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Figuring your spouse into a key annuity equation

When a recently retired pension actuary asks his colleagues a question about retirement income strategy, it pays to listen to their answers. After all, these people have spent their careers designing and operating employer-sponsored defined-benefit pension plans.

The actuary was wondering if he should elect a joint and survivor annuity for his spouse, given that he's eligible to receive a monthly income from a traditional pension plan. You might also face this choice if you're buying a lifetime payout annuity from an insurance company.

Actuaries are mathematicians with considerable expertise in finances and longevity. Learning about the choices pension actuaries make about their own retirement income strategies is like learning about the cars that skilled auto mechanics drive: You can gain interesting insights from the informed choices of experts. So let's take a look at some of the choices these actuaries were considering.

"Kevin" was analyzing the following situation:

  • He could purchase a single-life annuity that pays him $2,200 per month for the rest of his life. After his death, no further payments would be due, even if his wife survives him.
  • Or he could elect a 50 percent joint and survivor annuity that pays $2,000 per month for the rest of his life -- $200 less than the single life annuity. If he dies before his wife, she would receive 50 percent of that amount -- $1,000 per month -- for the rest of her life.

Kevin consulted some life expectancy tables and estimated that he has about 25 years left to live, while his wife might live for another 29 years. He figured that if he takes the 50 percent joint and survivor annuity, over the next 25 years, he'd receive $60,000 less in monthly payments compared to electing the single-life annuity ($60,000 is $200 per month for 25 years). Then his wife would receive $1,000 per month for four years, for a total of $48,000.

Kevin tentatively concluded that electing the joint and survivor annuity was a bad proposition because he would lose $60,000 over his lifetime, but his wife would only gain $48,000 after he passes away. His wife has also earned a pension from her employment, so each of them could elect a single-life annuity on their own benefit. This would ensure that each of them would have some lifetime income in addition to Social Security.

Kevin consulted several of his actuary colleagues -- "David, " "Chris," "Mark," "Jim," "Kal" and myself -- all of whom had started pensions within the last several years and faced a similar choice. The answers present a learning opportunity and show this question doesn't have a one-size-fits-all answer.

Here's their feedback:

Kal: "I agree with Kevin's analysis, and I elected the single-life annuity. My wife is pretty savvy when it comes to financial matters. She'll have other resources if I pass away before she does. We're drawing down our 401(k) balances conservatively so that she can rely on those savings for income."

David: "Actually, I elected the 100 percent joint and survivor annuity because I wanted to show my wife that I love her."

(Note: Kal's and David's pension plan also offers a 100 percent joint and survivor annuity that results in an even greater reduction in the initial monthly payment compared to the 50 percent joint and survivor annuity. But when the retiree dies, the spouse's monthly income isn't reduced).

Mark: "I'm single, so I didn't face that choice. But my brother had a similar choice, and a life insurance agent talked him into taking the single-life annuity and buying life insurance to protect his spouse. Now he regrets that choice. (Often these schemes are sold with a 20-year term insurance policy, so if the retiree dies after 20 years, the other spouse is left with nothing.)

Chris: "I'm also single, so I didn't face that choice, but I agree with Kal and would have elected the single-life annuity. The joint and survivor annuity can be considered as life insurance, where the 'premium' that you pay is the reduction in the amount of the monthly pension, and the 'death benefit' is the monthly income that's paid after the retiree dies. If the wife really has other resources she can tap after he dies, why buy the insurance?"

Jim: "I took the 100 percent joint and survivor annuity because my wife is much younger than I am and will most certainly outlive me. But I've already outlived my life expectancy given my family history. That doesn't bother me because I can sleep at night knowing that my wife will have an income stream after I pass away."

Me: "Life expectancies are just averages and can be deceiving -- there can be a great deviance between your life expectancy and when you actually die. A joint and survivor election is really insurance against the possibility that you might die soon and your wife will live a long time. While it's possible to calculate the odds with online longevity calculators, these odds are most likely greater than one out of five or one out of 10 and less than 50 percent. That is, it could happen, although there's a good chance it won't.

I made my election on other considerations in addition to a strict actuarial analysis. I wanted my wife to be secure after I pass away. She's competent with managing finances, but I don't know how sharp she'll be in her 80s and 90s.

The monthly annuity check will be deposited electronically, for the rest of her life, no matter how long she lives. It's very user-friendly for really old and frail people. So I elected the 100 percent joint and survivor annuity, even though the odds are pretty good that if we both die according to life expectancies, we would have lost money. I'm insuring against the not-so-likely event that she'll live a lot longer than I will.

Kevin and his wife ended up electing the 50 percent joint and survivor annuity on each of their pensions. This represents a middle ground between the two extremes discussed above -- the 100 percent joint and survivor annuity vs. the single-life annuity. As Kevin put it: "We're lucky to have these challenges. Many people are retiring these days without valuable pension benefits."

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