Non-COLA Pension impact on SWR

[Hermit]

Now that I have been retired for 6 months and it is a new year, I thought I should understand the SWR thing a little better. I have a non-COLA pension. I tried to find a thread that provided this information, but couldn’t find it exactly although I found the idea of using an annuity as a close approximation for the current value of a non-COLA pension. I’m sure I am stating the obvious for most, but maybe this post will help someone in a similar situation. Following is an example of calculations I used to determine the impact of a non-COLA pension on a SWR.



Portfolio = $1,000,000
Pension = $50,000 per year


Present Value of pension = $796,254:

The value of an annuity for a 60 year old male single life, no payments to beneficiaries represents the current value of the non-COLA pension. (See Immediate Annuities Overview — ImmediateAnnuities.com. My assumption is that all vendors are fairly close and this is a good ballpark number.)


Current value of Portfolio and Pension:

$1,000,000 + $796,254 = $1,796,254


Spendable income with SWR at 4%:

$1,796,254 * .04 = $71,850.16


Deduct Pension:

$71,850.16 - $50,000 = $21,850: available for withdrawal from portfolio at 4% SWR for the first year


SWR for spending pension only:

$50,000 / $1,796,254 = 2.8%



SWR ignoring non-COLA pension:


SWR: $1,000,000 * .04 = $40,000: available for withdrawal for the first year


Spendable income with pension:

$50,000 + $40,000 = $90,000: for the first year


Assumed additional available funds when ignoring impact of inflation on pension:
$90,000 – $71,850 = $18,150 or 1.8% of portfolio


SWR while ignoring pension:

$90,000 / $1,796,254 = 5%

Couclusion: If you ignore the effects of inflation associated with a non-COLA pension, your actual SWR will likely be a lot higher than you expect.

 

[rmark]

'Spendable income with SWR at 4%:

$1,796,254 * .04 = $71,850.16


Deduct Pension:

$71,850.16 - $50,000 = $21,850: available for withdrawal from portfolio at 4% SWR for the first year'

Assuming you want inflation adjusted withdrawals, above is correct. After deducting the pension cash flow from the portfolio & pension combined withdrawal you can then withdraw the remaining $21,580 from your portfolio.

Ignoring inflation doesn't change the withdrawal rate, its ignores the assumptions behind SWR. In essence you are double counting.

 

[RockyMtn]

Does this formula work only if you have started collecting your pension? Or does it also work if you NPV the amount based on the date you start receiving the pension?

 

[Hermit]

Does this formula work only if you have started collecting your pension? Or does it also work if you NPV the amount based on the date you start receiving the pension?

That's an interesting question. This type of calculator will give you the NPV of a pension that has already started. If you took that answer and plugged it into a calculator that gave you the monthly payout that started in the future and then plug that number back into this calculator, you would be in the same ball park. This is getting kind of complex to avoid making a best guess at an interest rate and running an NPV calculation, but the insurance companies probably have a better crystal ball than I have.

This line of thought has me thinking that I could apply a NPV to my SS which I will take at 70. I have been treating that as a future income stream, but have not tried to include it in my current SWR. Wow! If I include its present value in my current SWR, I could probably move up to the high priced beer!

 

[Danmar]

Seems pretty complicated to me and overly conservative. Why don't you just ignore the pension, take a reasonable SWR from you portfolio, then add the pension cash flow to this for your total spending. Typically pensions or annuities pay more than 4% per year as they are effectively amortizing principal over your expected life and taking into account mortality credits. These occur when people( presumably not you) die early so they can pay you more. Ie for a 60 year old male they pay a little over 6% per year I think. Your methodology reduces the SWR of you portfolio for this over payment on the annuity(pension). Not sure why you would do this?

 

[rmark]

'SWR for spending pension only:

$50,000 / $1,796,254 = 2.8%'

should this not be

$50,000/$796254 = 6.2%

for pension value only.

You've mixed together withdrawals from the portfolio & pension value with cash flow within the pension, double counting the pension cash flow which is already in the pension value. No extra money.

 

[Danmar]

Actually I don't think I read your post carefully enough (too complicated). rmark has it right. But the gist of my post is correct. Simply treat the pension as a source of funds towards spending then decide how much more you can pull out of portfolio within a SWR. Capitalizing pension can be useful in deciding AA and make you feel better about your net worth. Not much else.

 

[Hermit]

Actually I don't think I read your post carefully enough (too complicated). rmark has it right. But the gist of my post is correct. Simply treat the pension as a source of funds towards spending then decide how much more you can pull out of portfolio within a SWR. Capitalizing pension can be useful in deciding AA and make you feel better about your net worth. Not much else.

The issue I was having with treating a non-COLA pension as an income stream is that you are not taking into consideration the effects of inflation. In a few short years, that income stream will lose a lot of purchasing power. The question is what is its present value and what is its contribution to an SWR? I agree that the assumption that an annuity may not be completely accurate representation of the present value, but I thought it would be in the ball park. I think it is a lot closer than ignoring the effects of inflation.

RockyMtn is looking for the same kind of calculation to apply to a future non-COLA pension and its impact on SWR if I understood his post correctly.

 

[Danmar]

The SWR most people refer includes a step up each year for inflation. Agree it won't cover the portion of your spending represented by the non cola pension. The way I deal with this is to set my AA to more equity (ie treat the pension as the FI component of your AA). FI doesn't comp you for inflation either.

 

[jollystomper]

Actually I don't think I read your post carefully enough (too complicated). rmark has it right. But the gist of my post is correct. Simply treat the pension as a source of funds towards spending then decide how much more you can pull out of portfolio within a SWR. Capitalizing pension can be useful in deciding AA and make you feel better about your net worth. Not much else.

I tend to agree with this. I will have a non-COLA pension and my simple starting estimate is as follows:

- Look at planned spending (inflation-adjusted) for the next 8 years (why 8? I will begun to draw SS at that time which will provide a "bonus" bump)
- Subtract what my pension will give me during that 8 years
- Use the result to estimate what my withdrawal needs will be. That becomes my target SWR.
- As an optional buffer, put that amount in cash/fixed income so that I'm not forced to sell equities during this time.
- Review spending and portfolio changes every year and adjust accordingly

I choose to keep it simple to stay flexible - it is just a plan for starting purposes.

 

[Hermit]

Does this formula work only if you have started collecting your pension? Or does it also work if you NPV the amount based on the date you start receiving the pension?

I found an annuity estimator at Fidelity called Guaranteed Income Estimator that calculates the current cost of an annuity that starts in the future.

 

[Hermit]

I tend to agree with this. I will have a non-COLA pension and my simple starting estimate is as follows:

- Look at planned spending (inflation-adjusted) for the next 8 years (why 8? I will begun to draw SS at that time which will provide a "bonus" bump)
- Subtract what my pension will give me during that 8 years
- Use the result to estimate what my withdrawal needs will be. That becomes my target SWR.
- As an optional buffer, put that amount in cash/fixed income so that I'm not forced to sell equities during this time.
- Review spending and portfolio changes every year and adjust accordingly

I choose to keep it simple to stay flexible - it is just a plan for starting purposes.

Your approach is where I thought I would be when I retired. Unfortunately, I had an estimate for the cabin I am going to build next year come in at double what I was planning and I am going to have to fund a couple extra years of college for my son. I have a cash hoard to cover the original estimates, but I am trying to determine the amount I could pull out of my portfolio over the next 6 years while staying under a 3.5% SWR for any overruns.

 

[RockyMtn]

I found an annuity estimator at Fidelity called Guaranteed Income Estimator that calculates the current cost of an annuity that starts in the future.

If I plug the estimate of my monthly payout for my pensions that start in ten years into this calculator I get a number that was similar to my NPV calculations.

I think I am going to keep the NPV'd value of the pensions and SS out of my net worth and my SWR calculations for now. When the pension starts in roughly ten years I will probably include the then current NPV value of the two pensions and add to my Net Worth. Will calculate total dollars needed to cover my yearly expenses, subtract the portion covered by pensions and SS and then just cover rest with withdrawals from other accounts. I expect that 60% of my expenses will be covered by the pensions and DW and my SS payments.

We are less than 2% in SWR right now without pensions or SS. Once those kick in we will be even lower than that. Maybe I'll give us a raise!

This is probably the most conservative process and I'm comfortable with that.

 

[Hermit]

We are less than 2% in SWR right now without pensions or SS. Once those kick in we will be even lower than that. Maybe I'll give us a raise!

 

[rmark]

Assuming you desire inflation adjusted withdrawals and noting most studies suggest a minimum 40% in equities -

Fixed pensions should be included in your portfolio value as the portfolio provides the inflation offsetting growth.

Cola'd pensions need not be included since they are inflation already protected, making the cash flow spendable without adjustment.

 

[clifp]

Hermit, FYI FIRECalc does allow you input a non cola pension (In the other income/spending tab). It also allows for one time major changes in your portfolio building a cabin or a couple extra year of college tuition.

 

[Hermit]

Hermit, FYI FIRECalc does allow you input a non cola pension (In the other income/spending tab). It also allows for one time major changes in your portfolio building a cabin or a couple extra year of college tuition.

As best as I could figure out, those figures only impact the success rate chart. I was trying to come up with impact on the spending level chart. I have ran the simulation with and without the pension and it does not change the spending level chart. Documentation also seems to agree that additional income streams do not impact spending level results. If anyone can help here it would be appreciated.

 

[Hermit]

Assuming you desire inflation adjusted withdrawals and noting most studies suggest a minimum 40% in equities -

Fixed pensions should be included in your portfolio value as the portfolio provides the inflation offsetting growth.

Cola'd pensions need not be included since they are inflation already protected, making the cash flow spendable without adjustment.

I agree and in fact am receiving SS on my (deceased) wife's account that I am not counting toward SWR but am counting toward income. However, in 6 years I will begin receiving SS on my account. It will be a major additional income stream that will last for the rest of my life. If I knew how to treat this future stream, I'm sure I could raise my current safe withdrawals. I just like to have some kind of justifiable figure rather than my best guess.

I paid Vanguard to do a retirement plan. Their approach was to ignore SS on my wife's account and take my SS at retirement. It was never my plan, but that is all their simulation could handle. So much for paying the big bucks (well, not too big) for a plan.

 

[clifp]

As best as I could figure out, those figures only impact the success rate chart. I was trying to come up with impact on the spending level chart. I have ran the simulation with and without the pension and it does not change the spending level chart. Documentation also seems to agree that additional income streams do not impact spending level results. If anyone can help here it would be appreciated.

One of us is confused or I am not understanding
I take the standard $1 million portfolio add $20K non cola pension in 2014.
Click on investigate tab, look for max spending level it tells me $49,976 with 95.6% success rate.
Reduce the pension to 10K $44,683
Reduce the pension to 0 $39, 751

So roughly speaking it looks like for every $2 in non COLA pension you can increase spending by $1.

This would be a bit lower than I would have guessed knowing historical inflation rates. But since FIRECalc tells with the worse case. Some one retiring in the late 60s or early 70s would have face a decade plus of high inflation significantly decreasing the value of their pension.

 

[Running_Man]

Interesting enough in that I view pension differently, I take 45% of the starting value, invest the difference in 10 year US bonds and determine how long this will allow for increases in inflation, in the past 100 years it has worked for 30+ years in ll but a couple cases where it went 25 years. With a 4% withdrawl from the million dollars this would leave you with $72,000 as calculated by my method, virtually identical to your method.

 

[Hermit]

One of us is confused or I am not understanding
I take the standard $1 million portfolio add $20K non cola pension in 2014.
Click on investigate tab, look for max spending level it tells me $49,976 with 95.6% success rate.
Reduce the pension to 10K $44,683
Reduce the pension to 0 $39, 751

So roughly speaking it looks like for every $2 in non COLA pension you can increase spending by $1.

This would be a bit lower than I would have guessed knowing historical inflation rates. But since FIRECalc tells with the worse case. Some one retiring in the late 60s or early 70s would have face a decade plus of high inflation significantly decreasing the value of their pension.

I was using 2013 as the year:
2013, 50,000 pension - 39,751
2013, 0 pension - 39,751
2014, 50,000 pension - 65,313
2014, 0 pension - 39,751

Maybe you need to use this year or later

 

[Rustic23]

I was interested how inflation might affect my retirement. I have cola'd, non cola'd, ira, and SS income. I created a spreadsheet to give me some kind of idea what inflation would do to my retirement. For me, it starts with Expenses and not income. So I have several column of expenses, some go up with inflation, some don't, i.e. in Texas over 65 some property tax is frozen. I started with today's expenses and increased each year by 4% for 25 year. I also have a column for 'one time expense'. Like a new roof or car. I get this value by doing a simple FV calculation for x years at 4% of the cost today.

Income I handled in several columns also. Cola, non Cola, Ira withdrawal. As I am not that dependent on IRA/portfolio withdrawal, I used the RMD table to determine what this amount would be, however, it would be easy to use a set SWR. I also apply an inflation/income value to the IRA. I use the same inflation factor I use for general inflation. I know this is not right, but for me it is OK. I know my investment will not follow this straight line logic, but once more, I don't depend on this withdrawal so using the same 4% increase worked, and as FireCalc says I am OK, I did not want to a bunch of 25 year cases.

At the end of each row I sum expenses, income and subtract exp from inc. This number is added to my current 'Cash' account. The RMD is subtracted from the IRA account, a value is added for increase in value or the base, to get the starting value for the next year, and the cash bal plus the inc-exp number, is used for the next year start value. If the one time exp causes the inc-exp goes negative, cash on hand will go down. As long as this is positive, and my IRA is positive, I think I am OK.

Once you have the first row done, it is easy to duplicate it for x number of years, in my case it was 25. My core exp went from $52,000 to $132,000 in 25 years. It was easy to see that my $20,000 non-cola pension was greatly devalued.

I made the spreadsheet so I could 'what if' just about everything. I even included the ability to have a gap between inflation, and what the gov. might pay in Cola. i.e say 2% less. This allows you to inflate some income at what you think real inflation is, and inflate gov. pension, or SS at a lower rate.

This may sound complicated, but it is not. The trick is to think one column at a time.

 

[Hermit]

I was interested how inflation might affect my retirement. I have cola'd, non cola'd, ira, and SS income. I created a spreadsheet to give me some kind of idea what inflation would do to my retirement. For me, it starts with Expenses and not income. So I have several column of expenses, some go up with inflation, some don't, i.e. in Texas over 65 some property tax is frozen. I started with today's expenses and increased each year by 4% for 25 year. I also have a column for 'one time expense'. Like a new roof or car. I get this value by doing a simple FV calculation for x years at 4% of the cost today.

Income I handled in several columns also. Cola, non Cola, Ira withdrawal. As I am not that dependent on IRA/portfolio withdrawal, I used the RMD table to determine what this amount would be, however, it would be easy to use a set SWR. I also apply an inflation/income value to the IRA. I use the same inflation factor I use for general inflation. I know this is not right, but for me it is OK. I know my investment will not follow this straight line logic, but once more, I don't depend on this withdrawal so using the same 4% increase worked, and as FireCalc says I am OK, I did not want to a bunch of 25 year cases.

At the end of each row I sum expenses, income and subtract exp from inc. This number is added to my current 'Cash' account. The RMD is subtracted from the IRA account, a value is added for increase in value or the base, to get the starting value for the next year, and the cash bal plus the inc-exp number, is used for the next year start value. If the one time exp causes the inc-exp goes negative, cash on hand will go down. As long as this is positive, and my IRA is positive, I think I am OK.

Once you have the first row done, it is easy to duplicate it for x number of years, in my case it was 25. My core exp went from $52,000 to $132,000 in 25 years. It was easy to see that my $20,000 non-cola pension was greatly devalued.

I made the spreadsheet so I could 'what if' just about everything. I even included the ability to have a gap between inflation, and what the gov. might pay in Cola. i.e say 2% less. This allows you to inflate some income at what you think real inflation is, and inflate gov. pension, or SS at a lower rate.

This may sound complicated, but it is not. The trick is to think one column at a time.

Hi Rustic23,

You have a good approach for getting a handle on spending vs income in RE. I use Quicken's Lifetime Planner to do the same type of exercise. I definitely need to go though those numbers with the additional spending.

The issue I have is an additional 3 year's worth of spending suddenly becoming a very real possibility shortly after I retired. At what point will this additional drain on my portfolio put me in a non-recoverable situation? In reality, I am not too worried about reaching that point, but I would like to know what it is just in case other things come up. For this type of exercise, I trust a stochastic model such as FireCalc vs a deterministic model such as QLP. The good news is that with clifp's hint, (use 2014 instead of 2013) I have been able to validate the withdrawal rate including the non-COLA pension using FireCalc. The numbers using FireCalc were very close to those in the original post. Again, using FireCalc I now have a number for withdrawals starting at retirement that include my Social Security which will start 6.5 years later. I don't know of a good way to validate that number, but at least I have one.

Thanks for the input.