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The shift away from pensions (also known as defined benefit plans) to 401ks and other employer-sponsored plans (also known as defined contribution plans) is unlikely to abate anytime soon. Yet even as the number of pensions shrinks, there are still a sizeable number of people who are fortunate enough to have a pension as part of their retirement income plan.

When claiming pension benefits, there’s generally the option to choose either a single-life option (benefits stop once you die) or a joint-and-survivor benefit that will allow benefits to be paid out to your spouse if you’re the first to die. The single-life option provides the higher monthly benefit while the joint-option sacrifices some amount of benefits in order to provide greater long-term financial security for your spouse.

Pension Maximization Overview

There is a strategy known as “pension maximization” that seeks to make this pension claiming decision easier. Here’s how it works: Let’s say that you have a pension and can claim a single-life option that pays $4,250 a month or a joint-and-survivor option that pays $3,500 a month (these numbers are hypothetical). Rather than take the lower joint-and-survivor option, pension maximization says to take the higher single-life option, and then use that extra $750 to pay for life insurance.

The policy purchased is used to insure the life of the pension recipient. In the case that the pension recipient is the first to die, the death benefits are paid out to the surviving spouse to provide a sum of money to help provide financial security throughout the duration of the survivor’s retirement.

Caveats: Why Pension Maximization May Not Work For You

This strategy sounds great in theory, but in practice the numbers don’t often add up. For starters, the spread between the two options (in our example, $750) is typically not a large enough amount of money to pay for a permanent policy that will provide an adequate death benefit to replicate the lost benefits from the pension.

This can lead to having to make one of two sacrifices. One option is to purchase a policy with a lower death benefit than you may have initially wanted. The second option is to spend additional money above the spread between your two pension options (in our example, you may have to spend $900 a month) in order to get enough death benefits. Doing option two essentially means you’ll have less cash flow today than if you had simply taken the joint-and-survivor option.

The more cost-efficient option is to purchase a term policy. The glaring concern with using term is if the insured outlives the policy. In other words, you purchase a term-life policy with a duration of X years, and the insured outlives X, you’re essentially back where you started. The only difference now is that, because you’re some number of years older, purchasing a new term policy is likely to be prohibitively expensive.

That doesn’t mean the pension maximization strategy is an inherently bad idea. However, in our experience, pension maximization is a strategy that we rarely use because the cost of the amount of death benefits winds up being cost prohibitive. That said, there are times when it may make financial sense to use a pension maximization strategy. For example, if the pension recipient is significantly older than his/her spouse, then maximization may be an appropriate strategy. Being able to identify whether pension maximization is right for you relies on looking at your entire financial picture, including how equipped you are to pay for the life insurance policy.

Pension maximization is often painted as being a sort of “silver bullet” that universally solves your pension decision. It’s important to recognize that there are significant downsides to trying to use life insurance for to maximize pension benefits that you need to be aware of before making a decision on your pension benefits.

Planning for retirement income is complicated which is why we recommend working with a financial advisor who can make planning recommendations based on your unique circumstances. 

This article originally appeared on June 25, 2017 in the Brainerd Dispatch. You may view the article here. 

Bruce Helmer

Bruce Helmer

Co-Founder, Financial Advisor and Author, Speaker and Host of the "Your Money" Radio Show

Bruce Helmer, a founding member of Wealth Enhancement Group, has been the host of the “Your Money” Radio Show for more than 20 years. He is also featured weekly on the Twin Cities CBS affiliate WCCO, and has penned three financial advice publications.