Expert: Allen - 11/24/2009

Question
QUESTION: Hello:

At my place of employment, I have a pension through the state.  There are some options that a person retiring can select upon his/her retirement. However, most of the options require a reduction in the benefit payment, that is, his retirement income, throughout his retirement and if a beneficiary is selected. I believe that the full benefit should be provided even when there is a beneficiary.

1. Is this reduction common in most pensions that have beneficiaries?  

2. What is the reasoning for this reduction?

I thank you for your reply and answers.

ANSWER: This reduction is almost universal.

There is a very simple rationale. On average, the same pension paid as long as either of two people lives is more valuable than a pension paid only as long as one person lives. If you've earned a pension worth $100,000, you shouldn't be able to elect an alternative worth $125,000. So what is known as a joint and survivor pension provides a lower monthly amount.

---------- FOLLOW-UP ----------

QUESTION: Hello Allen:

I want to thank you for your reply.

It seems like a win-win situation for the survivor and not for the person who earned the pension. The survivor will get more of the pension than the person who earned it.  Am I missing the point here? I am still somewhat confused. This situation does not seem logical to me.
It would make more sense to me to have the person who earned the pension receive the whole amount and then upon his/her death the survivor would receive a reduced amount from the pension.

I thank you for your efforts to eliminate my confusion.

Answer
I believe you may be misinterpreting the choices. A joint and survivor annuity pays a certain amount while the annuitant lives. When the annuitant dies, if the joint annuitant is still living, he or she receives a certain percentage of the amount paid to the annuitant.

The choices might be (for purposes of this example I'll assume the annuitant is male and the joint annuitant is his wife):

1. Life annuity - Pays $100 per month as long as the annuitant lives. Payments stop when he dies.

2. Joint and 100% survivor annuity - Pays $70 per month as long as the annuitant lives. When he dies, if his wife is still living, she receives $70 per month as long as she lives.

3. Joint and 50% survivor annuity - Pays $80 per month as long as the annuitant lives. When he dies, if his wife is still living, she receives $40 per month as long as she lives.

4. Joint and 75% survivor annuity - Pays $76 per month as long as the annuitant lives. When he dies, if his wife is still living, she receives $57 per month as long as she lives.

Based on average life expectancies, all the annuity streams have the same value.