One of the common mistakes made in the calculation of survivor payout options is that most people believe there are only two pension payout options: life-only and joint survivor. In fact, there are several survivorship options to choose from, including 100%, 75%, 50%, and many more. If you want to make allowances for your spouse, for example, a 50% joint survivor option will reduce your pension payout about 7-8% (depending on age and length of service) in order to provide benefits during his or her lifetime. If you are to receive $60,000 per annum in life only, you’ll receive approximately $55,500 in order to provide your spouse $27,750 per annum during his/her lifetime.
DON’T FORGET, Cost of Living Adjustments (COLA) are based on your pension payout so if you choose to take the life only option you will dramatically increase your pension payouts in the future. The additional $4,500 per year, compounded at 3% over your lifetime, can add up to hundreds of thousands of additional dollars in income during retirement. (Exhibit B)
Using the example above, let’s assume you take the higher, life-only option and use part or all of the difference ($4,500 per annum) to buy life insurance. Proceeds upon your death pass tax-free to your spouse who can then gain interest on the lump sum while drawing additional amounts. Proceeds can also be used to purchase any type of investment that can also be passed on to other beneficiaries, including children and grandchildren, upon the spouse’s death. Want to keep the additional $4,500 per year to spend? If your investments are structured properly, they can pay the insurance premiums for you so you can keep the additional money from your pension to enjoy.
Choosing the correct type of life insurance is critical to the success of this strategy for your spouse and loved ones. There are many nuances to different types of life insurance and a simple mistake can cost your family a lot of money. But, a properly structured “private pension” can generate a tax-free lump sum “differential payment” to your spouse that can also be stretched to other beneficiaries.