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Non COLA DB pension reductions to cover inflation ?
Old 12-26-2009, 06:57 PM   #1
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Non COLA DB pension reductions to cover inflation ?

I'll have a non-COLA DB pension.

Is there a way to figure out how much you'd need to "set aside" each year to offset inflation in future years ? The goal is to "mimic" a COLA pension.

Example: Given a $10,000 /year DB pension. 3% inflation. 5% investment return. 30 year life expectancy.

I'm trying to understand the amount you can spend the first year, then spend the equivalent inflation-adjusted amount in future years.

I tried to model with some spreadsheets -- looks like one could spend around $7,000 first year and increased 3% more each year to offset inflation over a 30 year period.
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Old 12-26-2009, 08:21 PM   #2
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Quote:
Originally Posted by Delawaredave5 View Post
I'll have a non-COLA DB pension.

Is there a way to figure out how much you'd need to "set aside" each year to offset inflation in future years ? The goal is to "mimic" a COLA pension.

Example: Given a $10,000 /year DB pension. 3% inflation. 5% investment return. 30 year life expectancy.

I'm trying to understand the amount you can spend the first year, then spend the equivalent inflation-adjusted amount in future years.

I tried to model with some spreadsheets -- looks like one could spend around $7,000 first year and increased 3% more each year to offset inflation over a 30 year period.
using an annuity quoter i found that an inflation adjusted annuity with annual payments starting at $6633.72 ( and adjusted for inflation) costs the same as a fixed annuity with annual payments of $10000.00. so maybe $6633.72 is your answer.
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Old 12-26-2009, 09:18 PM   #3
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Originally Posted by jdw_fire View Post
using an annuity quoter i found that an inflation adjusted annuity with annual payments starting at $6633.72 ( and adjusted for inflation) costs the same as a fixed annuity with annual payments of $10000.00. so maybe $6633.72 is your answer.
Wow - great way to look at it - thanks !!!!!!!!!!!!

33% reduction is a big adjustment between COLA and non-COLA.

But I guess that reduction is reduced if one assumes shorter time periods.
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Old 12-27-2009, 10:26 AM   #4
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4. A very simple approach that almost anyone can use.
Each year you make a new calculation to determine how much you can spend by adding the following three components:
a) all of your after-tax social security or a COLA pension,
b) your after-tax fixed pension multiplied by your age as a percentage, e.g., 60% at age 60, and
c) each year you can spend your previous year’s investment balance divided by an estimate of the years you have yet to live. This is essentially the same budget you would get with the old IRA minimum distribution rules with the recalculation alternative, but it can be used much earlier than the mandatory 70 ½ age. The investment balance must be an after-tax value and should not include reserves needed for known large value items and some kind of allowance for emergencies.

(This approach is equivalent to assuming a zero percent real return which, in turn, is equivalent to a higher than 80% success rate for a fairly wide range of portfolio allocations.)


Frm Analyzenow.com
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Old 12-29-2009, 02:29 AM   #5
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Originally Posted by Delawaredave5 View Post
I'll have a non-COLA DB pension.

Is there a way to figure out how much you'd need to "set aside" each year to offset inflation in future years ? The goal is to "mimic" a COLA pension.

Example: Given a $10,000 /year DB pension. 3% inflation. 5% investment return. 30 year life expectancy.

I'm trying to understand the amount you can spend the first year, then spend the equivalent inflation-adjusted amount in future years.

I tried to model with some spreadsheets -- looks like one could spend around $7,000 first year and increased 3% more each year to offset inflation over a 30 year period.
Another way is to put your parameters into FIRE Calc and vary the spending to see how much you could have spent without ever running out of money. I put in a starting portfolio value of zero, annual income $10K, and 100% of the portfolio in 5-year treasuries (Intermediate term gov't bonds have returned an average of 5.3%/year from 1926-2007, which was as close as I could get to 5% with an actual asset class). There are 109 possible 30-year series. At 3% inflation, the first portfolio fails at a spending level of $6385/year, pretty close to the annuity quote. However, if the actual inflation rate is used, the historically safe spending level is much lower—with CPI instead of a constant 3% inflation, the first portfolio fails with annual spending of only $4687.

I can think of two possible reasons the safe level with CPI is so much lower than with 3%. The most obvious possibility is that inflation has historically averaged higher than 3%, or it could be that the sequence of inflation rates has a large effect, or maybe both.
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Old 12-29-2009, 05:15 AM   #6
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I'm even simpler - I use the exponential function in excel - for example, assuming an inflation rate of 3%, I multiply 1+the inflation rate and take it to the power of the year in question.

Example: amt*(1.03)^yr - so you could do this for each year, subtract the original amount and you will see what you would need to augment to equal the purchasing power of the original amount today.

Example: 10,000*(1.03)= year 1; 10,000*(1.03)^2 = year 2, etc.

At least that's what I remember from my financial engineering class before we had spreadsheets and did everything by hand :-)
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Old 12-29-2009, 07:14 AM   #7
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Another way is to put your parameters into FIRE Calc and vary the spending to see how much you could have spent without ever running out of money. I put in a starting portfolio value of zero, annual income $10K, and 100% of the portfolio in 5-year treasuries (Intermediate term gov't bonds have returned an average of 5.3%/year from 1926-2007, which was as close as I could get to 5% with an actual asset class). There are 109 possible 30-year series. At 3% inflation, the first portfolio fails at a spending level of $6385/year, pretty close to the annuity quote.
Thanks ! This is close to annuity calculation, my spreadsheet, and "spend percentage equal to your age" - so they are all consistent.
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Old 12-29-2009, 01:45 PM   #8
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Originally Posted by kyounge1956 View Post
(snip)At 3% inflation, the first portfolio fails at a spending level of $6385/year, pretty close to the annuity quote. However, if the actual inflation rate is used, the historically safe spending level is much lower—with CPI instead of a constant 3% inflation, the first portfolio fails with annual spending of only $4687.

I can think of two possible reasons the safe level with CPI is so much lower than with 3%. The most obvious possibility is that inflation has historically averaged higher than 3%, or it could be that the sequence of inflation rates has a large effect, or maybe both.
Thanks ! This is close to annuity calculation, my spreadsheet, and "spend percentage equal to your age" - so they are all consistent.
Consistent with each other maybe, but not with "reality"—the safe spending with CPI was much lower. You might want to try FIRE Calc again using CPI instead of 3% and see if you are comfortable with the percentage of times the portfolio would have been exhausted.

There are two other things I haven't taken into account. The first of these is determining an acceptable risk level. Are you counting on this pension to meet part of your basic living expenses, or do you have other resources for that and this pension is more like frosting on the cake? The other is the time span. I assumed a 30 year span, but if your pension will pay you $10K/year for your life, I think my FIRE Calc scenarios are probably somewhat off. Using a 30 year span may have been more akin to a "time certain" series of payments than a lifetime one. You might want to lengthen the span to 40, 50 or more years to see what happens to the safe spending level.
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Old 12-29-2009, 02:02 PM   #9
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Are you counting on this pension to meet part of your basic living expenses, or do you have other resources for that and this pension is more like frosting on the cake? The other is the time span. I assumed a 30 year span, but if your pension will pay you $10K/year for your life, I think my FIRE Calc scenarios are probably somewhat off.
I'm still w*rking and in planning stages. Right now I'm guessing my retirement "income" will be:
45% pensions
45% portfolio
10% SS

Plan to retire around 55 - so 30 year horizon seems OK (but I don't want to spark an "actuarial debate"...)
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Old 12-29-2009, 02:23 PM   #10
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Originally Posted by Delawaredave5 View Post
I'm still w*rking and in planning stages. Right now I'm guessing my retirement "income" will be:
45% pensions
45% portfolio
10% SS

Plan to retire around 55 - so 30 year horizon seems OK (but I don't want to spark an "actuarial debate"...)
OK, no debate, but for planning purposes it would probably be a good idea to find out what happens if you live longer than you expect to. Forewarned is forearmed, and all that.
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Old 12-30-2009, 10:12 AM   #11
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4. A very simple approach that almost anyone can use.

Each year you make a new calculation to determine how much you can spend by adding the following three components:
a) all of your after-tax social security or a COLA pension,
b) your after-tax fixed pension multiplied by your age as a percentage, e.g., 60% at age 60, and
c) each year you can spend your previous year’s investment balance divided by an estimate of the years you have yet to live. This is essentially the same budget you would get with the old IRA minimum distribution rules with the recalculation alternative, but it can be used much earlier than the mandatory 70 ½ age. The investment balance must be an after-tax value and should not include reserves needed for known large value items and some kind of allowance for emergencies.

(This approach is equivalent to assuming a zero percent real return which, in turn, is equivalent to a higher than 80% success rate for a fairly wide range of portfolio allocations.)


Frm Analyzenow.com
It looks like this is Option 4 on a list of approaches. I tried Googling and couldn't get a hit on this. I looked at the website and didn't see it toward the top. Do you have a link?
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Old 12-30-2009, 11:06 AM   #12
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Analyzenow.com - planning,post retirement - scroll down to article titled 'For Retirees only'.
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Old 12-30-2009, 01:31 PM   #13
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Thanks. This approach to a fixed pension is new to me. I was wondering what his other approaches were.
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Also looking at this approach
Old 12-31-2009, 03:26 PM   #14
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Also looking at this approach

I am also in the planning stages and have a $60K annual pension coming to me when I retire in about 8 years (at age 57). I had thought this would be a good approach and had used Excel to model it similar to the OP.

The amount quoted using FIRECALC sounds so different - I'll have to try that myself to see the results.

I haven't really seen this topic discussed before - is this commonly used by people with a fixed pension? Anyone have any real-life experience with this approach?

The most interesting part of this exercise is seeing how much money you need in 30 or 35 years to maintain the same level of spending. 3% a year sounds so harmless until you do the math!
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Old 12-31-2009, 11:06 PM   #15
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Analyzenow.com - planning,post retirement - scroll down to article titled 'For Retirees only'.
Could you post a link directly to the article? I went to the site and looked around but didn't see "For Retirees Only".

thx
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Old 01-01-2010, 11:16 AM   #16
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Could you post a link directly to the article? I went to the site and looked around but didn't see "For Retirees Only".

thx
From the main page, click on "Planning Post Retirement"; scroll down to "For Retirees Only"
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Old 01-01-2010, 01:48 PM   #17
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From the main page, click on "Planning Post Retirement"; scroll down to "For Retirees Only"
Finally found it. The link to Planning Post Retirement isn't on the main page, it's under "Helpful Articles".
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