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Value of a Pension (Net Worth Additive)
Old 08-20-2006, 08:02 AM   #1
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Value of a Pension (Net Worth Additive)

How does one value a Pension? Assume value of a COLA'd one is valued differently, and, if so, how does one assign multiple to them? Looking for the value to consider as part of one's Net Worth.
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 08:35 AM   #2
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Re: Value of a Pension (Net Worth Additive)

As long as you live a pension is perhaps your most valuable asset.

Unfortunately, it dies when you die. A death benefit could be added into your net worth along with insurance. Unless you have commuted the pension or taken a lump sum I don't think it would factor into your net worth.

Survivor benefits would carry on with your spouse, but after that the pension benefit is $0.
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 08:43 AM   #3
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Re: Value of a Pension (Net Worth Additive)

You should be able to value the pension by trying to find out the cost of an annuity with the same payouts and features (cola). Someone here can probably chime in with a specific url, but I believe there are a number of calculators online which will allow you to vary the payouts and features and will tell you how much that annuity will cost. If you haven't got the pension yet, whoever is giving it to you may also have a "cashout" figure which would be it's value.
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 09:10 AM   #4
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Re: Value of a Pension (Net Worth Additive)

I have seen pensions valued as follows:

--Multiply the annual amount by 12 for a non-survivorship pension
--By 15 for a pension with (full??) survivorship
--By 20 for a pension with a good COLA (like a federal govt pension) and no survivorship
--By 25 for a pension with good COLA and survivorship

I have no idea of these are correct in any case, let alone every case, but they give you a ballpark to play in.
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 09:52 AM   #5
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Re: Value of a Pension (Net Worth Additive)

Go to:

http://flagship4.vanguard.com/VGApp/...sOVContent.jsp

Click on Vanguard Lifetime Income Program - details
Then click on Get an Instant Quote and fill in the requested info.

You will get a result that shows what lump sum you would need to invest to get the monthly income amount you specify. This amount can be interpreted as the value of your pension to your net worth.

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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 11:05 AM   #6
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Re: Value of a Pension (Net Worth Additive)

I agree on calculating the "value" of a DB pension. The employer or government sets aside that amount usually in an individual account on retirement. They may estimate ~ 25 years payout and if you die sooner you subsidize those who live longer. I think astromeria's figures on a long term DB pension are accurate. A goldplated $50 000 pension X 25 means the employer/govt. would have to set aside $1 250 000.

That figure should NOT be included in your net worth. If you were to retire and you and your spouse die shortly thereafter, depending on the plan, the estate "might" get your contributions or a guaranteed 10 year payout, but definitely not the plan value.

For net worth purposes the same goes for CPP/OAS in Canada. You die and the estate gets a small ($2500?) death benefit. Your spouse gets a survivor benefit. My mother still receives a SS cheque each month. It has been a reliable steady source of income for her for many decades and some has been used to increase her net worth. On the other hand my father only collected for a very very short period.

A DC plan is under your control though, and it should be included in your net worth.
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 11:19 AM   #7
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Re: Value of a Pension (Net Worth Additive)

Quote:
Originally Posted by Old Army Guy
How does one value a Pension? Assume value of a COLA'd one is valued differently, and, if so, how does one assign multiple to them? Looking for the value to consider as part of one's Net Worth.
A quick & easy way to value your military pension is to attempt to reproduce the annuity with the real (after-inflation) return of I bonds or TIPS.

The pension only affects your net worth as long as you're alive to spend the money.* And on this forum, where we can't even decide on a common definition of net worth, the value of a pension is way too far down in the weeds for most people's calculations.* It's nowhere near as exciting as f*zzy-b*nny futures.

However your pension's equivalence in bonds will dramatically affect your thinking about your asset allocation.*
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 11:36 AM   #8
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Re: Value of a Pension (Net Worth Additive)

I agree with Zipper that it can be misleading to use the present value of a pension in your net worth. *After all, you probably can't sell your pension if you need money now. *On the other hand, pension payments are properly accommodated in firecalc so that you can plan your needs for additional income in retirement.

Measuring the value of a pension by seeking a quote for an immediate annuity may or may not be appropriate. *Under certain circumstances, that may actually misvalue the pension, as I will explain in a moment.

I don't know your level of experience in this area, so I apologize in advance if this is too basic.

This all begins with the asssumption that a dollar today is more valuable that a dollar received one year from today. *To calculate how much less valuable, you must use a discount rate to find the present value of the future payment. *The calculation is as follows: *

p = yearly pension payment amount nomimal amount
x = discount rate, expressed as a decimal (e.g. 5% is .05)
n = years until payment received
*n means "to the nth power. *thus *2 is squared * 3 is cubed etc

PV = present value = p/(1+x)*n

As an example, if you receive $100 in 1 year and use a 5% discount rate, the present value of that money is 100/1+.05)*1 = 1/1.05 = $95.24. *If you don't get the money for two years, the value is 100/(1+.05)*2 = 100/1.1025 = $90.70.

To value of string of yearly payments, you need to present value each year's payment back to the start of the payment stream and then add up all the present values. * Thus, the present value of receiving two $100 payments, one next year and one the year after, using a 5% discount rate, is $95.24 + $90.70 = $185.24. *Theoretically, you would calculate your life expectancy from the payment date and present value each year as above. *If you assume you will receive pension payments for 25 years, you would do 25 present value calculations and add them together. *Ultimately, the sum approaches the value of PV = p/x. *So, for payments received over long periods of time (say, more than about 15 years), many people present value the total sum of payments by simply dividing the yearly payment by the discount rate. *In our example, if you received $100 per year forever, using a 5% discount rate, the present value would be $2000 (100/.05).

Now, you may think at this point "but I won't receive $100 every year, because my pension is COLA'd, so the equation won't work" *A good point, but it can be taken care of in the selection of a discount rate (see below)

Obviously, the selection of discount rate makes a substantial difference in the calculation of present value. *Use of a smaller discount rate makes the present value larger and vice versa (run the calculation above using 8% and the present value is only $1250). *There are typically three components that go into the discount rate. *To understand them, it helps to think that if you received the calculated present value today, how would you invest it to get the future value when it comes due? *As with any investment, the returns you demand for parting with your money include some real rate of return, some inflation rate and some premium to compensate for the risk of default. *A 30 year treasury bond is "risk free" because, under any conceivable scenario, the federal government doesn't default. *If your pension is a federal pension you may want to use 30 year treasuries. *If it is from a private company, you may need to add a few percent. *Find the company's bond rating (AAA, BBB, C etc) and look up the prevailing market interest rates for corporate bonds issued by companies with that rating.

Now we come to the COLA part. *As you may have noticed, both treasuries and corporate bonds incorporate an inflation component in their nominal return. *If you assume that your COLA formula will keep up with actual inflation over the life of your pension (a big assumption if it is based on the CPI), you can account for the COLA (which increases payments in the future) by removing the inflation factor from your chosen rate (which reduces the discount rate and therefore increases the present value). For a federal pension, the "real return rate" on TIP's might be a good rate to use, since it is inflation protected, risk free. *If it is a corporate pension, you might simply subtract the Treasury/TIP's spread from the risk adjusted corporate bond rate you chose. *Thus, for a federal, COLA'd pension, assuming a 2% real return on TIPS, the present value might be 50 times the yearly payment (i.e. 1/.02).

A quote for an annuity incorporates assumptions by the insurance company about your life expectancy, inflation and their expected investment returns. *They also want to make a profit. * These assumptions may or may not be appropriate for your situation.

One last thing to remember -- if you will not receive your pension for several years, once you have valued it per the above equation, you will need to present value that figure back to today.

* * * *






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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 11:43 AM   #9
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Re: Value of a Pension (Net Worth Additive)

The main value of a pension, especially a COLAd pension, is that it removes the burden of one having to come up with the funds to live on day-to-day while retired. If your annual living costs are $50k and your pension kicks out $40k, you are 80% home before you even have to look at your investments as a support system. And we have not consisered SS yet. This is a huge asset.

That said, I still like to semi-include the pensions that I have as part of my bond allocation to remind me that I can easily have a greater portion of my stash in stocks than the guy that does not have this kind of downside protection. My feeling is that if I have something of value, I want to have it reflected somewhere in my overall financial plan.
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 11:45 AM   #10
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Re: Value of a Pension (Net Worth Additive)

I believe it is appropriate to NPV your DB (or annuity) pension benefits for use in asset allocation calculations and cash flow needs. *Beyond that, it has no value in Net Worth calculations. *Net worth has no personal value after death....only in terms of Estate if that is important to you (and wasn't to me since spouse has survivor benefits from my pension anyway).

When I was making a decision for lump sum or annuity as I retired, it turns out the multiplier was ~13 and I chose the pension payments. Now I simply take my pension payment, multiply by 12 and use it as part of my FI asset allocation.

Edit: Agree with mickeyd. He posted while I was still typing.
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 11:59 AM   #11
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Re: Value of a Pension (Net Worth Additive)

If you want to get a value... and I agree that you should for a look at what is a 4% withdrawl rate...

Go to:

http://www.immediateannuities.com/

An example... Female, 66, not payment to the spouse, $5,000 per month.. the value is $746,547
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 12:07 PM   #12
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Re: Value of a Pension (Net Worth Additive)

Quote:
Originally Posted by Gumby
After all, you probably can't sell your pension if you need money now.
Au contraire, mon frere, there are many fine financial institutions more than happy to assuage your cashflow problems for merely the trouble of filling out a simple allotment form...

http://www.solvecashflowproblems.com...657/page/83434
http://www.notecity.com/pension.htm

... and thousands more on Google.
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 12:14 PM   #13
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Re: Value of a Pension (Net Worth Additive)

LOL

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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 12:56 PM   #14
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Re: Value of a Pension (Net Worth Additive)

Hijack time. All this talk about pensions and NPV of an annuity got me thinking about the perenial annuity debate. I happened to read a posting about an academic paper from Wharton on "Rational Decumulation." The abstract stated among other things, "...In particular, high levels of annuitization are shown to be rational under a wide range of risk aversion levels, even when stock market returns and annuity price loadings are assumed to be much greater than is generally the case. Ours is also the first study to model individual behavior under the possibility of default by the insurer issuing annuities. We find that even a little default risk can have a very large impact on annuity purchase decisions. We further find that state insolvency guaranty programs can have a big impact upon the levels of rational life annuity purchases..."

The actual paper is pretty dense (way beyond my patience) but the gist of it as far as I could decipher is that these guys believe people should always annuitize a minimum survival capability (Social Security or pensions may be sufficient for this). In contrast to the self directed/controlled decumulation model most of us follow they argue that it is entirely rational (and, according to them, preferable) to devote a large chunk of remaining wealth to a CPI-adjusted life annuity - even for people who want to leave an estate. Here is the link for those interested: http://papers.ssrn.com/sol3/papers.c...ract_id=917223

As per other postings above about encorporating pensions in allocation models, it follows that anyone who annuitized per these guys' recommendation could devote the remainder to a much riskier allocation than would otherwise be prudent.
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 01:28 PM   #15
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Re: Value of a Pension (Net Worth Additive)

Quote:
Originally Posted by donheff
these guys believe people should always annuitize a minimum survival capability (Social Security or pensions may be sufficient for this).* In contrast to the self directed/controlled decumulation model most of us follow they argue that it is entirely rational (and, according to them, preferable) to devote a large chunk of remaining wealth to a CPI-adjusted life annuity - even for people who want to leave an estate.* Here is the link for those interested:* http://papers.ssrn.com/sol3/papers.c...ract_id=917223
DAVID F. BABBEL
Wharton School - Finance and Insurance Depts.; CRA International
CRAIG B. MERRILL
Brigham Young University - J. Willard and Alice S. Marriott School of Management

It'd be interesting to learn if this study was sponsored by someone...
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 01:45 PM   #16
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Re: Value of a Pension (Net Worth Additive)

P = (A(1-(1+i)^-n))/i

where:
P = Present Value
A = Annuity (in this case - annual pension)
i = interest rate (your guess is as good as mine)
n = number of equal payments in a series (number of years to receive the pension)

This is only an approximation since it uses the annual payment rather than your monthly pension amount. I use 4.5% for i and I use my current life expectancy minus current age for n.

I get life expectancy from this calculator from Wharton, although to be safe, you might want to use the upper quartile (which assumes that only 25% of the people in your category will outlive you).

I use this just to eyeball my total asset base so I can calculate my equity piece more accruately.
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 02:28 PM   #17
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Re: Value of a Pension (Net Worth Additive)

Quote:
Originally Posted by kcowan
P = (A(1-(1+i)^-n))/i

where:
P = Present Value
A = Annuity (in this case - annual pension)
i = interest rate (your guess is as good as mine)
n = number of equal payments in a series (number of years to receive the pension)
From which one can see that as "n" approaches infinity, P = A/i


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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 02:29 PM   #18
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Re: Value of a Pension (Net Worth Additive)

Thanks for all of the input. It always amazes me that a "simple" question on this board is met with so may great answers and information. Thank you to everyone again. Will work on those formula responses.
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 02:32 PM   #19
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Re: Value of a Pension (Net Worth Additive)

Quote:
Originally Posted by Nords
Au contraire, mon frere, there are many fine financial institutions more than happy to assuage your cashflow problems for merely the trouble of filling out a simple allotment form...

http://www.solvecashflowproblems.com...657/page/83434
http://www.notecity.com/pension.htm

... and thousands more on Google.
As far as I can tell, they all require that you have actually started receiving the pension. *I assumed that the OP is not yet receiving it, but upon review can see that such an assumption was unsupported by any facts presented.

More to the point, if you do sell a stream of payments, such as a pension, to any of these guys, they will use a very large discount rate and assign a very low present value. *There must be many better financing options than this.
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Re: Value of a Pension (Net Worth Additive)
Old 08-20-2006, 04:13 PM   #20
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Re: Value of a Pension (Net Worth Additive)

Donheff...

I did not even go to the link... but I will give an opinino... (I have one for MOST things)...

This is probably TRUE for the vast majority of the people who do not spend any, or very little time, looking at all the options.. Why would I say that?? Because of how people made decison on a small credit risk of the company.. these people are risk averse.. and most people are...

So, it is hard for them to take the 4% and live on that.. it is much easier to have a monthly amount coming in which they can equate to a salary and live on that annuity... using the savings to buy the one offs or fix the broken down whatever...

With a person with more sophistication can figure out the to maximize their return and estate an annuity is not the way to go.. yes, it is easy for them but not the best decision...
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