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Dear Fix My Portfolio,
My wife and I got married in 2023. I am 58 and she’s 55. I’m retiring in June 2025 at 59 and will get three pensions. I already get one of them, which is $1,000 a month before taxes.
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For the other two, we have to decide whether it’s worth it to take the option for a survivor’s benefit, which would lower the monthly amount, or just have the pension pay out for my lifetime, which would mean a higher monthly payout but would end at my death. If I add her to the benefit, she would receive 50% of the lesser amount of each of those two pensions in the event of my death. One is worth $4,500 a month at full benefit and would start when I retire, and the other is $1,450 a month but doesn’t start until I’m 67.
Instead of taking survivor’s benefits, we are considering taking out a $1 million life-insurance policy on me, with my wife as beneficiary, to replace the lost pensions if I were to pass away before her. The cost of that insurance is approximately $700 per month. I’m wondering about when to take Social Security, too.
Pension Quester
Dear Quester,
This is a basic math question that a lot of couples with pensions face, especially in cases when the primary earner is older.
The cautionary tale I have for you is one from my high school days. I had a teacher who faced this decision at retirement and chose the higher pension amount with no survivor benefit for his wife. Then he had a heart attack and died three months after he stopped teaching, leaving her with no income security.
He did not think through the step that you are contemplating, which is to add life insurance to replace the pension income. It’s smart to think of this as an either/or proposition. The lower-earning spouse, who often also has a longer life expectancy, needs protection from losing the income of the other spouse. Whatever you do, make sure you have one or the other. While you’re at it, think of Social Security the same way, because it also is like a pension benefit that has a survivor’s option for you.
The math comes in because the choice you make is simply the option that gives you the most bang for your buck.
“The question is, can they replace the survivorship option with insurance?” said Natalie Karp, an independent insurance broker from New York who deals with this situation often. When clients present this dilemma to her, she has an equation to help them work through the decision.
In your case, you’d first want to calculate the difference between the $5,950 of the two combined pensions and what your wife would get at 50% of the reduced pension amount with the survivorship option. That becomes your line in the sand, so to speak.
“Basically, if the cost of life insurance is greater than the difference, the analysis fails. She should keep the survivor options,” said Karp. If the cost of insurance is less than the difference, you’d want to go that route.
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But there’s a little more to it than that. You don’t want to just take out a $1 million life-insurance policy and not put that to work for you to replace the income you’ll be missing. That $1 million policy you priced out might not even be the right amount to replace the income gap you’re trying to fill.
Say the gap is $2,500 a month. Karp suggested that $1 million might be more than you’d need. “You might just need $500,000. That could buy you a 20-year term policy,” she said. You could also blend that with a guaranteed universal life policy to cover the possibility that the older spouse outlives the term, and even add a long-term-care insurance rider — “if you want to get a little fancy,” Karp said.
If the pensioner dies and the younger spouse gets the life-insurance payout, which is tax-free, Karp suggests putting it into a single-premium immediate annuity, or SPIA, which would set up an income stream for life at the amount the spouse would be expecting from the pension. That is the important final step that would replicate the pension survivor’s benefit.
“Boom, there’s your magic,” said Karp. “You want to leverage that $500,000 death benefit for an income stream.”
If that sounds like a lot of work, it is. If you’re on your own with this, it might be easier to just take the survivor benefit and know that it’s guaranteed. But if you can work with a professional you trust who has access to all the policy information and works frequently with these scenarios, you can make the math work in your favor.
Social Security, by the way, works in a similar way. A strategy that many couples use when the lower-earning spouse is younger is for that spouse to claim when they turn 62, while the older, higher-earning spouse waits to claim until they reach the maximum benefit age of 70. At that point, the younger spouse can claim a spousal benefit, if it’s greater than their own benefit. If the older spouse dies first, then the younger spouse would get that bigger benefit as their own, if they are both of full retirement age by then.
Whatever you do, think through all your options, taking into consideration all the variables at your disposal. The decision you make should be precise.
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