The Pension Max illustration has two methods for calculating the life insurance needed in retirement: interest bearing and annuitization. Both are explained below.
Interest Bearing
This method is simpler to understand. On the client's death, the proceeds of the life insurance are deposited into an account (called a Side Fund in TRAK). This fund earns interest. Each month interest is earned and distributions are made from the account. The balance at the spouse's life expectancy is configured.
Annuitized Account
The annuitization method is a little more complex than the interest bearing method. There are several factors that make the annuitized account more complex:
1.Generally a life time annuity does not have a cost of living adjustment (COLA) during retirement: it is a fixed income over a person's life time. A public pension systems may include some sort of COLA during retirement.
2.An annuity purchased with life insurance proceeds is typically not fully taxable, whereas the income from a pension plan is fully taxable.
TRAK uses the "Side Fund" to get the after-tax incomes from the two methods to match.
1.In the early years, the annuity will produce more after-tax income than the pension plan.
2.That annuity income that is above the projected pension is deposited into the Side Fund.
3.The Side Fund earns interest each month.
4.Each year the pension plan income will increase a little more. Eventually the pension will exceed the annuity.
5.At that point deposits are no longer made to the side fund, but rather withdrawals are taken to supplement the annuity—so that the annuity income plus the side fund withdrawals match the pension.
Note that the annuity is not fully taxable--it has an exclusion ratio associated. (Additional information on exclusion ratio can be found through Google).
