
10122009, 06:13 AM

#1

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Pension valuation
How do you place a monetary value on a pension? For example, is it too simplistic to say that a $100,000 per year noncola pension is equal in value to $2.5 Million in personal accounts from which you draw 4% annually?
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10122009, 06:42 AM

#2

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One way is to go here and plug in your numbers to see what a SPIA paying (in your example) $100k would cost.
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10122009, 11:23 AM

#3

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Quote:
Originally Posted by kenmck02
How do you place a monetary value on a pension? For example, is it too simplistic to say that a $100,000 per year noncola pension is equal in value to $2.5 Million in personal accounts from which you draw 4% annually?

I think using the 4% rule overstates the hypothetical current lump sum value of your pension. That's because (1) at a 4% WR, you'd have a 95% chance of having residual dollars left after 35 yrs, perhaps a large amount and (2) the 4% WR provides inflation adjusted withdrawals and you specified noncola.
The site referenced above is useful for what you want to do and will give you the cost of buying a pension that pays your specified $100k with a variety of qualifiers (such as with or without a beneficiary, etc.).
A 62 yo male in Illinois would pay $1.338M for a $100k/yr pension with no cola, beneficiaries or guaranteed term.
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10122009, 01:54 PM

#4

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Quote:
Originally Posted by youbet
I think using the 4% rule overstates the hypothetical current lump sum value of your pension. That's because (1) at a 4% WR, you'd have a 95% chance of having residual dollars left after 35 yrs, perhaps a large amount...

No problem, the annuity calculator only gives the insurance company a 95% chance of financial survival!
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10122009, 04:33 PM

#5

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Quote:
Originally Posted by kenmck02
How do you place a monetary value on a pension? For example, is it too simplistic to say that a $100,000 per year noncola pension is equal in value to $2.5 Million in personal accounts from which you draw 4% annually?

Somewhere in one of the retirement planning books that I read a few years ago...and I have no idea which one....that was generally the way the author(s) put it forth. Their idea was to use your estimated future life expectancy...25, 30 more years or whatever...and use that number to cypher it all out. So, in the case of $100K/year noncola, it would be like $100K x 25 = $2.5M.
Whether that is true & accurate I don't know for sure, but it certainly seemed reasonable to me.
In my case with a cola'd pension, when I ER'd, the pension plan folks gave me a document showing exactly how much I would receive each year for (IIRC) the first 40 years of retirement, along with a running total. So, by my guesstimates and ponderations, I figured my life expectancy to be somewhere round about 85...therefore I cyphered I had about (hopefully) 35 years of shelf life left. So I scribbled down the corresponding amount next to 35 years on that paper, and I used that for my exact, precise, ballpark figure for net worth calculations.....and IIRC again, it was somewhere about $1.2M +/.
What it boiled down to was that I probably wouldn't have to live in a cardboard box in the park and/or eat ramen noodles!



10122009, 06:34 PM

#6

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Quote:
Originally Posted by Goonie
Somewhere in one of the retirement planning books that I read a few years ago...and I have no idea which one....that was generally the way the author(s) put it forth. Their idea was to use your estimated future life expectancy...25, 30 more years or whatever...and use that number to cypher it all out. So, in the case of $100K/year noncola, it would be like $100K x 25 = $2.5M.
Whether that is true & accurate I don't know for sure, but it certainly seemed reasonable to me.
In my case with a cola'd pension, when I ER'd, the pension plan folks gave me a document showing exactly how much I would receive each year for (IIRC) the first 40 years of retirement, along with a running total. So, by my guesstimates and ponderations, I figured my life expectancy to be somewhere round about 85...therefore I cyphered I had about (hopefully) 35 years of shelf life left. So I scribbled down the corresponding amount next to 35 years on that paper, and I used that for my exact, precise, ballpark figure for net worth calculations.....and IIRC again, it was somewhere about $1.2M +/.
What it boiled down to was that I probably wouldn't have to live in a cardboard box in the park and/or eat ramen noodles!

seems to me that this method of figuring value would be like putting that value in a box (no interest being paid) and pulling out your yearly amount each year, except that you can only pull out your yearly amount every year and no more. doesnt sound all that resonable to me as it doesnt take into consideration the time value of money.



10122009, 07:02 PM

#7

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10132009, 05:52 AM

#8

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I read somewhere that Bogle suggests using 8x a noncola annual pension.
Rough ruleofthumb that should be adjusted for age, beneficiary, financial stability of company, etc.
I think 25x is way too optimistic. Using annuity value is more representative  but I think the "default risk" with most companies is higher than the annuity default risk.
Read story about a pilot for major airlines who was on path for $100k pension. Airline went bankrupt, backstopped by PGC, pilot now eligible for $30k max....
Maximum monthly guarantee tables (PBGC.gov)



10132009, 01:23 PM

#9

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At some time in the past I used to try to calculate the value of my pensions as well as SS. After wrestling with the concept for a few years I just gave up when I realized that it was far simpler to just reduce my monthly expenses while retired from the net amount of my pensions. i.e. expenses $2000 less $1500 pension = $500 needed from investments.
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10142009, 02:35 PM

#10

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P = (A(1(1+i)^n))/i
where: P = Present Value; A = Annuity (in this case  annual pension);
i = interest rate (your guess is as good as mine); n = number of equal payments in a series (number of years to receive the pension)
I use this in my financial plan to assess asset allocation based on the present value of my three pensions.
Example: 4.5% average yield over 25 years life expectancy would yield an annual payment of about $9000 from a $100k investment.
Now the trickiest part of this is to decide what is your life expectancy. If it is above average, then an annuity is a good deal. My Dad lived to 95 when his average should have been 76. He made that pension really pay off!
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10142009, 03:47 PM

#11

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I've got a significant DB pension, but I've never had a reason to put a PV on it. I do the typical yearbyyear spending model, and it's just nonCOLA'd income.
Alll annuities (pensions included) have the special feature that their value goes up if you live longer and down if you die sooner. It's hard for me to put that feature into a single number.
If I wanted a PV, I'd use youbet's method.



10142009, 03:56 PM

#12

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Quote:
Originally Posted by Independent
I've got a significant DB pension, but I've never had a reason to put a PV on it. I do the typical yearbyyear spending model, and it's just nonCOLA'd income.

I think of two reasons why some people would want to put a present value on their pension:
1) If they are offered a lumpsum buyout, they'd like to know if the offer is a fair one.
2) Some people choose to treat their pension like a "bond portfolio" and want to use the present value of their pension as part of their asset allocation to fixed income.
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10142009, 04:39 PM

#13

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Quote:
Originally Posted by ziggy29
I think of two reasons why some people would want to put a present value on their pension:
2) Some people choose to treat their pension like a "bond portfolio" and want to use the present value of their pension as part of their asset allocation to fixed income.

Yes, since joining this forum, I have come to regard my future pension as being like bonds, which, in turn, has caused me to switch more of our investable assets (including TSP) into stock funds. Before, I was looking at our investable assets as our whole portfolio. Funny, how blinkered one can be when it comes to money.
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10142009, 07:31 PM

#14

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Quote:
Originally Posted by Independent
I've got a significant DB pension, but I've never had a reason to put a PV on it. I do the typical yearbyyear spending model, and it's just nonCOLA'd income.

I read somewhere that Bogle (or someone like that) recommends that you get conservative valuation of DB pension  like 8x annual  and then represent that as a "bond" or fixedincome asset in one's overall asset allocation.
Sounds logical to me.



10152009, 09:08 AM

#15

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If the pension has a COLA, you'd need to do a NPV calculation which is probably best handled with a spreadsheet. As others have mentioned, there are assumptions that need to be made. Your life expectancy, although it is not as crucial as you might expect, since the years farthest down the line are discounted the heaviest. Also, very important is the discount rate. You probably want to be somewhat conservative here. You can easy fiddle with the inputs in excel to do your own sensitivity analysis. This'd give you a pretty good estimate of the potential number and range.
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10152009, 10:12 PM

#16

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Quote:
Originally Posted by kcowan
P = (A(1(1+i)^n))/i
where: P = Present Value; A = Annuity (in this case  annual pension);
i = interest rate (your guess is as good as mine); n = number of equal payments in a series (number of years to receive the pension)
I use this in my financial plan to assess asset allocation based on the present value of my three pensions.
Example: 4.5% average yield over 25 years life expectancy would yield an annual payment of about $9000 from a $100k investment.
Now the trickiest part of this is to decide what is your life expectancy. If it is above average, then an annuity is a good deal. My Dad lived to 95 when his average should have been 76. He made that pension really pay off!

This is the correct way...essentially this is a discounted cash flow method. The issue is estimating life expectancy and interest rate. Also, some would argue...you must estimate standard deviation...as we all know that a big down year IN THE BEGINNING of the time horizon is more disastrous than one near the END.
There are a bunch of formulas you can use in "money" calculations...the poster above gave one for an annuity, which is a good one. I also use the one below quite often...it will tell you how much a balance today will be worth in the future assuming you add nothing more to it.
FV = PV * (1+r) raised to the n power (don't know how to do superscripts)
FV = Future Value
PV = Present Value
r = interest rate per period
n = number of periods
The critical thing is to match r and n. In other words, if you use an ANNUAL interest rate, then n must be the number of years. If you want to use n MONTHS, then you must divide the annual rate by 12 to get r.



10172009, 05:39 AM

#17

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Quote:
Originally Posted by Finance Dave
...
FV = PV * (1+r) raised to the n power (don't know how to do superscripts)
FV = Future Value
PV = Present Value
r = interest rate per period
n = number of periods
The critical thing is to match r and n. In other words, if you use an ANNUAL interest rate, then n must be the number of years. If you want to use n MONTHS, then you must divide the annual rate by 12 to get r.

That is the same formula as mine. Mine just solves for PV. The point about monthly versus yearly is a good one. Yearly is close enough for nonCOLA. it is also close enough over a long period such as 25 or more years.
I struggled with this for a while. Being able to express a guaranteed pension in current net worth is extremely valuable when trying to use FIRECALC. NonCOLA pensions make planning much more tricky.
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10172009, 09:21 AM

#18

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Quote:
Originally Posted by Delawaredave5
I read somewhere that Bogle (or someone like that) recommends that you get conservative valuation of DB pension  like 8x annual  and then represent that as a "bond" or fixedincome asset in one's overall asset allocation.
Sounds logical to me.

I understand that notion, but then I ask "Where did I get my target asset allocation?"
In particular, did the AA model that I used recognize the unique needs of a retired person and the way that a pension fits into them?
I think most "rules of the thumb" like bond% = age, don't do that. If I were using such a rule, I could use a very rough value for the pension since the rule itself is so rough. Just using 8x for any pension and any age is probably good enough. If I'm trying for more accuarcy, the first step should be going to an AA tool that has both needs and investments (like FireCalc).



03092010, 12:22 AM

#19

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Like Goonie, I have had a cola'd pension (through CalPers in Ca) since 2004 and was curious how much I would be paid year after year up to 30 years when I would be 82, the approximate average age at death in America for me. The pension has a 2% annual COLA. Starting in 2005, I simply added 2% onto the previous years total and continued adding 2% 29 more times to reach the 30 year mark. I know how much I will be paid each year and the total amount for the full 30 years.
Granted this is simple to calculate, but it works. Without the cola option, it is more difficult to project.



03092010, 03:45 AM

#20

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Quote:
Originally Posted by Finance Dave
T
FV = PV * (1+r) raised to the n power (don't know how to do superscripts)
FV = Future Value
PV = Present Value
r = interest rate per period
n = number of periods

It depends on how you want to look at the assets in terms of time period. It also depends on whether you have many years to retire or are retired. Most pension formulas take care of inflation (while you are still working) by calculating the annuity value based on the highest few years of salary which are often the last few years of salary.
I tend to look at it in present day $. I also make an assumption about retirement date. I also assume the pension will be around (not fail). I also assume while working your salary will just keep up with inflation (conservative approach). You can do some best case worst case scenarios for a range of expected asset value (based on interest rates after you retire).
Flip the formula around that Dave presented for a PV calc.
Use your companies pension formula and rules with your assumed retirement date and calculate the annuity payment. It would best if you had the company do a projection based on your current salary.
Take the periodic income stream and discount each payment based on an assumed inflation rate (because spending power decrease with inflation when you are retired) from your assumed age at death back to your assumed retirement age.
That will give you a basic PV of your income streams discounted for inflation in today's $.
From a practical matter, you need to just look at the income stream from the angle that it will reduce the need to generate income from other sources. But if it is a noncola pension, the spending power decreases so you will need to discount the value in your income projections.
IMO  Looking at pensions (an annuity) as a current asset is helpful and provides a little insight. But I believe the key is looking at it as part of a set of future income streams that provide income. You really need to know what your expected income level will be in retirement vs your expected expenses.
If you want to try to look at the pension as a fixed asset for some sort of adjustment to your portfolio allocation, you can... but unlike a bond, you only get the coupon, not the principal.
IMO  If you are far away from retirement (i.e., younger), I would not factor a pension into the portfolio allocation. Life is funny... you might not make it there. Use a conventional portfolio model not considering the pension (i.e., bonds and stocks). That way if you stop working unexpectedly and by some chance that time occurs during a recession or market downturn, you will increase your chances of having some assets that did not take a haircut. People assume they will work tile retirement, but accidents or health problems can leave them disabled. You need to consider that risk.
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