If you’ve ever said, “I do,” it’s more than likely your spouse is the named beneficiary to begin receiving your pension benefits upon your death.
On the flip side, single and divorced federal employees have different decisions to make about wealth distribution when they die.
Why naming your beneficiary isn’t always a simple thing.
Whether married, divorced, or single, you should be informed about the facts – it’s the best way to make smart decisions for you, your family, and your financial legacy.
What if I’m not married, but I have kids?
If you aren’t married and have a child, you do have the option to name them as your beneficiary (if you have more than one child, you’ll have a tougher decision to make), or another close relative or someone you are financially responsible for.
As you might expect, however, beneficiary eligibility depends on a variety of factors, including your age and the age of your intended beneficiary.
On the surface, leaving your FERS pension to your family may seem like a logical decision, but as we dig deeper into the details below, you’ll see how the cost can outweigh the benefits, not to mention the hoops to jump through and the rules that apply.
Who can I leave my pension to?
You are allowed to leave a portion of your pension to someone other than your spouse, though they must qualify as an insurable interest.
An insurable interest is defined as someone who is related to you, who is closer than a first cousin, and who has a reasonable expectation of financial gain/interest from your continued life.
Examples include someone you financially contribute to for their livelihood or someone you share property with or have joint interest in. Additionally, your named insurable interest must be someone who will be put into a poor financial position when you die.
Who automatically qualifies as an insurable interest?
A “new” spouse after divorce qualifies as an insurable interest. Assuming your ex-spouse was awarded the full survivor benefit by way of the divorce decree, your current spouse could presumably be added as an insurable interest.
Former spouses qualify as an insurable interest, as do blood and adopted relatives who are closer to you than first cousins.
Examples include a sibling, parent, niece, nephew, or one of your children. Someone you are engaged to be married to can also be an insurable interest.
You’ll notice that we indicated you could name one of your children as an insurable interest. It is important to note that only one person can be named as an insurable interest. Even if you have multiple children, only one of them will qualify.
What survivor benefit will my insurable interest receive?
The only allowable benefit to an insurable interest is 55% of either the CSRS or FERS pension, after it has been decreased by the cost of the benefit.
This may sound confusing because the spousal survivor benefit is 50% of your pension, and the insurable interest benefit is 55%. The insurable interest benefit sounds like a better deal, doesn’t it? Not so fast.
You have to keep in mind that the percentage of the pension is reduced by the cost of the benefit. There are different variables that inform the costs, and all of them are incredibly high.
The cost of leaving your FERS pension to a non-spouse
The cost depends on the age difference between you, the retiree, and the person you name as your insurable interest.
Age variables impacting cost:
- If the person you name is older than you, the same age as you, or less than five years younger than you, the cost is 10% of your pension benefit. In this scenario, the cost is the same as the survivor benefit, although the benefit amount your beneficiary would receive would not be the same.
- If you name someone who is 10 to 14 years younger than you, the cost increases from the standard 10% to 20% of your pension benefit (yes, doubled the amount!).
- If the person you name is a child who is 30 or more years younger than you, you will pay a 40% premium during your living years to have this benefit in place after you die.
As you’ll see in the example below, the cost of this program makes it less desirable to most people, and it should be carefully considered.
Example of a FERS employee retiring with a $30,000 pension
These three examples illustrate the cost of the benefit depending on the age of the person you intend to name. Naming a person the same age as you would cost $3,000/yr. The cost doubles to $6,000/yr when the person named is 10 years younger. The cost will double again, to $12,00/yr, if the person is 30 years younger than you are.
If you intend to leave your pension to your child, who is 30 years younger than you, they will receive $9,900 per year, but the cost to you is $12,000 per year while you’re living in retirement. It’s a gamble as to whether the math will work in your favor.
Giving up an incredibly high percentage of your pension while you’re living may be a deal-breaker for you, as it is for the large majority of people.
Other important factors to note:
- The insurable interest option requires insurability, which will require you to go through a full underwriting process (similar to life insurance underwriting) to demonstrate that you are healthy enough to qualify for the program. You don’t have to be in perfect health. However, the requirements may be difficult for people, even those in generally good health, to achieve.
- The program provides less than the normal spousal survivor benefit. No matter how old the insurable interest beneficiary is, they will get far less than they would have received as a spousal benefit.
- Providing the benefit to someone considerably younger is unaffordable in the grand scheme. Consider it this way: You will eventually give up a huge portion of your pension to essentially provide a benefit that may or may not be paid for an extensive period of time.
Passing on your financial legacy to your child or a loved one is more than just a kind gesture. It can make a tremendous difference in their livelihoods and even help create generational wealth for years to come.
But when you understand the inner workings of this program and know the cost, it’s easy to conclude that there are far better options to consider.
If you have a child or loved one you want to help set up for financial success, we encourage you to partner with a financial advisor who will help you create a smart plan that allows your money to work for you rather than being used to pay for overinflated premiums.
If you’re ready to get serious about planning for your retirement from federal service, register to attend a workshop today!
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