Using Guaranteed Universal Life Insurance to Maximize Your Pension

If your company offers a defined benefit pension, or you work in some other area with this type of benefit (such as for a state/local government or public school), when it comes time to retire you will have an important choice to make.

There are multiple ways to receive a pension benefit. You could choose to receive a benefit for as long as you live (single life option), for as long as you or your spouse lives (joint life option), or a benefit that pays a reduced amount (such as two-thirds or one-half) to the survivor after the first spouse passes.

For each of these options you can often specify a minimum period of time, known as a certain period, over which benefits will always be paid. So, an example would be a payment made to you and your spouse, but for no less than 20 years (if both of you pass away before then, in which case beneficiaries would receive the remaining payments). Typical time periods are 10 or 20 years.

Of course, the benefits you’ll receive are not the same under each option. A selection that pays only for your lifetime (single life option) will have the highest payout, while a joint life option with a long certain period will have the lowest payout. The obvious risk of choosing the single life option is that if you die before your spouse, he/she will be left with nothing.

But, what if there were a way to choose a single life option, but make sure that your spouse would be taken care of? That’s where guaranteed universal life insurance comes in.

In this article, we’ll cover:

  • How the Strategy Works
  • Advantages of the Strategy
  • Things to Be Aware of
  • Who Could Benefit

How the Strategy Works

The goal is to get the most out of your pension benefits, while ensuring that your spouse will still have an income when you pass away.

To achieve this goal, the single life option is selected to maximize the pension benefit and a life insurance policy is purchased on the life of the person receiving the pension. The single life option will have the highest payout, so a portion of the income will be used to pay for the life insurance premiums.

The goal is for the death benefit to be sufficient to generate an income equal to the joint and survivor option (had it been selected) for the surviving spouse, should the spouse receiving the pension benefit pass away first.

When the death benefit is paid to the surviving spouse, it can be taken as a settlement option, or probably more commonly, it can be used to purchase an immediate annuity.

The life insurance should be purchased prior to retirement to avoid the possibility of becoming unhealthy or paying a higher premium due to being older. Another possibility would be to convert an existing term insurance policy.

Advantages of the Strategy

Maximize Your Income:

You are able to receive the same amount of income as the joint and survivor option (perhaps more, depending on the life insurance premiums), but if the spouse who is not receiving the pension passes away first, then you have a couple options.

You can continue paying premiums so that an heir will receive the death benefit. Or, you could stop making premium payments and your income would go up (since there is no surviving spouse depending on the death benefit for income).

And depending on when the spouse dies, the policy might already be fully paid for (you don’t necessarily have to pay for your entire life).

Death Benefit for Spouse:

If the person receiving pension benefits passes away first, then there will be a death benefit, generally income tax free, for the surviving spouse. The benefit can be used to purchase an immediate annuity or some other vehicle.

But that is if the surviving spouse is in good health (otherwise you might not want to purchase an immediate annuity). If the surviving spouse is in poor health, he/she could use a different vehicle so that any heirs receive a larger benefit.

Inheritance for Heirs:

With a joint and survivor option, heirs do not receive any benefits (unless there is a certain period). With life insurance, they will. What if both spouses pass away at the same time in an accident, for example? Or, like in the example above, the surviving spouse is in poor health and can leave a portion of the death benefit to heirs.

The key ideas in this section are that this strategy can give you more options and flexibility than just selecting a pension benefit on its own.

Things to be Aware Of

Calculating the Amount of the Death Benefit:

You’ll need to figure out how much death benefit is needed to generate a sufficient income for the surviving spouse. The easiest way to do this is probably to look at immediate annuity rates.

The amount of death benefit needed will be highest in the earliest years and decrease over time. You will want to decrease the death benefit on the policy over time, on a regular basis, such as every few years.

The purpose of this is to minimize the cost of the life insurance. Eventually you might level out the death benefit in very old age, since it will be at a relatively low level, and the later death benefits have less of an impact on premiums anyway.

When you calculate the amount of the death benefit, try to be conservative. You don’t want to leave the surviving spouse with insufficient assets, especially if death occurs soon after retirement.

Immediate annuity rates change over time and are impacted by bond yields. So when the plan is being set up, be cognizant of the annuity rates in effect at the time. Are they higher or lower than usual?

A few resources (with calculators) for calculating income replacement are here and here.

Cost of Living Adjustments:

Many pensions have some sort of cost of living adjustment (COLA). In this case, the COLA will increase the amount of death benefit needed. But, since the pension income will be going up over time, it also means that there will be more funds available to pay premiums.

Other Spousal Benefits:

Some pension plans require that the joint and survivor option be selected in order for the spouse to receive medical or other related benefits. It is best to check with the administrator of the plan to find out if this is the case. If it is, it is very important to consider the value of these benefits before choosing an election that would remove them.

Lapse of Life Insurance Policy:

If a policy is not funded properly, it can lapse. This is why guaranteed universal life insurance is a suitable option for this strategy. If premiums are paid on time, the policy will not lapse. And since premiums are paid out of pension benefits, there should be no loss of income that would result in the inability to pay premiums.

Who Could Benefit

This strategy is an ideal fit for a married couple where one or both spouses has a defined benefit pension and would like to maximize their income and flexibility.

Since life insurance is involved, health will be a concern, unless a policy is purchased a sufficient amount of time prior to retirement or a term policy is converted.

If you have not purchased a life insurance policy and are in poor health, this strategy might not be a good fit. In that case though, consider electing a certain period if the option is available. Pension/annuity payouts assume that participants are healthy, so if you are not, you want to make sure you’ll get as many benefits for you and your heirs.

Since the payout rates assume healthy participants, a life with certain period option might not even have a huge reduction in payout compared to a straight life or joint and survivor without no certain period.

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