What it means
When someone retires from a pension plan or cashes in an insurance benefit, they are often asked how they want to be paid. The life option is the simplest answer, paying a fixed amount each month for as long as the retiree lives.
When the retiree dies, payments end and nothing passes to a spouse or heirs. The plan can therefore offer a higher monthly amount than options that continue payments after death.
The alternative choices include joint and survivor options, where payments continue to a spouse at 100%, 75% or 50% of the original amount. There are also period-certain options, which guarantee payments for a set number of years even if the retiree dies early.
The choice is a trade-off between income now and protection for a partner. A healthy single person with no dependants may be well served by the life option, whereas a married retiree whose spouse depends on the income may prefer a joint and survivor option despite the lower payment.
An important nuance is that the decision is often irreversible. Once payments start and the election is made, it usually cannot be changed, so it is worth checking life expectancy, health, other income sources and the needs of any dependants before signing.
Many plans require the spouse's written consent if the retiree wants to pick the life option. This is designed to prevent a spouse from being left with nothing by surprise.
In practice
Real-world examples.
Example
A 65-year-old single teacher with no dependants retires and chooses the life option. Her pension is $2,600 a month, higher than any survivor alternative. She plans to spend it all during her own lifetime. She also notes that if she needs more flexibility, she can use her savings for large expenses.
Example
A married factory supervisor is offered $3,000 a month under the life option or $2,650 with a 100% survivor benefit. He picks the survivor option because his wife has no pension of her own. The $350 monthly reduction is the cost of protecting her income.
Example
A pension administrator reviews elections for a group of retirees and finds that the retirees choosing the life option were mostly unmarried. She uses the data to adjust the administrative guidance so that spousal consent forms are prepared in advance. This shortens processing time and reduces errors.
Formula
Calculation
Cost of survivor protection per year = (Life option payment - Joint and survivor payment) x 12
Suppose a pension offers $2,400 a month under the life option and $2,200 a month under a 100% joint and survivor option. The monthly difference is 2,400 - 2,200 = $200, so the yearly cost of protection is 200 x 12 = $2,400. Over 20 years of retirement that is 2,400 x 20 = $48,000 of income given up, in exchange for the promise that the spouse keeps receiving $2,200 a month after the retiree dies. Whether that cost is worth paying depends on the spouse's own income and health, and on how likely it is that the retiree dies first. A spouse with a large pension of their own may not need the protection, while a spouse with none usually does.Case study
Seen in the real world.
Kestrel Industries is an illustrative, fictional manufacturer with a pension plan. A fictional employee, Hamid, retires and elects the life option because it pays $2,800 a month rather than $2,450 with a joint and survivor feature. He believes his wife will be fine because they have savings.
Hamid dies four years later, and the pension stops. His wife keeps the savings, but her household income falls by $2,800 a month and she has to sell their holiday home. The story is invented, but it shows why the election should be made with the whole household in mind.
Kestrel's benefits team later changed its retirement packs so that every retiree sees the monthly figures for each option side by side, together with a plain statement of what happens to the household income after a death. Requests to change elections after payments begin fell sharply the following year.
Watch out
Common mistakes.
- Choosing the highest payment without considering a spouse. The life option stops at death, so a dependant may lose the income. A couple should compare both options side by side before signing.
- Assuming the election can be changed later. Most plans treat it as final once payments begin.
- Ignoring the spouse's consent rules. Many plans require written spousal consent for the life option.
Questions
People also ask.
Who should consider the life option?
People with no dependants, or whose partner has sufficient income of their own, often find it suitable. They should still check whether any other household income would cover the gap after death.
Is the life option the same as a straight life annuity?
Generally yes, both pay for the life of one person and stop at death, though plan names vary. The label in the plan documents is what counts, so read the wording carefully.
Does the life option ever pay out after death?
Not in its basic form, although some plans add a guaranteed minimum period as a separate option.
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