How should I view pension in AA

[pb4uski]

I would be interested in views on whether or not to consider pensions or SS in AA.

For example, right now I have a pension from a former employer that I can begin to draw anytime between now and 65. The sweet spot under that plan is about age 60 and I am now 55.

To date in AA, I have totally ignored this "asset".

However, I wonder if I should impute a value for this pension and include that as a fixed income in my AA, which would then result in higher equity positions in my investment accounts, but would still overall remain at my 60% equities/40% fixed income targets.

Do any of you consider pensions to be fixed income for AA purposes?

Also, if it is appropriate for private pension, should we apply the same notion to SS?

 

[REWahoo]

Here are a couple of threads on the subject:

http://www.early-retirement.org/forums/f28/treating-ss-as-a-bond-for-aa-purposes-40926.html
http://www.early-retirement.org/forums/f28/treating-colad-pension-as-bond-allocation-30975.html

 

[bbbamI]

I didn't reply to either one of the threads REW gave you, so I'll give you my answer...it is 'no'.

In our situation, we were able to take a partial lump sum and smaller annuity pension payment when DH retired. We invested the partial lump sum which we include in our AA, but the annuity is not included, nor is SS.

The pension and social security payments are promised. I don't include 'promises' in my AA.

YMMV

 

[Alan]

Do any of you consider pensions to be fixed income for AA purposes?

Also, if it is appropriate for private pension, should we apply the same notion to SS?

No, I don't compute an equivalent value in bonds.

I do include the income streams in the planning, and then have an AA in the investments to meet the income shortfall.

 

[haha]

I would include both a private pension from a well financed firm, and SS. They are as sure as anything else in the investment world. Can't remember for sure but I think it is Milevsky who used the "are you a stock or a bond" to help a person who is still working figure out what their reasonable allocation should be. He decided that as a tenured university professor, he is a bond, so he upped his allocation to equities. Pensions and SS are the same. Maybe SS will get fooled with, and then again maybe not in any way that would affect people who are close to retirement.

My personal opinion is that it is better to be approximately right as to the overall situation, and then don't worry about trying to turn this into numbers. It would just be a fantasy. However, you may have unconsciously already done this when you chose your 60:40 allocation. Maybe if you didn't know you had that pension and the SS coming up you might have chosen a 40:60 allocation instead.

Think it through for a few days, then execute.

Ha

 

[kyounge1956]

No, I don't compute an equivalent value in bonds.

I do include the income streams in the planning, and then have an AA in the investments to meet the income shortfall.

This is what I do too. I deduct pension & SS from my estimated living expenses, and the remaining amount is the income I need to generate from my portfolio.

 

[pb4uski]

Thanks to everyone for the input and thoughts. I guess implicitly that I have been reducing my projected living expenses by the pension and SS that I expect to receive and then assessing whether a 60/40 investment portfolio would then fill the gap.

It may well be mathmatically equivalent to considering social security and pension to be fixed income assets and assessing the resulting income stream of a "portfolio" that is less than 60/more than 40.

 

[deserat]

I would include both a private pension from a well financed firm, and SS. They are as sure as anything else in the investment world. Can't remember for sure but I think it is Milevsky who used the "are you a stock or a bond" to help a person who is still working figure out what their reasonable allocation should be. He decided that as a tenured university professor, he is a bond, so he upped his allocation to equities. Pensions and SS are the same. Maybe SS will get fooled with, and then again maybe not in any way that would affect people who are close to retirement.

My personal opinion is that it is better to be approximately right as to the overall situation, and then don't worry about trying to turn this into numbers. It would just be a fantasy. However, you may have unconsciously already done this when you chose your 60:40 allocation. Maybe if you didn't know you had that pension and the SS coming up you might have chosen a 40:60 allocation instead.

Think it through for a few days, then execute.

Ha

+1 - streams of income

I calculate the value of a pension by the 4% rule - and treat it like an annuity.....the investments are then allocated per the risk I'm willing to take for the rest of the income stream.

I tend to be conservative and lazy - the tax deferred investments are fairly equity heavy - the after tax investments are used for interim income during the gap between the retirement date and the dates the pensions kick in.

 

[kaudrey]

+1 on income stream, but not AA.

 

[donheff]

I treat my pension and DW's SS as guaranteed income streams that cover a certain portion of anticipated expenses. Our portfolio covers all other expenses and an estate for the kids. Our AA is based on the risk and probable variability we choose to accept with regard to those other expenses and the estate.

 

[rescueme]

I treat my pension and DW's SS as guaranteed income streams that cover a certain portion of anticipated expenses. Our portfolio covers all other expenses and an estate for the kids. Our AA is based on the risk and probable variability we choose to accept with regard to those other expenses and the estate.

DW/me do the same...

 

[Danmar]

This is what I do too. I deduct pension & SS from my estimated living expenses, and the remaining amount is the income I need to generate from my portfolio.

Makes sense and is what i do as well. However since I have a very large pension this reduces the requirement for income from the investment portfolio and inherently allows for a higher risk position. So effectively this is very much like including the pension in the AA. Works out to about 60/40 equity/FI if I do include it.

 

[devans0]

I include 75% of SS (the solvent %) as a bond with a 4% return as my take on a reasonable plan. I figure DW @ the same fraction. I could make a case for estimating DW @ a 3.5% since we will draw that at age 62, and defer mine until age 67 but I am lazy, so I use 4%.
As for pensions, I checked my company's 10K financials and have discounted that as well. They are underfunding the pension. I refuse to turn over my financial future to a Megacorps promise, nor to any promises of politicians. I need to see that the money is actually there. The solvent fraction of my pension is figured for 3.5% return bond.
Since we are still in the accumulating stage, this gives me a basis of security planning, allowing me to be comfortable with an aggressive portfolio while we climb out of the recession.

 

[easysurfer]

This is what I do too. I deduct pension & SS from my estimated living expenses, and the remaining amount is the income I need to generate from my portfolio.

I do the same too, use the amount in estimated living expenses for the year, but don't count in my AA.

 

[rmark]

Fixed pension payments are cash flow that is within the withdrawal from your portfolio. A lump sum value is needed to estimate withdrawals and the equity allocation needed to support them
Your expenses don’t care which part of your portfolio pays them – establish the withdrawal from the portfolio (including pension payments) before looking at cash flow in the portfolio.
As an example, my wife expects a university fixed pension paying $48,000 per year. Going to immediateannuities.com, they estimate that it would cost $700,000 to buy an annuity paying this at age 64.
Assuming she wants to spend all $48,000 in pension cash flow and wishes to keep her initial withdrawal to 4% of portfolio value + inflation, she’ll need an additional $500,000 in her personal portfolio. With most studies suggesting not less than 30% in equities, her initial retirement portfolio historically could be $700,000 pension value + $100,000 bonds + $400,000 equities. Her cash flow from all sources actually exceeds her starting withdrawal, though a few years of inflation will change this.

 

[kyounge1956]

Fixed pension payments are cash flow that is within the withdrawal from your portfolio. A lump sum value is needed to estimate withdrawals and the equity allocation needed to support them
Your expenses don’t care which part of your portfolio pays them – establish the withdrawal from the portfolio (including pension payments) before looking at cash flow in the portfolio.
As an example, my wife expects a university fixed pension paying $48,000 per year. Going to immediateannuities.com, they estimate that it would cost $700,000 to buy an annuity paying this at age 64.
Assuming she wants to spend all $48,000 in pension cash flow and wishes to keep her initial withdrawal to 4% of portfolio value + inflation, she’ll need an additional $500,000 in her personal portfolio. With most studies suggesting not less than 30% in equities, her initial retirement portfolio historically could be $700,000 pension value + $100,000 bonds + $400,000 equities. Her cash flow from all sources actually exceeds her starting withdrawal, though a few years of inflation will change this.

That's way too complicated for my taste. But I also wonder about the effect changing interest rates would have on the calculation. If interest rates went up, the price of the annuity would go down, which would change the amount of equity in the non-pension portion of the portfolio—I haven't grasped this well enough to estimate how much or in which direction. Is that a bug, or a feature?

 

[RunningBum]

Fixed pension payments are cash flow that is within the withdrawal from your portfolio. A lump sum value is needed to estimate withdrawals and the equity allocation needed to support them
Your expenses don’t care which part of your portfolio pays them – establish the withdrawal from the portfolio (including pension payments) before looking at cash flow in the portfolio.
As an example, my wife expects a university fixed pension paying $48,000 per year. Going to immediateannuities.com, they estimate that it would cost $700,000 to buy an annuity paying this at age 64.
Assuming she wants to spend all $48,000 in pension cash flow and wishes to keep her initial withdrawal to 4% of portfolio value + inflation, she’ll need an additional $500,000 in her personal portfolio. With most studies suggesting not less than 30% in equities, her initial retirement portfolio historically could be $700,000 pension value + $100,000 bonds + $400,000 equities. Her cash flow from all sources actually exceeds her starting withdrawal, though a few years of inflation will change this.

Is your wife 64 now, or is that pension COLA'd? It looks like that tool is calculating the cost of providing that $48K/yr starting now. I've been trying to figure out the value of my non-COLA pension that won't start for 16 years. I'm just cutting my number in half to account for inflation between now and then. It's not a large pension so very little is affected if I'm off by even a lot.

 

[donheff]

Fixed pension payments are cash flow that is within the withdrawal from your portfolio. A lump sum value is needed to estimate withdrawals and the equity allocation needed to support them
Your expenses don’t care which part of your portfolio pays them – establish the withdrawal from the portfolio (including pension payments) before looking at cash flow in the portfolio.
As an example, my wife expects a university fixed pension paying $48,000 per year. Going to immediateannuities.com, they estimate that it would cost $700,000 to buy an annuity paying this at age 64.
Assuming she wants to spend all $48,000 in pension cash flow and wishes to keep her initial withdrawal to 4% of portfolio value + inflation, she’ll need an additional $500,000 in her personal portfolio. With most studies suggesting not less than 30% in equities, her initial retirement portfolio historically could be $700,000 pension value + $100,000 bonds + $400,000 equities. Her cash flow from all sources actually exceeds her starting withdrawal, though a few years of inflation will change this.

This doesn't make sense to me. I can see valuing a pension as a bond for determining AA. But not using a purported value to determine the overall size of a portfolio which you appear to be doing. It seems what you need to estimate is how large a portfolio do you require to generate sufficient income to pay the anticipated COLA component of $48K over x years. You could then adjust the AA to accommodate reduced risk since the base $48K is guaranteed. That might call for 80% equities as you propose but I don't see how you arrive at the $500K figure. By the way, I tried to model this in Firecalc but the results didn't make sense. If I entered $48K expenses with a $48K inflation adjucted pension FC said I need a $300K portfolio (should have been $0). If I included a $48K fixed pension it calculated ~$700K Maybe the math gurus can calculate how you estimate the cost of an increasing stream of payments starting at about 3% of 48K and increasing by 3% of that plus $48K the next year and so on.

 

[haha]

If I entered $48K expenses with a $48K inflation adjucted pension FC said I need a $300K portfolio (should have been $0). If I included a $48K fixed pension it calculated ~$700K

When does this sort of thing decrease one's faith in the reliability of FireCalc?

 

[Danmar]

Rmark. Your post confuses me too. If my portfolio covers spending over my pension plus inflation on total spending I think I'm good? In my case spending requirement is set to equal pension plus cash portfolio returns ( divs and interest). Spending could easily be reduced if returns reduce. Seems to me you are using pension value swings caused by interest rate movements to increase or decrease spending? Seems risky?

 

[rmark]

No, the pension is not COLA’d nor is my wife currently 64. For illustrative purposes I used her pension formula to generate the hypothetical fixed payment due from the pension and assumed that the OP desires inflation adjusted spending so as to maintain their lifestyle through retirement (as is commonly used with the 4% + inflation rule). A truly COLA’d pension is a much simpler problem – just spend it (after taxes) as it is contractually obligated to maintain purchasing power. No portfolio allocation is needed to support it. Changing interest rates will change the pension lump sum value – which is why I used nice round numbers, so as to not pretend that there is a high level of precision in this calculation.

Using the 4% + annual inflation rule as a starting point, a $48,000 annual withdrawal from a mixed portfolio required a $1,200,000 portfolio – much more than the $700,000 estimated value of the pension. To maintain the purchasing power of the pension, my wife historically needed an additional $500,000 in her personal portfolio. I set her equity allocation in the illustration at the minimum suggested by withdrawal studies with the intent of generating a cash flow from the pension, bond payments, and stock dividends in excess of withdrawals.

Taking a fixed pension, subtracting some expenses, then taking an inflation adjusted withdrawal from a portfolio is mixing nominal spending and real withdrawals – apples and oranges as I see it.

 

[donheff]

Using the 4% + annual inflation rule as a starting point, a $48,000 annual withdrawal from a mixed portfolio required a $1,200,000 portfolio – much more than the $700,000 estimated value of the pension. To maintain the purchasing power of the pension, my wife historically needed an additional $500,000 in her personal portfolio.

On the surface that sounds sensible but think about it. If the interest rate climate was better for annuities you might find that you could buy it for $650,000. Then you would calculate another $550,000 for your portfolio. Which one is right?

 

[youbet]

I do consider my pension and SS in making AA decisions. Right now, at age 63, I'm running about 50-50. Without the pension and SS, I'd target something on the order of 40 - 60.

 

[youbet]

Taking a fixed pension, subtracting some expenses, then taking an inflation adjusted withdrawal from a portfolio is mixing nominal spending and real withdrawals – apples and oranges as I see it.

FYI, FireCalc does handle a non-cola'd pension plus inflation adjusted portfolio withdrawals correctly.

 

[donheff]

FYI, FireCalc does handle a non-cola'd pension plus inflation adjusted portfolio withdrawals correctly.

I coudln't get it to do it but I don't often use Firecalc so I was probably inputting the variables incorrectly. How about running a 48,000 expense with a non-COLAd 48K annuity and see what FC puts out as a 95% portfolio.