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Pension survivor option or life insurance: how to compare the choice
Weighing a bigger single-life pension plus a policy against a joint-and-survivor payout, with an invented couple's arithmetic and the key checks.
Say Pat is retiring at 62 and the pension office sends a form with three boxes: a single-life payment, a smaller joint payment that continues at half to a spouse, and a smaller one still that continues at the full amount. Pat's spouse Lee is 60. A friend has told Pat to take the biggest check and cover Lee with life insurance. That plan can work, and it can also leave Lee with nothing. The difference depends on a handful of facts you can check before you sign.
This post compares the two routes: take a smaller pension that protects the survivor, or take the larger single-life pension and buy a policy. It uses an invented couple and round numbers. Nothing here is a quote or a prediction, and a pension election is a decision to review with the plan administrator and, for the money questions, a fee-only planner.
What the survivor option actually does
A pension can be paid in different forms. A single-life pension pays the retiree until death and then stops. A joint and survivor annuity pays the retiree during life and then continues a stated share to the surviving spouse, commonly half, two-thirds, three-quarters or all of the original amount. Because the plan expects to pay for two lifetimes instead of one, the starting payment is lower, and it is lower still the larger the survivor share.
Private-sector pension plans covered by ERISA are generally required to offer married participants a joint-and-survivor form, and choosing a single-life payment instead usually requires the spouse's written consent, witnessed by a notary or plan representative. Plans for public employees follow their own rules, and so do some church and government plans. Ask the plan for its election form and its rules before you assume anything.
The pension-maximization idea is simple. Take the single-life payment, which is the largest. Use some of the extra monthly income to pay premiums on a life insurance policy on the retiree. If the retiree dies first, the spouse receives the death benefit in place of the lost pension. If the spouse dies first, the retiree has the full pension and the policy can be dropped.
It is a real strategy and sometimes a good one. It is also a trade of a guarantee for a bet, so it deserves arithmetic.
An invented couple, in numbers
All figures below are illustrations.
Pat's pension offers three forms:
| Form | Monthly payment to Pat | Monthly payment to Lee after Pat dies |
|---|---|---|
| Single life | $3,000 | $0 |
| Joint and 50 percent survivor | $2,700 | $1,350 |
| Joint and 100 percent survivor | $2,500 | $2,500 |
The cost of the 100 percent option, compared with single life, is $500 a month while Pat is alive ($3,000 - $2,500), or $6,000 a year. The cost of the 50 percent option is $300 a month ($3,000 - $2,700).
What a replacement policy has to do. Under the 100 percent option, Lee receives $2,500 a month for life after Pat dies. To match that with a policy, the death benefit must produce the same income. Say Lee, 60, is expected to need it for 25 years, to age 85. That is $2,500 x 12 = $30,000 a year, or $750,000 over 25 years if the money earned nothing.
If the policy's proceeds earned an illustrative 4 percent a year and Lee drew $30,000 at the end of each year for 25 years, the amount needed on day one would be about $469,000. That figure comes from the standard present-value formula for a level payment:
- $30,000 x (1 - 1.04^-25) / 0.04
- 1.04^25 is about 2.6658, so 1.04^-25 is about 0.3751
- $30,000 x (1 - 0.3751) / 0.04 = $30,000 x 15.62 = about $468,700
So to replace the 100 percent option, the policy would need to be somewhere between about $469,000 (with the 4 percent illustration) and $750,000 (with no earnings), and more if Lee lives past 85. The result moves with the assumption. If you change 4 percent to 2 percent, the answer rises; if you change it to 6 percent, it falls. This is the first thing to check about the strategy: the amount of insurance needed is large.
What it costs. Say Pat gets a quote for a $500,000 permanent policy, one that does not expire, at an illustrative $420 a month. The extra pension income from taking single life instead of the 100 percent option is $500 a month, so the premium is covered with $80 a month to spare ($500 - $420). On paper, that works.
But three other things are true.
- The $80 spare is a budget cushion, not a return. If the premium on a guaranteed policy rises or the policy is a type whose cost can change, the cushion shrinks.
- If Lee dies first, Pat has paid $420 a month for nothing, unless Pat chooses to keep the policy for its own sake. The pension is larger, but the premium paid in the meantime has to be counted.
- The policy's price came from Pat's health at 62. If Pat's health had been worse, the premium would be higher, or the policy would not be offered.
Side by side
| Single life plus a policy | Joint and 50 percent | Joint and 100 percent | |
|---|---|---|---|
| Pension while both live | Highest ($3,000) | $2,700 | $2,500 |
| Cost of protecting Lee | Premium on a policy | $300 a month of lost pension | $500 a month of lost pension |
| What Lee receives if Pat dies first | A lump-sum death benefit, which Lee must invest or spend | $1,350 a month for life | $2,500 a month for life |
| Needs Pat to be insurable | Yes | No | No |
| Guarantee | Only as good as the policy staying in force | Guaranteed by the pension plan | Guaranteed by the pension plan |
| If Lee dies first | Pat keeps $3,000 and can drop the policy | Pat's pension stays $2,700 | Pat's pension stays $2,500 |
| Tax treatment | Pension payments are generally taxable income; a death benefit paid to a named beneficiary is generally income-tax-free | Pension payments, taxable | Pension payments, taxable |
| Survivor's longevity risk | Lee bears it, because a lump sum can run out | The plan bears it | The plan bears it |
| Reversible after payments start | Policy can be dropped; pension election usually cannot be changed | Usually final | Usually final |
The last row matters. Pension elections are generally irrevocable once payments begin, though there are exceptions, such as when a spouse dies or there is a divorce, and some plans have their own rules. Ask the administrator what the plan allows.
The checks that decide it
1. Can Pat get the policy at all?
This is the gating question. A policy requires evidence of insurability, which means the insurer will review health history, perhaps an exam, and prescription and medical records. If Pat has a serious condition, the policy may be expensive, rated, limited or declined. The joint-and-survivor choice has no such test. This is why the strategy often looks best on a spreadsheet and worst in an underwriting department. Apply for the policy and get an offer before you make the pension election, because you cannot go back to the plan.
Do not sign the pension form on the strength of a quote. A quote is an estimate; an offer is from the insurer after underwriting. See life insurance at 70: options and costs and term life insurance at 60 and beyond for how age and health affect what is available.
2. What type of policy, and for how long?
A pension survivor benefit lasts for Lee's lifetime. A policy has to last as long as Pat might die while Lee needs it, which could be to age 90 or later. A term policy that ends at 75 or 80 leaves a gap. A permanent policy with a guarantee, such as guaranteed universal life: permanent coverage without the cash, can last for life, at a higher cost. A policy whose cost can rise, or one that depends on interest credits, needs yearly review; see why universal life policies lapse, and how to prevent it.
Pat should ask: if I buy a policy that ends at 80 and I live to 86, what has the plan cost, and what did Lee get? The answer might be "nothing," and that is the strategy's biggest risk.
3. What does Pat's pension do after the first check?
Some pensions have cost-of-living increases. Some survivor benefits carry the increases; some do not. A survivor who receives a fixed lump sum has no increase unless the money is invested to produce one. Compare what each path does to the buying power of Lee's income over 25 years, not only in the first year.
4. What else does Lee have?
Lee's own pension, savings, work history and Social Security change the picture. A surviving spouse may be able to claim the higher of the two Social Security benefits, so the loss of the smaller one is the real change; see Social Security survivor benefits and the $255 death payment. If Lee has substantial income and assets of their own, the survivor pension is less important, and the strategy that gives Pat the highest income may be right. If Lee has little, the guarantee is worth more. A How much life insurance do I need? or a planner can show what Lee needs; the broader retirement view is in life insurance in retirement: keep, cut or cash out.
5. How long do you expect to live?
Nobody knows. The plan's pricing assumes average life expectancy for people of your age; your health and family history may put you above or below. Pat's health matters twice: it affects whether the policy is available and how likely Pat is to die before Lee. If Pat is in poor health and insurable on standard terms, the policy might pay out soon. If Pat is in poor health and not insurable, the survivor option is the only way to protect Lee.
6. Is the pension itself safe?
A pension is a promise from an employer or a government plan. Many private plans are insured up to limits by a federal agency, and public plans depend on the funding of the state or city. A joint-and-survivor pension is only as good as the plan paying it. A life insurance death benefit is only as good as the insurer, which has a state guaranty association backstop; see state life and health guaranty associations. Neither is risk-free, and the risks are different.
Who each route suits
Single life plus a policy tends to suit a retiree who is clearly insurable on good terms, whose spouse has substantial income and assets, whose spouse is in poorer health, or who simply wants the larger check and is willing to manage the policy. It can also suit a couple that wants some of the money to pass to children as well as to the spouse, because a death benefit can be split and a pension survivor payment cannot.
Joint and survivor tends to suit a retiree who is uninsurable or would pay a high price, whose spouse depends on the pension, whose spouse is younger or in good health, or who values the simplicity of a guarantee that requires no further decisions. It is also easier on a surviving spouse who is not comfortable managing a lump sum.
A middle route is the 50 percent option, sometimes paired with a smaller policy to fill part of the gap. In Pat's example, the 50 percent option leaves Lee with $1,350 a month and costs $300 a month. A policy sized to replace the missing $1,150 a month ($2,500 - $1,350) would be smaller than one sized to replace $2,500. That is one way to share the risk between the plan and the policy.
Mistakes to avoid
- Signing the pension form before the policy is issued. The election cannot be undone, but a policy offer can be turned down.
- Buying a term policy that ends before the need does.
- Comparing the first month only. The strategy's cost is the premiums over decades, and its benefit comes only if Pat dies first.
- Leaving out the spouse's consent. Where federal rules require it, a form without consent may be invalid, and a plan will reject it.
- Forgetting the beneficiary form. The death benefit goes to whoever is named. See how to choose a life insurance beneficiary if you are unsure how to set it up.
- Dropping the policy later without a plan. If premiums become hard to pay, Lee loses the protection that was the reason for the election.
Questions to put to the plan administrator and the insurer
For the pension plan:
- What are the exact monthly amounts for each form, at my age and my spouse's age?
- Is the election final once payments begin? Under what circumstances can it change?
- Does a survivor benefit receive cost-of-living increases?
- What happens if my spouse dies before I do? Does my pension go back up under any form?
- Is the plan insured, and how is it funded?
For the insurer or agent:
- What is the offer, not the quote, after underwriting?
- What are the guaranteed premiums, and are any of them able to change?
- Until what age does the policy last, and what happens after?
- What is the conversion or continuation option if it is a term policy?
For the comparison in a wider context, see pension lump sum or monthly annuity at retirement: a decision framework, which covers the related choice between taking a lump sum and taking monthly payments.
Key takeaways
- The survivor option costs a stated amount of monthly pension; compare that to the premium on a policy that would have to replace the same lifetime income, which in the example needed a death benefit of roughly $469,000 to $750,000.
- The strategy depends on Pat being insurable on good terms, so get an actual offer before electing, because the pension election is usually final.
- A policy must last as long as the survivor needs the money; a term policy that ends early reintroduces the risk the survivor option was meant to remove.
- A joint-and-survivor pension is guaranteed by the plan, while a lump-sum death benefit leaves the investing and longevity risk with the survivor.
- Neither choice is right for everyone; weigh health, the spouse's own income, taxes and the pension plan's strength, and bring the final numbers to a fee-only planner.