Posted on Thursday, 9th February 2012 by

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A few months ago, while meeting with a federal employee couple, I came across a story that I think is worth repeating. I’ve changed the names and some of the details, but the overall theme of the story is true.

Mr. Jones was a good man and longtime CSRS government employee with many years of service. His wife was not a federal employee. Mr. and Mrs. Jones had a wonderful life together. One day, many years into Mr. Jones’ retirement, he fell ill and passed away. Mrs. Jones was greatly distraught and the last thing she wanted to do was worry about the bills coming in the mail. You see, up to her husband’s passing, all their benefits were being paid by his monthly pension and there were no worries. Now, however, she continues to get bills and can’t understand why.

Well, the reason why Mrs. Jones was getting bills in the mail was because someone had approached Mr. Jones years earlier and talked to him about Pension Maximization.

At the time, this may have seemed like a wonderful thing to do. However, Mrs. Jones is now in her 80’s and had long forgotten that she would only be receiving a small retirement benefit following the passing of her husband.

So, what is Pension Maximization and how does it work? Pension Maximization is giving your spouse a lesser benefit when the primary annuitant passes away. Under the CSRS system an annuitant may give their spouse between 0% to a 55% benefit. As a FERS employee, an annuitant may give their spouse either a 0%, 25%, or 50% benefit. To continue health benefits in the CSRS system you must give your spouse at least a 1% benefit and a 25% benefit under FERS. You then take the difference and purchase a life insurance policy to make up the difference in income in retirement.

Let’s do an example:

Bob is a FERS employee and is nearing retirement. His full gross annuity will be about $3,000 a month. He can give his spouse a survivor benefit of $0, $750, or $1,500. It costs Bob about $150 a month (5%) to give his spouse a $750 monthly benefit and $300 (10%) a month to give his spouse a $1,500 monthly benefit. The idea of pension maximization is to give Bob’s spouse a $750 benefit and take the $150 and buy a life insurance policy. Bob would then purchase a life insurance policy large enough to provide $750 of monthly income.

What Mr. Jones did in the story above was to give his wife a very small survivor benefit which was enough to keep health benefits at the time, but not enough to pay the premium. So, Mrs. Jones lost her health care coverage because she didn’t know she needed to pay any premiums. Another issue to consider is that Bob’s annuity increased most years due to COLAs and at the time of his death his wife would have received a much higher amount. The insurance coverage did not increase annually to keep up with the CPI and his annual COLA adjustments. Typically, due to COLA adjustments, an annuitants’ annual payment increases dramatically over a 20 year period. One retiree recently reported in one of the articles on this blog that his annuity increased 19% since he retired in 2005 not counting any compounding! Look under Updates in the referenced article under 2012 COLA.

I’m not saying I’m totally against Pension Maximization, but it’s not the first time I’ve heard a story like the one above. If a federal employee is planning to give a spouse anything other than the maximum benefit I would strongly encourage you to inform other family members. It’s important for family members to understand that when either Mom or Dad passes away bills might need to be paid.

In my experience I have found that it’s pretty difficult to purchase a permanent life insurance policy with the difference of premium saved through Pension Maximization. The one thing federal employees may not understand; according to OPM if your spouse predeceases you, there is paperwork to fill out and you “may” get your annuity reinstated in full.

Paul H Risser is an Investment Advisor Representative with and securities and investment and investment advisory services offered through Transamerica Financial Advisors, Inc. Member FINRA, SIPC, and Registered Investment Advisor.

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