What Federal Employee Pension Options Maximize Lifetime Income for Your Family?
The Federal Employee Retirement System (FERS) provides a lifetime retirement income benefit based on a formula that considers various factors that are used to calculate the income received by federal employees and their spouse or qualified beneficiary. The retirement income benefit calculation is based on any 36 consecutive months of employment with the highest pay average multiplied by an annuity factor determined by the total number of creditable years of service, paid over the selected life expectancies. Does it not make sense to Maximize your Pension Benefits? What is the best Income Election option for me and my family?
Survivor Income Benefits
The financial security offered by the FERS Basic Pension is a benefit that is relied on by employees and dependent family members. For married employees, the retirement income benefits are paid over the employee’s life with a survivor benefit paid to a spouse (or qualified beneficiary), depending on the survivorship option selected there is an associated cost that lowers the employee’s lifetime benefit. For single, unmarried employees, retirement income benefits are paid over the employee’s life, with no income reduction. Single employees can decide whether to select a survivor benefit paid to a qualified beneficiary, that is “legally dependent” upon the employee, with an associated cost or income reduction.
Depending on the survivorship option selected and the age difference between beneficiaries, the employee’s lifetime income benefit will be reduced, as well. The potential costs of the survivorship benefit could be significant.
To illustrate, there are two beneficiary survivorship options available: Option 1) A survivor benefit that is 25% of the employee’s single-life benefit amount, which results in a 5% reduction in the lifetime income benefit and Option 2) A survivor benefit that is 50% of the employee’s single-life benefit amount, which results in a 10% reduction in the lifetime income benefit.
These costs are known as “insurance annuity costs” which are the additional costs an employee will have associated with the selected lifetime income benefit, if there is a survivorship benefit (survivor benefits for married couples). The annuitization costs are even greater for employee’s beneficiaries whose age difference is more than 5 years. For instance, the reduction in an employee’s retirement income benefit is reduced by 15% and 20% for beneficiaries whose age difference is greater than 5 and 10 years, respectively, and so on.
Pension Maximization
FERS employees are provided with different retirement income options to meet their retirement income needs. The retirement income amounts under the different payout options are based on assumed life expectancies for employees and their beneficiaries. What if your life expectancies are different from the assumptions? How does this affect your decision? What are the difference in ages between married couples or a qualified beneficiary? Greater than 5-10 years? What is the cost associated with the survivorship income? Single members have limited survivor and beneficiary options. Married members might be unwilling to elect “lower survivorship income” options (Option #1) which can leave the survivor with inadequate income, but what if the non-member spouse dies first? FERS employees who are married should consider pension income options to maximize retirement income.
Implementation of Pension Maximization Strategy
For most married couples, a successful retirement plan would include income security for both life expectancies without a substantial reduction of income at the death of the FERS employee. In most instances, FERS employees can maximize lifetime income for married couples through the purchase of a life insurance policy to insure the FERS employee’s life with the survivor spouse as the beneficiary.
This “pension maximization” strategy must meet certain criteria for the recommendation to significantly improve the retirement income benefits for a FERS employee and their spouse or qualified beneficiary.
1. Secure life insurance coverage with death benefit used to replace the income lost at employees’ death. The tax-free death benefit replaces a fully taxable pension benefit.
2. Purchase a “No-Lapse Guaranteed Life Insurance Policy” guaranteed for life to replace the Federal Employee Group Life Insurance (FEGLI) coverage at potentially lower costs.
3. The insurer must be financially sound and insured must be healthy enough to meet insurance company “Preferred” Underwriting Standards. If you are healthy, qualify now at significantly lower lifetime premiums. The replacement coverage costs are most likely lower because the FEGLI coverages (with 5-year rate increases) do not offer “Preferred” risks policies.
Two Retirement Scenario Outcomes
The Pension Benefits are maximized for the FERS employee and their beneficiaries under both life expectancy scenarios with the use of use of life insurance. To illustrate, assume the employee selects Option #1 which provides a 25% Survivorship Benefit and life insurance replaces any lost income to beneficiary. Let’s review the two life expectancy scenarios.
First scenario, FERS employee survives their spouse, or qualified beneficiary. This will result in higher lifetime income for an employee than had the survivorship Option #2 been chosen. The employee would still own a life insurance policy which might be sold under a life settlement arrangement (certain conditions apply), maintain coverage for family, and/or reduce the face amount to provide a family benefit.
Second scenario, FERS employee is first-to-die. Survivor spouse or qualified beneficiary replaces lost pension income benefit with life insurance proceeds that are tax free. The total taxes paid over the survivor’s lifetime could be less due to the receipt of the tax-free lump sum. Survivors can designate a beneficiary for any unused death benefit proceeds at their death which would not be available had survivorship options #1 or #2, been selected.
Pension Maximization Strategies can provide significant retirement income benefits for FERS families through reliance upon financial professionals. True North Financial Advisors can provide retirement planning and investment management services to FERS employee and their families. To better understand your retirement plan investment options, contact us.
This is a hypothetical example for illustrative purposes only.
