Pension, Social Security, and a Child Who Will Always Need Support
Ken, 63, retires in six months; Nora, 60, has a teacher pension of 12,000 a year with no cost-of-living adjustment and a Social Security benefit of 22,000 at her full retirement age. Ken's defined-benefit pension offers 62,000 a year for life, 54,000 with a 50% survivor benefit, or a lump sum of 780,000; the plan is covered by the federal guarantee programme. His own Social Security at 67 is 30,000. Assets are a 401(k) of 620,000, a traditional IRA of 150,000, a Roth IRA of 90,000, a taxable account of 210,000, and a mortgage-free home worth 480,000. Spending is 58,000 a year after tax, including health cover until Medicare at 65. Both are healthy, with parents who lived past 90. They have two adult children: one is financially independent; the other, 28, has Down syndrome, receives means-tested benefits, and needs lifelong support.
1. Analyse the pension decision: annuity versus lump sum. Show the numbers and state a recommendation with the conditions attached to it.
Read the worked answer
Payout maths: 62,000 / 780,000 = 7.95% single life; 54,000 / 780,000 = 6.92% joint and 50% survivor. For a joint life expectancy of about 30 years, 54,000 a year on a 780,000 lump sum implies an internal return of roughly 5.5-5.6% - competitive with a balanced portfolio's expected return, and guaranteed.
What the annuity solves: the income floor. 54,000 plus Nora's 12,000 pension = 66,000 a year, which already exceeds 58,000 of spending before either Social Security benefit begins. The annuity therefore covers the essential budget without market risk, and the remaining 1,070,000 of investable assets can be managed for growth, long-term care and the children.
What it costs: no liquidity, no residual to the children, no inflation protection (at 2.5% inflation, 54,000 has the purchasing power of about 33,000 in 20 years), and the federal guarantee covers only a limited present value - check the state guarantee limit against the plan's funded status.
Recommendation: take the joint and 50% survivor option if the plan is adequately funded; take the lump sum if the funding ratio is weak, if the guarantee limit is a concern, or if a 100% survivor option is needed. Critical detail: on Ken's death the survivor income falls to 27,000 plus 12,000 = 39,000, a real drop for Nora, who is younger and likely to outlive him; the answer is either a 100% joint option if available, or term life on Ken to bridge the gap, or ring-fencing assets for her.
2. Recommend a Social Security claiming strategy and identify the Roth conversion window, including the competing thresholds.
Read the worked answer
Social Security: Ken should claim at 70, giving 30,000 x 1.24 = 37,200, not at 67 and certainly not at 62 when the reduction is 30%. Break-even against claiming at 67 is 90,000 of forgone benefits divided by 7,200 extra a year = about 12.5 years, age 82.5 - well inside a family history of living past 90. Delaying also maximises Nora's survivor benefit: on his death she steps up to 37,200 rather than 30,000, which is the cheapest longevity and widowhood insurance available. Nora should claim at her full retirement age of 67 for 22,000; her teacher pension may reduce or eliminate a spousal benefit, so check the windfall-elimination and government-pension-offset rules.
The bridge from 63 to 70 is funded from the taxable account and the pension, which is exactly what that 210,000 is for.
Roth conversion window: between 63 and 75 there is a low-income gap before Social Security and required minimum distributions. Two thresholds compete:
- 63-64: ACA premium tax credits. Conversions raise modified adjusted gross income and can add roughly 8.5 cents of lost subsidy per dollar while the enhanced rules apply, making large conversions costly.
- 65 onward: IRMAA. Medicare premiums are set from income two years earlier, so a conversion at 63 sets the 65 premium. Keep each year's conversion below the relevant IRMAA tier or accept the surcharge knowingly.
Plan: modest conversions at 63-64, larger conversions from 65 to 70 up to the top of the 22% or 24% bracket, then reassess. With 770,000 of tax-deferred assets growing at 5%, the first RMD at age 75 could be around 56,000, pushing total taxable income near 160,000 - so converting now at 22-24% is cheaper than distributing later. Fill brackets deliberately, check IRMAA each autumn, and use qualified charitable distributions from age 70½.
3. Design the estate and beneficiary plan, with particular attention to the child with a disability.
Read the worked answer
First principle: never leave assets outright to the child receiving means-tested benefits. An outright inheritance would count as a resource and could disqualify her from support. A properly drafted special needs trust - either a third-party trust funded at the second death, or a first-party trust funded from her own assets if needed - preserves eligibility while supplementing her life. Fund it with life insurance on Ken and Nora in an irrevocable life insurance trust so the proceeds are outside both estates, and name the trust, not the child, as beneficiary.
Beneficiary designations must match the plan. The 401(k), traditional IRA and Roth currently pass by designation, not by will; every form must be reviewed and the trust named where appropriate. Under the SECURE Act a trust for a chronically ill or disabled beneficiary can qualify as an eligible designated beneficiary and use a life expectancy distribution period rather than the 10-year rule - but only if the trust is drafted as a see-through trust with the required language. Confirm this with the drafting lawyer; it is worth substantial tax.
Asset location: leave the Roth to the trust - tax-free growth inside a trust taxed at compressed rates is the most valuable asset to shelter - and leave tax-deferred accounts where the stretch is longest. Keep the taxable account for the step-up in basis at death rather than gifting appreciated shares during life.
Also: elect portability of Ken's unused estate tax exclusion at the first death; check state estate tax exposure, which may apply at a much lower threshold than the federal one; equalise fairly rather than equally, since the independent child can receive outright what the other receives in trust; and fund an ABLE account for day-to-day needs. Document a letter of intent covering care, housing, medical preferences and the trustee succession plan.