develops "pension max" strategies for clients of fee-only certified financial planners. He says that just 20% of the clients he reviews do better with pension max than with the joint-pension option.

Maurer offers an illustration of one plan he developed for a 61-year-old man and his 59-year-old wife. The husband's pension offered a choice of a monthly $4,356 life-only payout or a 100% joint benefit, which would pay $3,557 as long as one of the spouses lived.

Under pension max, the worker chooses the life-only benefit with its extra $799 a month. He uses $660 a month to pay premiums on three life insurance policies—a 10-year $200,000 term policy, a 20-year $200,000 term policy and a $370,000 universal life policy. He qualifies for low rates because he is healthy. "This won't work unless the client is a better-than-average healthy non-smoker," Maurer says.

Protecting the Surviving Spouse

A big issue for pension max plans: If the husband dies, will the death benefit be big enough? "You really want to see if the wife would be able to use the death benefit to buy a guaranteed fixed annuity that is greater than what she would get with the joint pension," says Steve Vernon, president of Rest-of-Life Communications, a consulting firm in Oxnard, Cal. He says he's "skeptical" that these plans work in the survivor's favor.

In Maurer's example, if the husband dies after 22 years, the 81-year-old wife could use the tax-free $370,000 death benefit to buy a fixed-payout annuity. At today's rates, the annuity would pay out $3,388 a month, according to That's lower than the joint pension's $3,557.

But Maurer notes that with the pension, payments would be fully taxable and, at the 15% rate, would leave the widow with just $3,023 of after-tax spending money. With the annuity, most of each payout would be tax-free return of investment so, according to Maurer, the widow would have more spendable cash.

However, Vernon says that pension max plans are often based on assumptions that may not pan out. He has seen plans that provide just a 20-year term life insurance policy on the worker's life. If the husband lives longer, "he will have to buy term life insurance in his eighties, and that will be phenomenally expensive," he says. Some strategies use insurance with death benefits that grow based on market assumptions. If the market grows at a lower rate, the death benefit could be too low to cover the survivor's expenses.

Also, pension max plans often don't account for taxes. In Maurer's example, the couple must pay tax on the $4,356 payout, squeezing the after-tax cash on hand to cover the insurance premiums.

Haven’t yet filed for Social Security? Create a personalized strategy to maximize your lifetime income from Social Security. Order Kiplinger’s Social Security Solutions today.

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