Editor’s Note: At the Ready exists to give a voice to responders everywhere. We believe that the information shared through At the Ready, by responders to other responders, benefits the entire responder community. We know too that information shared by others can be just as useful. In the case of this article series, the information shared will help the responder community be more prepared for the day when you turn in your badge and gun, or take-off and hang-up the turn-out gear for the last time. We asked Mark Burnam, State of Florida Financial Advisor/Director of Marketing and Client Services for “The Second Half Team” at C/F/R Financial LLC, to write about strategies you can take to ensure more peace-of-mind when that day comes.
When you retire, you begin your “second half of life” work because you want to not because you have to. Isn’t that what you want? In our June article, we talked about the 4 basic steps to securing a more sound retirement, particularly for those in their early years: saving more, spending less, opening and then maximizing their contributions to their 457 deferred compensation plan, and becoming debt-free (or close to it) once one retires. We also provided some specific steps and strategies to do so (http://bit.ly/AtTheReadyMagJune2014).
For those of you closer to retiring (T-minus 5-8 years), there are some choices you are or will be facing as you near “decision time”: Lump sum payouts vs. receiving a monthly pension check for life, DROP, payout options, beneficiary concerns, COLA’s (and lack thereof), healthcare insurance coverage and costs, withdrawal options, tax rules and penalties, sick and unused vacation time payouts, and more.
Today, we’ll address pension payout options and beneficiary concerns. In Florida, most First Responders, whether they are in a municipal pension plan or the Florida Retirement System (FRS), have a pension payout decision that is simultaneously an income and beneficiary payout decision. Non-Florida resident plan and most city plans have similar options as well.
The four option choices can be found here, but today we’ll address what we see are the two most common choices: Option 1 (max payout with no survivor payout), and Option 3 (reduced payout with 100% for surviving spouse). Everyone’s situation is different and there are many different aspects and nuances to making this decision: Single? Married? Happily married? Divorced? Kids? No kids? Spouse working? and so forth. For today’s discussion we are going to assume we are talking about “John and Lisa Smith”, a happily married couple in their 50’s with a couple of kids and a family in good health.
Do they choose Option 1 (max payout/no survivor benefits)? If they do, his monthly pension check will be $8,000 (for example), but if John predeceases Lisa on day 1 or day 2000 of retirement, the pension income ceases and she gets no future monthly pension from that point forward. Gulp!
Should they choose Option 3 (reduced payout/100% survivor)? If so, they will receive $7000/month(for example), but if John passes away Lisa would continue to receive the $7000 for her life.
Inherently, the issue is the $1000/month difference. John and Lisa have some manageable, but still life-cramping debt and are struggling with pre-retirement bills, lifestyle, and outflow; this makes that extra $1000 sorely needed and hence, their decision is a tough one. Take the extra $1000/month and potentially leave Lisa with $0 income, or take $1000 less and have the “stress” of less income, but have peace-of-mind of having providing for Lisa. This can be a tough decision for many approaching “decision time”.
If we all knew when “our day would come” the decision would be much easier, but we don’t. So one strategy some consider is taking Option 1 and buying a term life insurance policy (or series of policies) for $1million or $2million or so to provide for the surviving spouse. In John and Lisa’s case, the premise being the cost of the policy may be less than $1000 month i.e. $500/month. So they receive an extra $1000/month, pay $500/month for insurance, and net $500 more per month than Option 3 -- and still have Lisa provided for should John predecease her.
“Provided for,” and “sufficiently provided for” can be vastly different! $1 million sounds like a nice figure, but the key thing you really need to think about, which many do not, is the pension income replacement should you predecease your spouse. In John and Lisa’s case, had they chosen Option 3 Lisa would still get $7,000/month for life. That is $84,000/year. How much income would $1 million generate in today’s interest rate environment? Bank money markets and CD’s are paying little to nothing and even at 3%, for example, that would only be $30,000/year – a $54,000 shortfall. Two million at 3% is still only $60,000 – a $24,000 shortfall. You can do the math; e.g. $84,000 on $1million = 8.4% and so forth. Note: some of you have a COLA and we aren’t even factoring that into the equation. If we did, the difference could be even more significant!
In sum and from our experience, taking Option 1 and going the insurance route makes financial sense for less than 50% of the first responders we meet with. And, many factors will affect the “financial sense” of this decision including age, health, income needs, spouse’s assets, cost of insurance, monthly pension payout difference, COLA/no COLA, interest rates and how much income can be generated from the $1mllion or $2million, and more. It is still worth investigating well ahead of time so you are in a more educated position PRIOR to selecting your income payout option. Best case, if it makes sense, then it makes financial sense and you can max your pension and pocket more income. If not, then it doesn’t. End of story. At least you’ll have the peace-of-mind knowing you investigated it and you made the best and most educated financial decision for you and yours.
In our next article series we’ll address 1) Lump Sum payout vs Monthly Pension Income 2) DROP, and more. See you then. Stay safe!
The first half was for them – the second half should be for you so you can retire one day and truly be able to say “so long tension – hello pension!”
Mark Burnam, State of Florida Financial Advisor/Director of Marketing and Client Services for The Second Half Team at C/F/R Financial LLC -- an alliance of Cross, Fernandez, and Riley CPA LLP. Proactively guiding 1st responders and more at 66+ departments and agencies from Ocala to South Beach better plan and prepare for retirement and their “second half of life”. For more information or answers to some of your questions please email me at MBurnam@cfrcpa.com www.cfrcpa.com/SecondHalfTeam