The idea of insuring a pension seems a little counter-intuitive. Why and how would a person “insure” a source of income in retirement? It may surprise you to know that all pensions are inherently insured and setting your coverage up the right way could pay off BIG time in retirement.
The concept of an insured pension is pretty straightforward: “while I’m alive, I get a consistent income in retirement from a large asset I built while working. When I pass away, I want the remainder of that asset to go to loved ones.”
Where it gets complicated is with the plethora of options that come with pensions. In a Single-Life pension, with no guarantees, the pensioner will receive the largest possible monthly payout (let’s use $5,000/month as our example). When the pensioner dies, the payments stop and the pension provider keeps any unspent proceeds. It doesn’t matter if the pension was paid for one month or 40 years, there’s nothing left over to be bequeathed. This is a “self-insured” route where all risk of mortality is born by surviving family members, who receive nothing after the pensioner is gone.
Pension companies (and provincial legislators) recognize that pensions are a family asset and therefore mandate insured options be available, to continue providing income for loved ones beyond the pensioner’s lifetime. Most commonly, the pension may be in a form that provides 2/3 of the previous benefit to a surviving spouse. There is a cost to doing this option compared to a Single-Life variant. Our example may see the pension drop to $4,800/month for having this estate benefit; however, it comes with the knowledge that a surviving spouse receives $3,200/ month (66.67% of the initial amount) for their lifetime.
Another common option is a 100% survivor benefit where the payments are the same for both the pensioner and their surviving spouse. Given this is a higher estate benefit than the 2/3 option, we can expect a further reduced pension amount. For our example, perhaps $4,600/month for the lives of both spouses compared to $5,000/month on a Single-Life. As you can see, it can cost hundreds or even thousands of dollars a year in lost retirement income for these insurance options.
Additional options may include a 5 year, 10 year, or even longer guarantee window that the pension will be paid to a non-spouse beneficiary, commonly your children. In cases where the pensioner passes away very early on in retirement, a minimum number of pension payments will continue on to the beneficiary based on the guarantee window chosen. The longer the window, the higher the estate benefit, the lower your monthly pension will be.
Alternatively, Canadians with pensions can be proactive in insuring their assets while still in their working years. If you have a spouse, children, or both and want to leave them the largest amount of your pension possible, consider buying a permanent life insurance policy while you’re young. The premiums can be quite affordable, you can design the policy to no longer require payment by the time you retire, and having a large, tax-free estate benefit can empower you to select fewer expensive guarantees at retirement. It’s a win-win scenario wherein you can elect larger pension payments without the downside risk of leaving your family empty-handed.
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