Financial advisors are charged with considering the long-term well-being of not only their client, but their client’s family. Taking on the mentoring, coaching and — even in small doses — therapist roles in client interactions, if done artfully, can serve to strengthen the client-advisor bond and broaden the advisor’s role from numbers person to family resource.
One such opportunity presents itself when questions and concerns relative to pensions and spousal finances arise.
According to the latest Quarterly Retirement Market Data released by the Investment Company Institute, defined benefit plans account for 30% of U.S. retirement market assets. Those who depend on these defined benefits can experience anxiety when weighing which payout option to choose: Do you elect the highest payout and roll the dice that you don’t predecease your spouse? Do you elect the lowest payout and lock in a lifetime of lower income for your family unit?
Clients mulling over this choice are often blue-collar and service-industry workers, engineers, first responders, teachers and career military service members, to name a few — individuals often charged with putting the needs of others ahead of themselves. Adding to the gravity of the decision, you have one shot to get this right. Once you make your election and begin receiving payments, you cannot change your mind. This emotion-filled decision offers a unique planning opportunity for advisors to prove their worth by providing clear solutions.
A three-door approach
Most of us are familiar with the generic “What’s behind door No. 1 or door No. 2” scenario. It’s an either/or choice that can be limiting for those contemplating the path forward. Specific to this situation, door No. 1 is the single life payout option: Get the highest benefit payment as long as you live, but after you die, your spouse no longer receives this income. Behind door No. 2, the joint life payout option — you and your spouse will receive these as long as either of you are alive.
When working with clients on this pension question, consider a conversational pivot to a door No. 3: a pension maximization strategy. Although its primary purpose is the death benefit, life insurance plays a pivotal role in pension maximization. Under this approach, the pension holder obtains enough term and permanent life insurance protection so that they can elect the single life pension at retirement. Designed correctly, one of two scenarios can occur:
The spouse outlives the pension holder. In this scenario, the pension holder gets the higher payments. When the pension holder dies, the spouse receives the life insurance proceeds, which are then invested to replace the pension income that stops.
The pension holder survives the spouse. In this case, the pension holder gets the higher payments. After the spouse passes, the pension holder continues to get the higher pension payments. They can choose to use the cash value in the permanent life policy to supplement retirement, leave the full death benefit to the next generation or some of each.
Is pension maximization for everyone?
No approach is appropriate for everyone. In discussions with clients it is important to set expectations and stress that you are assessing feasibility, not waving a magic wand.
The following client factors could indicate that this strategy is not a good fit:
- Health history: Based upon medical underwriting, insurers may not approve coverage, or could price premiums above the client’s budget.
- Age of retiree: Insurance premiums increase with age, affecting the financial cost/benefit of the strategy. Depending upon the single vs. joint life payout differences, determining the right age to begin the insurance protection (even before retirement) could make or break the viability of the strategy.
- Age of the spouse: If the retiree’s spouse is much younger, there is more lifetime income to protect. This increased protection could become cost-prohibitive.
- Emotions: If the client or their spouse has an emotional barrier regarding life insurance, they may not be open to considering a strategy, regardless of its merits.
Financial factors include:
- Social Security: In some scenarios, the insurance premiums may exceed the increase in pension payout for a limited time. If the client doesn’t have assets to absorb this temporary shortfall, they could be forced to take Social Security earlier than is optimal.
- Health insurance: In some plans, electing a single life pension could affect the availability of health insurance coverage for the spouse. If the spouse depends on the retiree’s health benefits, this is a critical consideration to investigate.
- Pension payout dollar differences: The “spread” between the single vs. joint life payouts differs from plan to plan. A joint life payout might make more financial sense in some plans.
With a little mentoring and a lot of listening, a financial advisor can determine if this is the optimal path forward for the client. Whatever the outcome, it’s likely that the client will come away from the conversation with increased confidence in the process and newfound respect and trust for the advisor.
Financial Advisor, International Planning Alliance