taken from the November 2002 AAUP AZ Advocate

Pension Maximization -- An Alternative to the Joint Survivor Option

By Ray Martin, CFP

Financial Directions, LLC

At retirement, each Arizona State Retirement Plan participant must make a distribution election. This can be a full cash-out or rollover, a partial cash-out combined with a monthly distribution or a pure income election among several options. This article will focus on the latter…the pure income election with analysis of the joint survivor option.

As the Arizona State Retirement Plan (AZSTRP) is a defined benefit plan, it’s useful to review the "defined benefit" formula which is: average salary x years of service x a multiplier. The average salary can be the higher of the average 3 of the last 5 years or the high 5 of the last 10 years of employment. The multiplier of 2 will increase fractionally with total years of employment.

This understanding is pertinent to early planning around your own retirement forecast. At any time prior to retirement, anyone can go online to the retirement plan website to make a personal forecast. Simply search www.asrs.state.az.us. Select the "high-tech" option, then select "non-retired members" then in the left column, click on "benefit estimator" and complete the personal data inputs. The calculation request will generate "your" numbers in all the available options. Many different assumptions and combinations can be checked out. This procedure can be initiated at any time in your career and a very early look can be useful as a planning tool. This article advocates the usefulness of the early look.

For example, an early look at age 45 for a sponsor or participant with 15 years of service, one can forecast to age 65 (with 35 years of service) by estimating the average salary input in solving for the retirement income options. To illustrate this example, lets estimate the average salary as $50,000.

Resulting Income Estimates

Option

100% straight life annuity

maximum monthly benefit

Sponsor/Participant

$3354 per month

Spouse/Survivor

0

Cost

0

Joint survivor annuity, with

100% continued to survivor

$2807 per month

$2807 per month

$547 per month

By opting for the joint reduced pension benefit, you are in effect, buying an insurance policy to provide the survivor benefit.

The annual premium is $6564 ($547 x 12). Assuming a life expectancy of 85, the total reduction in retirement income would be $131,280 ($6564 x 20). This reduction in income continues for life, even if the spouse dies before the sponsor. This is a fairly typical and predictable trade-off at retirement unless the spouse has also created a significant independent retirement benefit.

Consider this. A pension maximization payout strategy can be developed early on, funded with full working income resources. This concept involves buying enough life insurance death benefit whereby the income-tax-free benefit would be enough capital to fund a replacement survivor benefit of $2807 per month, in this example. The required insurance death benefit, based upon a guaranteed immediate annuity concept, would have to be around $455,000. Such an insurance policy, initiated at age 45, with a $5000 lump sum would call for a monthly guideline premium of $350 (actual cost will vary). This would provide that no further premium payments would be required, once retired, when resources would probably be more limited. This flexibly structured policy would allow alterations in the build-up payment schedule, if so needed. The basic policy funding requirement is to always have enough dollar value in the policy from which the premiums are paid, so as not to terminate the policy, nor too much policy cash value whereby the policy might be reclassified as a tax-deferred money contract and lose its tax-free death benefit status.

While the death benefit is primarily to fund a spouse pension when and if the sponsor predeceases the spouse in retirement, it would also be available should the sponsor die prior to retirement. In such early death the sponsor’s pension account could not be mature and the insurance death benefit would augment the spouse’s pension beneficiary death benefit.

Once into retirement and having elected the maximum payout annuity from the outset, should the spouse die before the sponsor, then the sponsor would continue to receive the maximum payout of $3354, in this example. Also, the cash value of the policy, which could easily be in excess of $100,000, would be available to the sponsor, or a subsequent beneficiary could be named while keeping the insurance policy in force.

So, when there is only one major pension account available to a couple, the pension maximization concept really addresses the issue of how to most effectively provide for a spouse survivor pension. At retirement, with no prior planning for this contingency, the availability of a joint-survivor option is a welcomed feature of the retirement plan. Understand that these last minute options and combinations do come at a non-negotiable cost. It may be that, in your personal situation, you anticipate the existence of a single major pension account to cover the retirement income of a couple. If so, then early analysis of this pension maximization concept should be pursued. This could prove to be a beneficial endeavor.

By Ray Martin, CFP

Financial Directions, LLC

A Registered Investment Advisor