Pension Maximization

Pension maximization, often shortened to "pension max", is a retirement-income strategy built on two decisions made together. First, a married retiree elects a single-life annuity, the largest monthly pension the plan pays, which ends when the retiree dies. Second, the retiree buys a life insurance policy on their own life, naming their spouse as beneficiary, intending the death benefit to replace the survivor pension the spouse would otherwise have received under a joint and survivor annuity. It is a sales strategy rather than a plan feature: the pension plan offers the payout options, and the insurance is bought separately.

The comparison that decides it. A joint and survivor option pays less each month than a single-life annuity because it keeps paying the spouse after the retiree's death. Pension maximization bets that a life insurance policy can provide that protection for less than the monthly reduction. The fair comparison has several parts that a quick illustration can leave out. The pension difference is taxable income, while the premium is paid from after-tax money, so the extra pension available to pay premiums is smaller than it looks; Utah Retirement Systems makes this point to its members, noting that insurance illustrations often begin by comparing the larger pre-tax income. The death benefit is generally excluded from the beneficiary's gross income under IRC 101(a), which helps the strategy. And the death benefit has to be large enough to produce, for the rest of the spouse's life, something close to the survivor pension it replaces.

The risks the survivor option does not have. A survivor annuity, once elected, keeps paying without further premiums and cannot lapse. The policy can. Premiums must be paid for as long as the coverage is needed, possibly for decades; a policy whose cost or credited interest is not guaranteed can become more expensive or underfunded; and if money gets tight and the premiums stop, the spouse's protection ends with them. A pension with a cost-of-living adjustment, as the Utah Retirement Systems pension has, grows over time in a way a level death benefit does not. The retiree also has to qualify for the coverage at a reasonable price at the age and health they are in when they retire. And after the retiree's death, the surviving spouse has to invest a lump sum or buy an annuity with it, a task the pension would have handled for them. Before waiving a survivor option, it is also worth checking whether any other benefit, such as continued retiree health coverage for a surviving spouse, is tied to it under the plan's rules.

Where it can make sense. It holds up best where its assumptions happen to be true: the spouse has a large pension or other income of their own; the spouse's life expectancy is much shorter than the retiree's; the survivor option's reduction is unusually large; or the retiree already owns adequate, paid-up life insurance. If the spouse dies first, the retiree keeps the full single-life pension and can stop paying for a policy no longer needed, which is the strategy's clearest advantage. Some plans offer a "pop-up" joint option that reverts to the full amount if the spouse dies first, which addresses the same concern inside the pension.

Consent and finality. Under IRC 417, a plan subject to the federal qualified joint and survivor annuity rules must pay a married participant a joint and survivor annuity unless the participant elects otherwise and the spouse consents in writing, with the consent acknowledging its effect and witnessed by a plan representative or a notary public. Governmental plans set their own rules, and Utah Retirement Systems tells its members that the payout option chosen "is final". The pension election is generally irrevocable once payments begin; the insurance is the part that can change.

How it is sold. Pension maximization is presented as a life insurance purchase, and the insurance is the product being sold. Utah Retirement Systems' notice to members approaching retirement warns that they "could get a call from an insurance agent" proposing it and that "insurance sales people can have a direct financial interest in selling you the product that pays them the highest commission." Its own assessment is that there are cases where the strategy may work, but that "for most people it does not measure up to its claims." That is the view of one pension system, not a finding about every proposal, and the only way to judge a specific one is to run its numbers on an after-tax, worst-case basis.

Evaluating a proposal comes down to a handful of comparisons.

1. Get the plan's numbers: the single-life amount and each joint and survivor amount, and whether the pension has a cost-of-living adjustment.
2. Compute the after-tax difference between the single-life and survivor options at the retiree's tax rate.
3. Get the policy's real cost: the premium, whether it is guaranteed, and for how long it must be paid.
4. Size the death benefit against what the spouse would need to replace the survivor pension for life, including inflation if the pension would have had it.
5. Run the bad cases: premiums that rise, a policy that lapses, an early death of the retiree, and the spouse dying first.

Take an example: a plan offers Teresa a single-life pension of $3,000 a month or a 100% joint and survivor pension of $2,640. The difference is $360 a month. At a 22% income tax rate, $360 of pension leaves $360 x 0.78 = $280.80 after tax. The proposal's policy costs $330 a month, so while both spouses are alive the couple has $330 - $280.80 = $49.20 a month less to spend than if Teresa had simply taken the survivor option, about $590 a year. If the pension has a cost-of-living adjustment, the survivor benefit would have grown each year, while the death benefit stays fixed. The strategy comes out ahead on this cash flow only if Teresa's husband dies first and she can drop the policy, or if the policy's death benefit ends up worth more to him than the survivor pension would have been.

Pros

• The retiree receives the largest monthly pension the plan pays.
• If the spouse dies first, the retiree keeps the full pension and can cancel the policy, which a standard survivor option does not allow.
• The death benefit is generally income-tax-free and can pass to children or other heirs, not only to the spouse.

Cons

• The premium is paid with after-tax income, so the extra pension available to pay it is smaller than the gross difference suggests.
• A policy can lapse, rise in cost or turn out too small, while the pension election generally cannot be undone.
• A level death benefit does not keep up with a pension that has a cost-of-living adjustment.
• It is sold as an insurance product, so the person presenting the comparison may be paid on the policy.