Pension lump sum value?

[hankster]

I have a DB pension plan at my company that either pays an annuity payment after retirement or offers a lump sum payout. I plan to take the monthly payments and we have an excel calculator on the HR website that shows what the monthly payment will be. However, they don't have a way to calculate the lump sum value. Anyone know of a rough formula to get a ballpark lump sum value? I simply want a number to use for the purposes of net worth estimate.:confused:

Hank

[travelover]

You could compare it to the cost of a Vanguard annuity at this site:

Vanguard - Annuities Overview

[OAG]

Assume it as a 4% withdrawal, then, multiply the annual, before taxes total, by 25. Lack of a Cola and any type of survivor benefit probably should reduce the multiplier. Simple enough, but I know there are a lot more complicated methods. They will be along soon - stay tuned.

[Htown Harry]

Here’s a calculator for the actuarial at heart:

https://www.pensionbenefits.com/calculators/lumpcal/

“The Lump Sum Value Calculator gives you the ability to calculate the lump sum value of your pension benefits, or to verify the accuracy of the lump sum payout that your company has calculated.”

Besides age and other data, it requires that you know quite a bit about the mortality tables and interest rates used by your plan.

A less precise approach is to estimate the up-front purchase cost of an immediate annuity that would pay a monthly amount equivalent to your pension.

This site has a calculator that does that: Immediate Annuities - Instant Annuity Quote Calculator.

I used a variation of the latter approach when I recently left a job and had to choose between taking a lump sum today vs. taking pension payments at age 65. I entered the future monthly pension payments amount into the annuity calculator to figure the cost of the equivalent annuity at age 65. I then compared that value and the lump sum amount offered today and used another calculator to figure a rate of return on today's lump sum that would be needed to produce the annuity purchase amount at age 65.

[Midpack]

Quote:

Originally Posted by travelover You could compare it to the cost of a Vanguard annuity at this site: Vanguard - Annuities Overview

That's how I'm doing it. I thought I was going to take my lump sum, but realized it was very, very low compared to the monthly payout. Taking 4% of the lump sum was a little over half the monthly income they are offering. Watch out and do your homework!

FWIW, with my small DB pension. The monthly payment increases 5% each year from 56 to 61 and then remains constant. The lump sums also increase from 56 to 61 - but then it declines each year after. A few people where I work who are 61 or 62, and planning to work until 65, are seriously thinking about retiring now.

The other wildcard factor of course is how sure are you they will be around for the rest of your life? If you're uncertain (as I am), the decision goes beyond the numbers...

[hogwild]

Quote:

Originally Posted by R Wood It seems strange to me how far off these calculators are as I do have 29 years experience with a payout from a taxable military retirement that I started in 1979. When I put in the numbers at, backed to 1979, these calculators generally come up with a number of about $330K but the actual amount received is over $550K. The only explanation for such a large disparity I can come up with is the calculators do not account for a COLA at the BLS CPI rate over time.

The calculator gives you the present value of an annuity. In other words, this is the amount you would need, in a lump sum initially, to produce the payout at the discount rate used. You can use Excel to get the same result using the PV function.

[hankster]

Quote:

Originally Posted by Midpack That's how I'm doing it. I thought I was going to take my lump sum, but realized it was very, very low compared to the monthly payout. Taking 4% of the lump sum was a little over half the monthly income they are offering. Watch out and do your homework! FWIW, with my small DB pension. The monthly payment increases 5% each year from 56 to 61 and then remains constant. The lump sums also increase from 56 to 61 - but then it declines each year after. A few people where I work who are 61 or 62, and planning to work until 65, are seriously thinking about retiring now. The other wildcard factor of course is how sure are you they will be around for the rest of your life? If you're uncertain (as I am), the decision goes beyond the numbers...

The people in my company that are close to retirement that I've talked to all agree that the monthly annuity payment is by far the best way to go. The only reason to consider the lump sum would be something like a terminal illness diagnosis. A friend of mine just retired and took the lump sum because stomach cancer will be cutting his retirement short. This was best for his wife since the annuity only pays 50% to surviving spouse. I'm not comfortable asking how much he got. Also, he's 65 and I plan to retire much earlier than that so the number probably wouldn't tell me much. Mainly was curious about amount to use when I do net worth calculations. As far as the company's future prospects, I feel good about that aspect. It's a private utility company in business since 1889 and is on good financial footing, at least presently Thanks to all who responded. I'll run some numbers later this week.

Hank

[Average Joe]

I’m not financially sophisticated – so I’m shocked to see a financial question for which I actually think I have a useful answer. I don’t know how applicable my method with be to your situation but here’s what used to answer the question “what principal would I have to use to generate my pension from my own assets?” --

12X/Y
Where
X=monthly pension
and
Y=annual SWR that I’d use if I were withdrawing from my own investments

I use .04 for the SWR under the assumption (maybe a good assumption – maybe not) that a 4% SWR allows withdrawals to remain roughly constant in purchasing power but to actually increase with inflation. Were I to assume otherwise I suppose I’d use a lower SWR because my military pension is indexed to the CPI.

Two flaws in this method are that if I die young no one will inherit the principal (though I do pay each month for an annuity that will allow my wife to continue to receive half my pension in the event of my death) and the formula underestimates the value if I live longer. To put this in perspective – I retired at age 42 so by age 67 I will have been paid the entire value of my pension using 12X/Y method above to calculate it. But if I live just 5 years longer, my pension is worth fully 20% more.

If I knew when I was going to die I could more accurately calculate the exact value of my pension. So far I’m not tempted to choose a date myself.

While I was in a situation in which I had to choose between collecting pension X this month or continuing to work for salary A another month and collecting a slightly increased pension the following month, I needed a formula to calculate my actually compensation for work (which had to reduced by the pension I could have collected for not working but then increased by the increased value of the slightly higher pension).
I used a formula roughly like this:
A-X+12Q/Y-12X/Y
Where
A=month’s salary
X=monthly pension if retired that month
Q=monthy pension if retired the next month
Y=annual SWR I assume I’d use to withdraw the amount of my pension from investments

[OAG]

Quote:

Originally Posted by Average Joe I’m not financially sophisticated – so I’m shocked to see a financial question for which I actually think I have a useful answer. I don’t know how applicable my method with be to your situation but here’s what used to answer the question “what principal would I have to use to generate my pension from my own assets?” -- 12X/Y Where X=monthly pension and Y=annual SWR that I’d use if I were withdrawing from my own investments I use .04 for the SWR under the assumption (maybe a good assumption – maybe not) that a 4% SWR allows withdrawals to remain roughly constant in purchasing power but to actually increase with inflation. Were I to assume otherwise I suppose I’d use a lower SWR because my military pension is indexed to the CPI. Two flaws in this method are that if I die young no one will inherit the principal (though I do pay each month for an annuity that will allow my wife to continue to receive half my pension in the event of my death) and the formula underestimates the value if I live longer. To put this in perspective – I retired at age 42 so by age 67 I will have been paid the entire value of my pension using 12X/Y method above to calculate it. But if I live just 5 years longer, my pension is worth fully 20% more. If I knew when I was going to die I could more accurately calculate the exact value of my pension. So far I’m not tempted to choose a date myself. While I was in a situation in which I had to choose between collecting pension X this month or continuing to work for salary A another month and collecting a slightly increased pension the following month, I needed a formula to calculate my actually compensation for work (which had to reduced by the pension I could have collected for not working but then increased by the increased value of the slightly higher pension). I used a formula roughly like this: A-X+12Q/Y-12X/Y Where A=month’s salary X=monthly pension if retired that month Q=monthy pension if retired the next month Y=annual SWR I assume I’d use to withdraw the amount of my pension from investments

So basically what you have done by using the divisor of 4% is multiply the annual payout by 25 - I suggested this earlier but in reality it does not really work very well. Case in point is that I have drawn a military retirement payment for 29 years this June and if I had used the 25 multiplier or 4% divisor it would have fell well over 50% short. COLA and/or living long in retirement changes the value very significantly as you point out.

[Average Joe]

Quote:

Originally Posted by R Wood So basically what you have done by using the divisor of 4% is multiply the annual payout by 25 - I suggested this earlier but in reality it does not really work very well. Case in point is that I have drawn a military retirement payment for 29 years this June and if I had used the 25 multiplier or 4% divisor it would have fell well over 50% short. COLA and/or living long in retirement changes the value very significantly as you point out.

Yes - same thing. I hope to live to make my calculations as innaccurate as I can. I think if I were in a lump sum vs pension choice I'd lean toward pension unless I was reasonably sure that I would soon die or I already had plenty to provide for the financial future.

[rayvt]

Quote:

Originally Posted by Average Joe Yes - same thing. I hope to live to make my calculations as innaccurate as I can. I think if I were in a lump sum vs pension choice I'd lean toward pension unless I was reasonably sure that I would soon die or I already had plenty to provide for the financial future.

I didn't have the choice. Dunno if that's good or bad. For those Motorolans who stayed with the Tradional Pension, the only option is to take the pension---lump sum isn't/wasn't an option.

But to balance the greed/fear factor, I took the 10-year certain payout. I'll probably outlive my wife, but if I don't then our investment portfolio will have certainly grown enough to replace the pension by the 10 year mark.

[Alan]

I know the value of my DB pension as a non-COLA monthly annuity, 50/50 joint survivor. I just went to the Vanguard site listed earlier and got a quote for that exact amount. The lump sum needed is almost exactly 15 x the pension, so for estimating my pension as part of my net worth, 15 x is god enough. (I won't have a lump sum option when I RE so that is one decision I won't need to make)

[Midpack]

Quote:

Originally Posted by Alan I know the value of my DB pension as a non-COLA monthly annuity, 50/50 joint survivor. I just went to the Vanguard site listed earlier and got a quote for that exact amount. The lump sum needed is almost exactly 15 x the pension, so for estimating my pension as part of my net worth, 15 x is god enough. (I won't have a lump sum option when I RE so that is one decision I won't need to make)

That's probably a good thing. My DB pension is non-COLA and the monthly benefit is equal to an over 8% withdrawal rate on the lump sum. In other words, the lump sum is very, very low - as the pension fund does not want to pay lump sums. However, it's a public company that has been through bankruptcy and I have doubts as to whether they are going to survive to see me through my lengthy retirement so I will probably have to take the lump sum at about 50¢ on the dollar (I have used online annuity calculators to compare)...

[2B]

One thing to consider while crunching the numbers is the effect of interest rates on the calculation. Taking a lump sum now would be better financially if interest rates rise significantly going forward. The uniform payments are calculated based on an effective interest rate. With the low rates, the payments will be smaller than they would have been just a few years ago.

This is the same thing that determines annuity payments. They pensions and annuities are basically the same. They combine estimated mortalities with effective interest rates to determine a payout.

I would always lean towards the lump sum since I'd rather be in control of my own destiny. If it is a fabulous payout (unlikely), I would take the payments.

Disclosure: I will eventually receive a collection of small DB pensions from several previous employers. All together they will be about 15% of my initial retirement income. I wish I could get a lump sum but that is not an option for any of them.

One thing to consider about non-COLA'd annuities and pensions is that the payment that seems pretty good today isn't worth crap in 20 years. Both my father and in-laws have/had non-COLA'd pensions that are/were pretty pathetic as their end of life finances played out.

[hankster]

One thing to consider about non-COLA'd annuities and pensions is that the payment that seems pretty good today isn't worth crap in 20 years. Both my father and in-laws have/had non-COLA'd pensions that are/were pretty pathetic as their end of life finances played out. (by 2B)

Exactly right! My non-COLA'd pension which figures to be around $4,600/month at age 60 would more than take care of all normal expenses. A 3% inflation rate would chop it in half in about 23 years. The nest egg is there for inflation protection, medical costs and travel money.

Hank

[Alan]

Quote:

Originally Posted by hankster Exactly right! My non-COLA'd pension which figures to be around $4,600/month at age 60 would more than take care of all normal expenses. A 3% inflation rate would chop it in half in about 23 years. The nest egg is there for inflation protection, medical costs and travel money

Similar situation here. My non COLA pension will be very good in 2 years when I RE ( ~ $5k/month) and it should take care of the majority of my needs for several years until I start to need to seriously begin using my savings. Also at ages 62 and 65 I have SS plus a smaller ($12K COLA) pension kicking in.

[donheff]

Quote:

Originally Posted by Htown Harry Here’s a calculator for the actuarial at heart: https://www.pensionbenefits.com/calculators/lumpcal/ “The Lump Sum Value Calculator gives you the ability to calculate the lump sum value of your pension benefits, or to verify the accuracy of the lump sum payout that your company has calculated.”

I don't think that is a good one. I ran my pension thru it (Fed gov with approximately the 66% spousal benefit of this one) and the calculator used 28X as the lump sum multiplier. It must have assumed a full COLA although it didn't ask. You can buy a Vanguard inflation protected (10%) annuity for substantially less than 28X. I even think a 25X multiplier is a bit high since the lump sum SWR approach has a high likelihood of leaving a big nest egg while the pension does not.

[aenlighten]

are here for fixed and indexed. Inflation of 3% over 20 years doubles the present value of an indexed pension.