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 5% (depending on age and length of service) to provide benefits during his or her lifetime. If you are to receive approximately $40,000/year in life only, you’ll receive approximately $38,000 in order to provide your spouse $19,000/year during his/her lifetime. Because you are receiving your COLA on the lower amount, the difference can add up to a lot of money “lost” by taking a survivorship payout.
You should also consider payout protection through the use of life insurance, which also provides tax-free transfer of face value. Some people make up the above mentioned shortfalls by making sure their spouses, and in some cases their kids and grandchildren, are taken care of by purchasing life insurance to provide a “make-up” lump sum distribution. Keep in mind that 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 kids and grandkids, upon the spouse’s death.
Another nuance specific to teachers is the reversion option. If the teacher originally selects the joint survivor option but is willing to take a slightly lower pension payment, the surviving spouse (if he/she is the teacher) can have the right to change the payout option to the higher payout, sole survivor option if the non-teacher passes away first. However, the “with reversion” option must be selected on the date of pension election.