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Pension calculation -time value of money
Old 06-14-2011, 09:32 AM   #1
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Pension calculation -time value of money

What is the right calculation to use to determine the value of taking a reduced pension amount earlier.

Current pension (benefits have been frozen), reduces the payout by 5% each year before age 65. So at age 55 (earliest you can take it) would give you 50% of your full pension. No COLA involved.

I do not need the money and (belive) i could always go back to company and start it earlier than 65 (assuming I left) but some little part of me worries what if i leave them alone for 10 years they may forget who i am when i want my money .

I know for SS there is a calculation which shows the best option of when to start.

As with all retirement calculations knowing the date of death makes it so much easier but ...

Any thoughts on how to calculate this mathematically?

Thanks
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Old 06-14-2011, 09:40 AM   #2
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...what if i leave them alone for 10 years they may forget who i am when i want my money .
I don't believe that's a problem, at all since you should be receiving (at least) annual information on the "viability" of the program.

My DW just went through this, since she is planning on retirement within the next year.

She has a 403(b) - non-profit employer, which she left over 20 years ago. When we contacted the company (nursing home) about rollover of her assets (we left them there, since the investment options were good, and low cost), they had no problem in executing the rollover with her 403(b) provider, who is no longer being used by the nursing home, after many years.

Just her situation, but just to give an example where a 20+ year old plan (with a long-past administrator) was taken care of, with no problems at all....

Just my $.02.
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Old 06-14-2011, 09:48 AM   #3
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The laziest way to do this would be to price two SPIAs. One will be the 50% option starting now, the other would be to price the 100% option starting in 10 years. See which is worth more.
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Old 06-14-2011, 09:57 AM   #4
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What is the right calculation to use to determine the value of taking a reduced pension amount earlier.
The income stream calculation is fairly trivial (even if you don't just plug the numbers into FIREcalc). The real calculation is how much each extra year is worth to you, and there ain't no mathematical formula for that.

For example, the average retire-earlier-reduced-payout scheme - provided that it's been fairly worked out by competent actuaries - will typically produce results that show that for every 1 year you retire early, it will be 1.5 years before the not-retiring-early option pays the same amount. (YMMV, but if you see numbers above 1.8 or below 1.2, check your arithmetic.) So if the nominal "full pension" age is 60, and you retire at 50, the reduction in the annual pension will start to outweigh the fact that you've been getting the money for 10 more years, at around age 75, assuming investment returns which "sort of" keep pace with inflation. (Of course, if you put the first 10 years money on the 13 at Vegas and it comes up, you'll have beaten the street quite handily...)

But this ignores two huge factors, one either way:
- If you retire at 50, you aren't getting your salary. So you will probably have to dig into the portfolio to keep up the same standard of living.
- On the other hand, many people want to spend more money in the first few years of (early) retirement, than later. Leaving out health care costs, which in any case are highly volatile for each individual, most people spend more around 60 than they do around 75. So the extra value to you of $1000/year more at 60 may be a lot more than the same $1000/year at 75, even after allowing for inflation.

The other issue, regardless of money, is how long you are going to be able to enjoy spending it. I'm 50 and reckon that, with a bit of luck, I will be able to do pretty much what I like until I'm 75, after which I'll be happy with a glass of wine, a book, and my grandkids bringingme cookies from time to time. That means I have 25 good years ahead of me, which means that ever year I spend w*rking is 4% off my available quality time. I'd better be increasing my retirement spending capacity by a good deal more than 4% per year if I'm to justify the BS which I have to take at work.
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Old 06-14-2011, 12:39 PM   #5
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I'm going to assume you have already (or will soon) quit working and that you have a significant chunk of assets to fund your spending for 10 years if you defer the start date.

If so, the best approach is just to set up FireCalc or a similar calculator with your situation and run it both ways. You can specify the same annual spending and see which plan leaves you with more money at the end. You can look at the FireCalc annual detail to see the differences in assets at various points along the way (since you don't know for sure which point is really the "end" for you). Or, you can solve for different spending patterns that provide the same ending values, if that makes more sense to you.

The advantage of this approach is that it uses all your other facts about your preferred AA, what you're doing with social security, your risk tolerance, your preference for spending now vs. an estate, etc.

If you want a stand alone comparison, brewer's idea is simplest for puttng a value on mortality. Suppose the premium for a $2,000 monthly benefit starting at 65 is $480,000. Then the difference between starting at 55 with $1,000 per month or starting at 65 with $2,000 amounts to comparing the additional dollars you'd get in the first 10 years with the half the premium you'd need to pay at 65 ($240,000). If that extra $1,000 per month accumulates to more than the $240,000, you'd seem to be better off starting at 55. If they are less, you'd seem to want to defer. But this of course is plain math that ignores all sorts of risk tolerance issues which could be important to you.
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Old 06-14-2011, 02:54 PM   #6
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Sorry to piggyback but is this the same as the FERS early retirement option? If I am not yet retirement eligible but have 10+ years into FERS I can take an early pension with 5% redux for each year prior to my actual retirement date. Does anyone know with the federal government will that then lose its COLA and/or medical benefits? I'm thinking if I go this route, I will have enough cash in portfolio to live off of and the extra pension would be nice but the medical benefits would be a real plus.
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Old 06-14-2011, 07:14 PM   #7
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Sorry to piggyback but is this the same as the FERS early retirement option? If I am not yet retirement eligible but have 10+ years into FERS I can take an early pension with 5% redux for each year prior to my actual retirement date. Does anyone know with the federal government will that then lose its COLA and/or medical benefits? I'm thinking if I go this route, I will have enough cash in portfolio to live off of and the extra pension would be nice but the medical benefits would be a real plus.
I am a FERS retiree under the MRA+10 provision, and retired about half a year before I turned 62 so my monthly bank deposit from FERS is reduced about 2.5%. I went straight from working into retirement, and I still have medical benefits and I will retain whatever COLAs other FERS retirees get. However, it is not a full COLA for anyone retiring under FERS. For the correct details instead of my anecdotal remarks, go to FERS Retirement
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Old 06-15-2011, 06:34 AM   #8
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A 5% reduction for every year before 65 is about actuarialy neutral.

So the key question is, do you feel lucky? If you are male, lean towards drawing early. If female, lean towards waiting. (Because employers use unisex mortality tables). If in excellent health and a history of longevity in your family, wait.

Your pension should be insured by PBGC, so no need to worry about them "forgetting you" or going insolvent.

You might also consider your personal tax situation. If drawing a bigger pension later on top of SS leads to higher taxes, it might be advantageous to draw a smaller amount over 10 more years. On the other hand, if you live on the pension and let your tax deferred accounts build, increased RMD's could also push you into higher bracket.
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Old 06-15-2011, 08:40 AM   #9
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A 5% reduction for every year before 65 is about actuarialy neutral.
Is this true? So if my pension cuts 4%/yr before retirement age, it's better to take it early?

Source?
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Old 06-15-2011, 09:07 AM   #10
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The mathematical way to calculate the value is to take the payments from age 55 and extend to your life expectancy, for a male in the US your life expectancy per the US Government census bureau is 24.9 years. You then extend those benefits and discount using an appropriate interest rate. Then compare the string of payments doubled at age 65 for your expected life at age 65, which per the US government is 17.2 years and discount those back.

With no spouse involved assuming no cola the present values of the payments are identical at a 5% discount rate. The lower the discount rate the higher the value of waiting, the higher the discount rate the more taking now is of greater value.

Some factors to look for are if you die in the next 10 years does your spouse then get 50% of your full pension at age 65? If so then the risk of those 10 years are not reflected in the calculation, nor the spousal benefit. In other words if you die at age 64 your wife is only going to get what you would have been able to start taking at age 55 and 9 years of potential investing would have been lost, but without knowing all the details it is not possible to calculate.

The 2011 Statistical Abstract: Life Expectancy
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Old 06-15-2011, 10:18 AM   #11
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Originally Posted by arebelspy

Is this true? So if my pension cuts 4%/yr before retirement age, it's better to take it early?

Source?
I have a govt pension and 30 years is considered full retirement age. I went out with 28 and reduced multiplier because I hadn't reached rule of 80 (years working plus age). This cost me 13% of my pension. I used "creative math" to justify ER. That being if I continued working, I am in effect refusing to take "free money" they are trying to give me if I don't work. It would take 14 years to recoup this money by working 2 more years. By retiring earlier, I get my cola's sooner recouping some of that 13%. It's all how you twist the math. I could afford to retire so I did is the bottom line.
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Old 06-15-2011, 10:51 AM   #12
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DH's pension would have maxed at 65 (5% reduction per year under 65) but we decided to take it now (62) because the max survivor benefit is 50% if he passed and had not started taking his pension. Our plan was to select the 100% survivor benefit at 65 but I started thinking about the risk of him not being around at 65. He is in good health and has longevity in his family but we can't control for the drunk driver or crazy FL driver who might change our plans.
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Old 06-15-2011, 05:27 PM   #13
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.... but some little part of me worries what if i leave them alone for 10 years they may forget who i am when i want my money .

...

I would think it would be unlikely they would forget... Do you have some pay stubs or other information that would serve as proof of employment?


Ask your pension for quotes at each age.

As you said, you can reevaluate your situation each year to determine if you should take it or wait another year.
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Old 06-15-2011, 05:51 PM   #14
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What is the right calculation to use to determine the value of taking a reduced pension amount earlier.

Current pension (benefits have been frozen), reduces the payout by 5% each year before age 65. So at age 55 (earliest you can take it) would give you 50% of your full pension. No COLA involved.

I do not need the money and (belive) i could always go back to company and start it earlier than 65 (assuming I left) but some little part of me worries what if i leave them alone for 10 years they may forget who i am when i want my money .

I know for SS there is a calculation which shows the best option of when to start.

As with all retirement calculations knowing the date of death makes it so much easier but ...

Any thoughts on how to calculate this mathematically?

Thanks
Doesn't your company have a website where you can see your status and run "what-if's?" My husband and I left our "pension employer" 10 years ago but I have regularly accessed the benefits website hosted by Hewitt. We recently completed almost all of DH's paperwork online to start his pension next month.
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Old 06-15-2011, 07:22 PM   #15
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Doesn't your company have a website where you can see your status and run "what-if's?" My husband and I left our "pension employer" 10 years ago but I have regularly accessed the benefits website hosted by Hewitt. We recently completed almost all of DH's paperwork online to start his pension next month.
Not really, no. I've tried to figure it out on my own using excel. Whee.

It is COLA'd, but not tied to the CPI, fixed increases (small at first, 2% after a few years, but then increasing to cap out at a 5% increase / year after year 8)

That increase is one other reason why it makes sense to take it early. The main reason I had been considering (to start the cola increase earlier, younger) and take a 4% hit/year to do so.. I hadn't considered actuary information as well.

Now I've got a bunch of work to do.
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Old 06-15-2011, 07:36 PM   #16
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Not really, no. I've tried to figure it out on my own using excel. Whee.
Yikes! Now we have a "Whee" on pensions. The end is nigh...
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Old 06-15-2011, 08:04 PM   #17
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Yikes! Now we have a "Whee" on pensions. The end is nigh...
It was more to research and playing with excel than the pension itself.
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