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Make your pension generate income beyond your death

There are ways to generate spousal income, inheritance

By Alan Klayman

Maturing Loans
Maturing Loans, Alan Klayman
Alan Klayman is CEO of Klayman Financial LLC. He served as a vice president at Fidelity Investments, worked as a financial planner for American Express, and built fixed income strategies on Wall Street at The First Boston Corporation. At CreditCards.com, he writes Maturing Loans, a weekly feature in which he answers readers' questions about retirement and debt issues.

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Question for the CreditCards.com expert

Dear Maturing Loans,
I have a situation that I was hoping you could help with. I am not very good with my credit cards. Every time I get extra money, I end up spending it or charging something. I have money in my 401(k), and money in some investments, plus I do part-time work and my wife does some part-time work. We both are getting Social Security, and now I can start receiving my pension. I don't want to get the pension because I am afraid I am going to spend it all on things I won't need and not have enough available for my wife. I know there are a number of options that can lower the payment, and help my wife out in the future? Can you help? -- Benn

Answer for the CreditCards.com expert

Dear Benn,
It sounds as if you are in a very good position, Benn, with your income meeting or exceeding your expenses. It is also commendable that you recognize that you have a spending problem and want to correct it. I think you are on the right track in looking at ways of taking your pension as a way to reduce your income, your spending and your debt. So let's get started.

First, make sure your income is exceeding your expenses, so you don't need to generate extra dollars off of your investments. Here is an online tool to help you make that comparison.

Next, make sure you pay down your debt by paying more than the minimum required payment each month.

Then, sign up for an automatic deduction plan that pulls money from your bank account into a savings or investment program. This will help guarantee that money coming in from any source is not spent on frivolous purchases

As far as your pension goes, you are correct in your assumption that there are many ways to calculate a pension. If you are single, then your pension will die with you. If you have joint or survivor pension, you get paid a reduced amount, which means the survivor (who could be anyone) gets a reduced payment. There are other options, but these are less relevant to the situation presented in your question.

You should look into pension maximization. If you are in good health, you are a candidate for this type of program. (We are taking some liberties with assumptions here, but this is for illustrative purposes only.) For example, here are two choices:

Choice 1-- You get a full pension of $5,000 a month, which after taxes comes to $4,000 a month, and when you die, your wife gets nothing.

Choice 2 -- You get a partial pension of $2,500 a month, which after taxes comes to $2,000 a month, and when you die, your wife gets the same.

At first glance, choice No. 2 would appear to be the more logical choice, but there is something else you need to figure in the equation. If your wife is 65 years old, and we assume she lives to age 100 (she could live longer or shorter), then for 35 years she will receive $2,500 before taxes a month in choice No. 2.

Next, you need to figure out how much money you need in order to generate $2,500 a month. With a little help from this bond rate calculator or some simple calculations, we can figure out that $500,000 at 6 percent gives us $30,000 a year, which equals $2,500 a month. And at the end of the 35 years, you still have the $500,000!

Let's take a look at an alternative to choice No. 2, which is taking choice No. 1 and buying permanent life insurance.

To do this, you need to figure out where you're going to get $500,000 to invest. That is where the pension of $5,000 a month in choice No. 1 comes in. Can you take $2,000 a month and buy $500,000 worth of life insurance on your life? If the answer is yes, then this is what happens:

Old Choice No. 1 -- You get a full pension of $5,000 a month, which after taxes comes to $4,000 a month, and when you die, your wife gets nothing.

New Choice No. 1 -- You get a full pension of $5,000 a month, which after taxes comes to $4,000 a month. You take $2,000 a month of that and use it as your pension. You take the other $2,000 a month and buy $500,000 worth of life insurance. At your death, your wife gets the $500,000 in a lump sum. If she can then invest that at a fixed rate of 6 percent, she will get $2,500 a month for the rest of her life. If she never uses any more of that $500,000, then her heirs get $500,000, which is an option that didn't exist under either choice before. If your wife dies before you, you continue to get your full pension of $5,000 a month and you get whatever cash value is in your life insurance.

Good luck and see you back here next week.

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Published: September 17, 2008


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