One of the perks offered to federal government (FERS) employees is having access to a pension at retirement. With the pension comes an important decision on whether to select a survivor benefit option, and if so, what percentage? This decision helps determine what percentage will be paid to the surviving spouse over their lifetime.
Taking a step back, the FERS pension consists of employee and employer contributions. Most employees pay .8% of their basic annual pay, along with the government’s annual contribution of 10.7%. These percentages can vary based on governmental departments.
There are certain eligibility requirements that must be met that determine the gross pension paid at retirement. Generally, a FERS pension equates to 1% of your “high-3” years of income multiplied by years of service. Typically, the higher the years of service, the larger the monthly pension.
FERS Three Survivor Benefit Options
When it comes time to apply for FERS survivor benefits, there are three options:
No survivor benefit
Partial (25% joint and survivor)
Maximum (50% joint and survivor)
It’s important to note that the maximum survivor monthly annuity benefit is the default and only can be changed within 30 days of the first payment, which makes this decision even more vital.
If no survivor benefit is elected, not only will the pension cease at the retiree’s passing, but any subsidized FEHB benefits (health insurance) will also be terminated. This means that not only will the survivor’s income stream be terminated, but out-of-pocket health insurance premiums will likely increase.
The partial and maximum survivor benefit options are not “free” and come with a 5% or 10% reduction. If the survivor predeceases the retiree, it’s important to notify the Office of Personnel Management (OPM) to have the reduction stopped.
Ex: Jake qualifies for an unreduced pension of $4,000/m. He elects the maximum survivor benefit to provide for his spouse, Maggie, in the event he passes first. Jake collects $3,600/m ($4,000 - 10%), and upon his passing, Maggie collects a $2,000 per month annuity (she will receive 50 percent of $4,000).
In the example above, if Maggie predeceases Jake, he will notify OPM, and his benefit will be adjusted to $4,000/m for the remainder of his life.
One key feature with the FERS pension is the cost-of-living adjustment (COLA). This adjustment was put in place to help keep up with inflation. Depending on the change in the Consumer Price Index (CPI), the FERS pension will be adjusted annually. It also extends to the survivor benefits as well.
Inflation risk is often overlooked, and the long-term impact of inflation can be detrimental if not accounted for since overall purchasing power decreases as inflation increases.
“Pension Maximization”
Often, people will look into a strategy called “pension maximization”. This involves the retiree electing no survivor benefit to maximize the monthly payout and subsequently purchasing a life insurance policy with a portion of the savings. If the retiree dies first, the surviving spouse will receive a lump-sum, tax-free death benefit to use as they desire over time.
Ex: Jake elects a pension with no survivor benefit of $4,000/m vs. the 50% survivorship that would pay Jake $3,600/m ($4,000 - 10% reduction). Jake takes a portion of the $400/m savings and purchases a life insurance policy and names Maggie as beneficiary.
While the example above seems sound, it’s important to note that many factors come into play. Is the retiree insurable? If so, oftentimes, they need to be in better-than-average health to qualify for an affordable premium. Can the retiree continue to pay the premiums if they increase over time? If the surviving spouse outlives the retiree by 20 years, will the lump sum be enough? What impact will inflation have on the life insurance lump sum over time?
Also, and perhaps most important to note is the surviving spouse can ONLY continue utilizing the FEHB retiree medical benefits if a survivor benefit annuity option was elected. Otherwise, the coverage will terminate 31 days after the retiree’s death.
These are a few of the factors that must be considered when looking into the pension maximization strategy.
Survivor Benefits via court order
In some cases a former spouse may be eligible to receive a survivor benefit. For example, court ordered benefits can come into play via a divorce decree. In these special cases it is important for the former spouse to fully understand how their benefits will be treated.
Your Needs Are Unique
There are many elements that need to be taken into account prior to making a final decision about your FERS retirement options, such as income streams (e.g. other pensions and social security), assets, liabilities, and expenses, to name a few.
Our Bethesda, MD financial planning firm understands that everyone’s situation is unique in its own right. That’s why we suggest you work with a financial advisor who can help you create a financial plan that will assist you in making the best and most comfortable decision based on your financial goals and desires.
There is “no one size fits all” approach here, thus making it important to focus on your specific situation.
Discuss your situation with a fee-only financial advisor.
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