Three key decisions about retirement benefits can help couples make their money last -- or dramatically increase the chances the survivor will end up old and broke. Widowed women are twice as likely as their male counterparts to live in poverty during retirement, according to a March study by the National Institute on Retirement Security. But anyone who outlives a mate can be vulnerable to a big drop in income and lifestyle because of shortsighted decisions about claiming benefits.
"Most people don't quite get the math," says Delia Fernandez, a certified financial planner in Los Alamitos, California, who primarily advises middle-class clients. "They're so focused on getting the highest payment now."
Fernandez remembers one husband who wanted to take early retirement and the maximum possible pension, not realizing that if he died first, his wife's income would fall by 75 percent.
"It's all about, 'I'm getting out of this job and getting the most money because I've got things to do,'" Fernandez says. People don't realize their spouses may have to live for years, or even decades, on truncated incomes.
How to take retirement benefits
You may be offered a choice between taking a lump-sum distribution from your retirement plan or accepting a series of monthly checks. Theoretically it's possible to earn more over time by investing the lump sum, but a bad market or a too-rapid withdrawal rate can undermine your returns. By contrast, the monthly checks could be guaranteed income that can last for both your lifetimes.
Couples should try to make sure that at least their basic expenses in retirement are covered by sources of income that are guaranteed, which can include Social Security, pension payouts and annuities, says Gary Koenig, vice president of financial security for AARP's Public Policy Institute.
All 401(k) plans give savers a lump-sum payout option, and many offer the choice of taking a monthly check but the amount you get may vary depending on how your investments perform. If you want guaranteed income, you typically would have to roll your money into an IRA, then use some or all of the money to buy an immediate fixed annuity from an insurance company to create a steady income stream.
Those with traditional pensions typically are offered guaranteed monthly checks as the default option, but some pension plans may offer a lump sum. If an adviser suggests you take the lump sum and then buy an annuity, ask how that's better than just getting the checks from the original retirement plan, says Jim Ludwick, a certified financial planner with MainStreet Financial Planning in Odenton, Maryland. "In 10 years of analyzing annuities, I've never seen one that was better" than what a pension plan offered its participants directly, he says. "The company payout is always more generous because it doesn't have to make a profit."
Which payout option to choose
If you do opt for monthly checks from a pension fund, you need to decide how big your checks will be and how long they will last.
Let's say your pension plan would give you $3,000 a month if you opted for the single-life payout -- but that payment ends when you die. A joint-and-survivor payout that drops by half after your death might start at $2,873, assuming you and your spouse are roughly the same age.
If you want the checks to stay level after you die, your initial monthly payments might shrink to $2,754. Fernandez suggests clients choose this option unless there's a compelling reason to reduce it, such as a spouse who "has a whole bunch of money or a pension of her own and she doesn't need the survivor option, thank you very much."
Also, be wary of insurance schemes that suggest you opt for a single-life payout from a pension and use a part of that larger check to buy life insurance instead. This so-called pension maximization may be a plan only an insurance agent could love, so run it past a fee-only financial planner -- one who doesn't earn commissions on insurance sales -- for an objective second opinion before you proceed.
When to claim Social Security
The higher earner typically should delay starting Social Security as long as possible, because that's the benefit the survivor will get, Koenig says. (The survivor's benefit is the larger of the two the couple receives.) Delaying is particularly important if one spouse didn't work or didn't earn enough to get a significant benefit, since the spousal benefit is based on what the higher earner gets.
Here's an example to illustrate the difference. Say the higher earner would get a $2,000 monthly check at 66, the current full-retirement age. That would entitle the lower earner to a spousal benefit of $1,000 at his or her full retirement age.
If, instead, the couple applies when they first become eligible for benefits at 62, the higher earner's check falls to $1,500 and the lower earner's to $700. So instead of $3,000 they would get $2,200. When one dies, the other gets a survivor benefit of just $1,500, versus the $2,000 that spouse would have received had the couple waited until the higher earner turned 66.
Those who wait beyond full retirement age can increase their benefits by an additional 8 percent a year until their checks max out at age 70. Conversely, an early start locks in a permanently reduced check.
With all three decisions, couples should talk about the various "what if" scenarios, including what would happen to the household's income and savings if either partner lives longer or dies sooner than expected, says Mark Struthers, a certified financial planner and certified financial analyst with Sona Financial in Minneapolis.
Struthers cautions against obsessing too much about which payout option would result in the most money, because those calculations assume we can predict what lies ahead.
"The break-even point is not really relevant," Struthers says. "The question is, is your wife going to end up eating cat food because her income dropped 75 percent?"