We make a lot of big decisions as we approach retirement, but perhaps there is none bigger than which pension option at FRS you should choose. In this video, I’m going to overview the options and bring up a couple of things that maybe you haven’t considered but should.
Whether you are single or married, everybody has the choice of at least Option 1 or Option 2. Option 1 is purely based on your life expectancy and yours alone. So, what that means is, it dies when you die. Even if that happens to be the day after you retire.
If that were to happen, Option 1 actually does pay out a refund of everything you’ve personally paid into the account less any distributions you’ve taken to whoever you’ve listed as your beneficiary. That payout amount your beneficiary would receive is that 3% of your paycheck that you’ve been contributing to the pension plan. Maybe you didn’t even realize you were contributing.
So, if over your whole career, you’ve put $75,000 in and are getting a pension check of $5,000 every month, for the first 15 months or so of your retirement there would be some residual and dwindling benefit payable to your beneficiary if you died.
So Option 1 is pretty simple. But the thing about it that gets a lot of attention is that it’s the option with the highest payout.
Option 2 is also available to single as well as married participants. Option 2 is based on one life expectancy as well, just like Option 1. But Option 2 offers just a little bit less because it gives you a guarantee that it will pay out at least 10 years from the date you start, even if you died before the 10 years is up.
It’s important you understand that the clock starts ticking on Option 2 as soon as benefits are released—even if it’s going to your DROP account, if you are participating in DROP. So, if you are in DROP and do a full 60-month DROP, then when you actually leave employment, there are only five years left on that 10-year guaranteed payout. We’ve seen more than one person who didn’t realize their clock started ticking as soon as they started the DROP.
If you are married, there are two more choices you have, in addition to Options 1 and 2. Option 3 is based on two life expectancies and pays the same monthly payout, with whatever applicable cost-of-living increases if available, as long as either of the two are still alive.
Now, it can’t be just any two people. That second annuitant has to be either a spouse or a natural or legally adopted child who either is under age 25 or is physically or mentally disabled and incapable of self-support, regardless of their age. It can also be any person who is financially dependent on you for one-half or more of their support and is your parent, grandparent, or a person for whom you are the legal guardian. Gets a little complicated!
Option 4 is very similar to Option 3, but the difference is that after the first person dies, the payout amount changes to two-thirds of the monthly benefit you were receiving when both were living. I’d point out, that in my opinion, that’s a pretty big haircut.
An important consideration to add here is that under both Options 3 and 4, if the FRS participant dies and the joint annuitant is under age 25, the amount they would receive is not the Option 3 amount but the higher Option 1 benefit—until they are 25. If the joint annuitant is disabled, they receive the higher Option 1 benefit for as long as they are disabled, possibly even the rest of their lives.
The last thing I want to mention is to be very wary of proposals from life insurance agents that urge you to pick Option 1 for its higher benefit amount and then buy a life insurance policy from them to pay off in case you die early. This is usually a sign of not very good planning and, more likely, someone trying to create a case to sell a commissionable life insurance policy.
If you get such a proposal and it’s seeming too good to be true, it probably is too good to be true. Give us a call and we’ll be glad to give it a second look for you. Remember, we don’t sell life insurance, so we’ve got no bias there. We also talk about this tactic in a couple of other videos.
We’ve seen a lot and talked to many pre-retired special risk FRS participants about which pension option is best—for them. Want to talk it over with someone that won’t try and sell you a financial product? Give us a call!
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