We are always looking for ways to add significant meaningful value to the financial lives of the people we serve, and I just learned about a planning opportunity that needs to be considered.
Please note that this opportunity is likely to change soon and may be lost completely. If you are preparing to retire from one of these three Washington State Retirement Systems please take a minute to read this and be sure to pass it on to anyone who you think this may help.
1) Public Employees (PERS)
2) Teachers (TRS)
3) School Employees (SERS)
You probably know at the time of your retirement you can name a beneficiary to your pension. Depending on the income option you select, your beneficiary would continue to receive all or a portion of your pension income after you die.
For most retirees retiring from one of these three systems, you have the option of electing a lower initial monthly pension in exchange for a pension that is tied to the consumer price index (CPI) for Seattle. Your election at the time of your retirement will determine if you will have static income or inflation adjusted income once payments begin.
What most people do not know, and what I was shocked to discover, is you could name your grandchild as beneficiary on your pension income.
Let me give you a quick hypothetical example of the power of this planning opportunity. Mrs. Jones is 77 years old and preparing to retire from the Teachers Retirement System (TRS). If she elects her maximum single life pension benefit with no survivor option, then she would have a guaranteed inflation adjusted retirement income of $3,999 per month.
If she were to name her husband, Mr. Jones, who is currently age 75, as her beneficiary at 100% of her retirement income, then she would take a 10.3% reduced initial benefit and would receive $3,587 per month. This income would be guaranteed on an inflation adjusted basis for the rest of both of their lifetimes.
The third and lesser known option which is simply unbelievable to me is that these retirement systems allow for her to name her six-year-old grandson as the 100% beneficiary in lieu of her husband. If she were to die, her grandson would continue to receive inflation adjusted income for the remainder of his lifetime. By naming her grandson as beneficiary, she would take a 16.3% reduction in her initial benefit and would only receive $3,347 per month to start instead of the higher $3,999 per month had she did not named a beneficiary. But now this income of $3,347 would be guaranteed for the remainder of both her and her grandson’s lifetimes.
In order to consider the planning possibilities, we need to make some four assumptions:
1) Mrs. Jones will live to age 90;
2) Her husband has a life expectancy of age 90;
3) Her grandson has a life expectancy of age 90;
4) They will elect the income that is adjusted for inflation and use a constant COLA/inflation factor on their income of 2.5% per year.
If Mrs. Jones just elects her maximum single life benefit over her lifetime, then she would receive approximately $792,712 of lifetime benefits.
If Mrs. Jones names Mr. Jones as her primary beneficiary, then the combined lifetime benefit would be approximately $834,202 of lifetime benefits.
If Mrs. Jones names her six- year-old grandson as the primary beneficiary over both her lifetime and his lifetime, then they would receive approximately $11,498,092 of lifetime benefits. (Yes, you read that correctly. That is more than 11 million dollars.)
For the couple who will not need to rely solely on their pension income for their retirement lifestyle, this could be a really interesting gifting strategy.
Obviously other considerations exist, and you should never make this type of a decision in a vacuum. You want to look at your entire retirement plan including the tax and and estate implications before you select the best strategy for you. You will also want to consider the tax implications for your grandson.
This initial election is irrevocable so it’s important that you get it right. Once you make your decision in most instances you will not be able to change it. If you have already retired from one of these Washington State retirement systems, you cannot go back and make any changes.
This type of planning is controversial, as it should be. When you choose to name your grandchild as your beneficiary, you are increasing the burden of the retirement system to pay income for a very long time. Your grandchild never paid a penny into the system, but would benefit from a lifetime of guaranteed income. I do not believe this is what the retirement system was designed for, but for now this is how the system is structured.
However, when I spoke with representatives at the Department of Retirement System’s, I was told in a recent meeting they discussed changing who you can name as beneficiary for 100% of your benefit, and they anticipated these changes would be made by July 2014.
If you found this article interesting you may also be interested in a recent post I wrote about the opportunity to purchase service credits. You can read that article by clicking here.
The reduction in pension benefits will be determined by several different factors and the percentages above may not be an accurate representation of your personalized pension benefits. The example above assumes Mrs. Jones does not withdraw her own contributions. Be sure to request an estimate from the department of retirement systems to better understand what this decision would look like for your specific situation.
I spoke with Gabby, Lee & Shayna at the DRS when researching this beneficiary election option. 1-800-547-6657.
This article was also featured in the February 2014 Kitsap Peninsula Business Journal.