Pension in your asset allocation

[Jerry1]

How do you handle Pensions and Annuities in your asset allocation. DW and I have separate 401K's. She has two of them. Today I combined all of our accounts in order to determine our overall asset allocation.

In the process, I came to consider my pension. It's a defined contribution plan. When I leave, I can take a lump sum or an annuity. It's obviously pretty safe and I wouldn't consider it a stock, however, is it a bond or cash? Or, is it not considered? It represents about 20% of our nest egg.

I also have a small annuity where I have the same question. It's only about 2% of our nest egg.

So it seems like two time periods are in play - before and after retirement. Before retirement, I guess it doesn't matter how I classify it as long as I recognize that it dilutes the risk in my overall nest egg. After retirement it will become something (likely to take the lump sum) and then there won't be this question. At that point, for today's purposes, it matters for planning purposes, i.e., what I put into retirement planning calculators.

Thoughts?

Thanks.

 

[DrRoy]

I do not include my pension. I just reduce the monthly/annual amount from my desired income.

 

[stepford]

I do not include my pension. I just reduce the monthly/annual amount from my desired income.

I've been doing the same, but others here have made a good argument that this results in too conservative an AA. In my case I maintain a fairly conservative 50/40/10 AA not counting the pension, but if I were to consider the equivalent annuity value of the pension as a "bond-like" asset my AA would become something like 40/55/5 - which is more conservative than I'd like. I haven't changed my AA based on this, but I may use this as another argument to increase my equity allocation as I get a few more years into retirement.

 

[Blue Collar Guy]

For planning purposes if your going to take the lump sum, just add its present value into the firecalc calculator in your desired asset allocation. When i was about to run out the door(retire), i knew i was going to take the max lump sum 172k, and then get 103k a year pension. i threw that info into the calculator. The 172k went into my AA

 

[Alan]

I do not include my pension. I just reduce the monthly/annual amount from my desired income.

This is what I do.

I am currently drawing 4 defined benefit pensions, all small and well within the PBGC insurance scheme, but combined they are significant. Between us we have another 4 pensions scheduled to come on stream over the next 8 years (UK and US SS for each of us)

When I calculate our AA I don't include any of the pensions.

 

[donheff]

Ditto most of the other replies. I deduct all fixed income (pension, DW's SS) from my expected/desired expenses leaving an expense amount that needs to be funded from my portfolio. I set the SWR and AA based on portfolio size, anticipated expenses to be funded from the portfolio, desire to leave an estate, etc.

 

[Hopeful]

I don't know that there is a right or wrong answer. Personally mine and DW's pension if annuitized income wouldn't be for 15+ years from now. The lump sum amount currently gets 1% interest now. For these reasons I count it towards my fixed income allocation. For us to do otherwise would make us to conservative in my opinion. Once we do RE, we will have to look at the annuity vs lump sum question. If we ever get close to the point of annuitizing it, I would probably no longer count it towards my fixed income allocation.

 

[Danmar]

Deducting the pension from your required spending to determine your required portfolio size works fine. However, notionally capitalizing the pension and including this amount as fixed income in your AA determination is conceptually correct. They are two different issues. if you don't do this your effective AA will not be comparable to others and will be more conservative than the "accepted AA recommendations" assume. Certainly not a terrible problem but for those with large pensions could be an important consideration.

 

[braumeister]

I calculate my AA both with and without pensions, and simply keep things in between those two levels. Simpleminded, but works for me.

 

[audreyh1]

Considering the pension might mean your equity allocation "could" be higher, but it doesn't follow that it "should" be.

I think folks ultimately chose their equity allocation based on their comfort level with the volatility of their investment portfolio. Some folks might feel quite comfortable with high volatility in their investments because most of their expenses are covered by pension/SS. Other folks may not be comfortable with high volatility in spite of having a high guaranteed income stream, and may still choose a lower equity allocation.

Personally, I think it makes more sense to chose the AA based on the survival characteristics of a retirement portfolio over a given time period, independently of other income. And both the AA and the withdrawal rate determine survival probability. Moreover, there is a very wide range of equity allocation where survival rates are highest, and relatively close. So someone can pick say between 45% to 80% equity and expect similar chances of the money lasting for 30 years.

There is nothing that says you have to maximize your equity allocation. Sure doing so will most likely increase the size of the portfolio at end of life, which is a plus for heirs, but you also have to live through the higher volatility in the intervening years. It comes down to personal preference, comfort, and short term versus long term goals.

Having a pension just means a smaller investment portfolio is needed to fund retirement.

And it's not like you get to rebalance your pension lump sum with the rest of your portfolio.

 

[DrRoy]

I've been doing the same, but others here have made a good argument that this results in too conservative an AA. In my case I maintain a fairly conservative 50/40/10 AA not counting the pension, but if I were to consider the equivalent annuity value of the pension as a "bond-like" asset my AA would become something like 40/55/5 - which is more conservative than I'd like. I haven't changed my AA based on this, but I may use this as another argument to increase my equity allocation as I get a few more years into retirement.

I'm at roughly 60/35/5.

 

[Danmar]

Considering the pension might mean your equity allocation "could" be higher, but it doesn't follow that it "should" be.

I think folks ultimately chose their equity allocation based on their comfort level with the volatility of their investment portfolio. Some folks might feel quite comfortable with high volatility in their investments because most of their expenses are covered by pension/SS. Other folks may not be comfortable with high volatility in spite of having a high guaranteed income stream, and may still choose a lower equity allocation.

Personally, I think it makes more sense to chose the AA based on the survival characteristics of a retirement portfolio over a given time period, independently of other income. And both the AA and the withdrawal rate determine survival probability. Moreover, there is a very wide range of equity allocation where survival rates are highest, and relatively close. So someone can pick say between 45% to 80% equity and expect similar chances of the money lasting for 30 years.

There is nothing that says you have to maximize your equity allocation. Sure doing so will most likely increase the size of the portfolio at end of life, which is a plus for heirs, but you also have to live through the higher volatility in the intervening years. It comes down to personal preference, comfort, and short term versus long term goals.

Having a pension just means a smaller investment portfolio is needed to fund retirement.

And it's not like you get to rebalance your pension lump sum with the rest of your portfolio.

Agree. However, I think most people develop their AA based on "rule of thumb" norms. I doubt many people settle on an AA from bottom up principles as you suggest. Although that would be a preferred approach. So if you are going to use these "rules" , you should at least calculate a comparable AA. I think a pension does more than simply "a smaller portfolio is needed to fund retirement" it also can significantly reduce your risk. You can ignore this if you wish, but I chose not to as my pension is quite large. For many (most) people it wouldn't matter much.

 

[bingybear]

At one point I had a DB pension... but the tech bubble made that less viable. The only defined contribution like plan I've had has been a 401k that I could control the investments.
Have you read your DC plan documents? I would assume they would document how returns occur in the DC plan. Do you have options as to the investments? or options for higher or lower risk?
I would think that they would need some documentation as to how the DC plan would be invested. Now this may change with age like a target date fund.
I would use and income stream for annuities when annuitized. Before annuitization I would l would look at how it grows to model it.

 

[audreyh1]

Agree. However, I think most people develop their AA based on "rule of thumb" norms. I doubt many people settle on an AA from bottom up principles as you suggest. Although that would be a preferred approach. So if you are going to use these "rules" , you should at least calculate a comparable AA. I think a pension does more than simply "a smaller portfolio is needed to fund retirement" it also can significantly reduce your risk. You can ignore this if you wish, but I chose not to as my pension is quite large. For many (most) people it wouldn't matter much.

I just wanted to point out that using a SWR approach has you select an AA based on portfolio survival rates and desired withdrawal rates rather than some "rule of thumb norm" like age in bonds. A lot of folks here model SWR to choose withdrawal rate, so they probably are taking this bottom up approach in choosing their AA which is tied to withdrawal rate success.

 

[Gotadimple]

The problem with including pensions in your asset allocation is that the pension value goes down each year you live and you need to adjust for that. That is, if you die younger you collect less, and no one knows how long they will live. Assuming you know your pension is well-funded, the best you can do is use the value of the guaranteed income to reduce to total portfolio needed to fund retirement (as others here have already said).

In my mind, the issue of 'asset allocation,' has nothing to do with guaranteed income (pensions, annuities, social security), and everything to do with funding retirement needs net of guaranteed income. For some, there is also a need to leave a legacy. Guaranteed income provides no legacy if taken as a payment made over several years.

So, no, I wouldn't count it. No legacy value, no liquidation value, no independent way to measure current value. I might count it if I planned on taking a lump sum and investing in bonds. But again, you need an independent measure of the value.

- Rita

 

[Nature Lover]

I've been doing the same, but others here have made a good argument that this results in too conservative an AA. In my case I maintain a fairly conservative 50/40/10 AA not counting the pension, but if I were to consider the equivalent annuity value of the pension as a "bond-like" asset my AA would become something like 40/55/5 - which is more conservative than I'd like. I haven't changed my AA based on this, but I may use this as another argument to increase my equity allocation as I get a few more years into retirement.

Deducting the pension from your required spending to determine your required portfolio size works fine. However, notionally capitalizing the pension and including this amount as fixed income in your AA determination is conceptually correct. They are two different issues. if you don't do this your effective AA will not be comparable to others and will be more conservative than the "accepted AA recommendations" assume. Certainly not a terrible problem but for those with large pensions could be an important consideration.

Agree with both of you. I have what is to me substantial pension income, and agree that how I view it can be an important consideration. As a result, after the last time we had a discussion like this, I took a look at my own situation more carefully - reverse engineering the pension value's AA in Firecalc using the annuitized pension valuation and pension income stream. I found that while I view my pension income as entirely "fixed income-like" (paying out regularly and with near certainty), Firecalc showed that at their annuity values, the pension income streams were equivalent to a SWR using an ~40/60 allocation. This made me aware that, in my circumstance, I need to verify the AA equivalency the best I can before using a value for my pensions in a "comprehensive AA" view calculation.

That being said, while I don't invest differently ---or use that "comprehensive AA" in retirement calculators, just creating a comparative "comprehensive AA" calculation (using its annuity value @ 40/60) has provided an additional view of my financial assets; helping me better understand 1) how I feel about my financial plan and 2) how others are handling their retirement finance without pensions.

NL

 

[Fedup]

I choose my AA base on my comfort level. I play around with the portfolio analysis. I ignore my rental income, even though it acts as a bond, and I ignore my pensions.
I don't want to set at some crazy level and then panic and sell them. My AA is set at a non panic level. No anxiety drug is needed to calm me down.

 

[Danmar]

I just wanted to point out that using a SWR approach has you select an AA based on portfolio survival rates and desired withdrawal rates rather than some "rule of thumb norm" like age in bonds. A lot of folks here model SWR to choose withdrawal rate, so they probably are taking this bottom up approach in choosing their AA which is tied to withdrawal rate success.

Valid points. If your are running firecalc you would not include your pension in the AA and thus if the firecalc survivor rate drives your AA you would ignore the pension. If, on the other hand, you determine your desired AA based on risk tolerance and then run firecalc, I think there is a good case for including the pension in AA.

 

[Danmar]

Agree with both of you. I have what is to me substantial pension income, and agree that how I view it can be an important consideration. As a result, after the last time we had a discussion like this, I took a look at my own situation more carefully - reverse engineering the pension value's AA in Firecalc using the annuitized pension valuation and pension income stream. I found that while I view my pension income as entirely "fixed income-like" (paying out regularly and with near certainty), Firecalc showed that at their annuity values, the pension income streams were equivalent to a SWR using an ~40/60 allocation. This made me aware that, in my circumstance, I need to verify the AA equivalency the best I can before using a value for my pensions in a "comprehensive AA" view calculation.

That being said, while I don't invest differently ---or use that "comprehensive AA" in retirement calculators, just creating a comparative "comprehensive AA" calculation (using its annuity value @ 40/60) has provided an additional view of my financial assets; helping me better understand 1) how I feel about my financial plan and 2) how others are handling their retirement finance without pensions.

NL

Intelligent approach.

 

[Nature Lover]

Thank you.

 

[Mulligan]

I live off of about 65% of my monthly pension. So I have a built in cushion. My investments? I dont have an allocation. I invest however I want for whatever reason I want. Overall, its pretty conservative, but it really doesn't matter because I will never spend the money anyways.

 

[bada bing]

I think it depends on the terms of your pension. Pensions in the private sector,
where they are offered at all, vary widely. I have been bounced around between
employers during my career, but have always been earning pensions. I've lump
summed out of 3 small DB pensions already because the terms for holding them
didn't compete with reasonable investing.

The pension from my current employer is different. It is a DC plan. It earns
employment credits deposited every month (9% of pay) and also earns interest
credits every month on the balance (the greater of 30 year treasury rates or 5%).
It has no principle risk/reward from rising/falling rates. When I retire, I can annuitize
at any time at whatever the prevailing annuity rates are. Or I can leave the balance in
the plan from retirement to age 70 and it will grow with interest rate credits. If I
haven't annuitized it, the balance is part of my estate if I die.

I count my current pension as a bond in my AA. I am not aware of any bond
investment available with terms as good as my pension. I may or may not take
the annuity, but not until I reach age 70. Hopefully annuity rates will be better
in 11 years when I reach 70, and I'll have a better estimate of my potential
longevity. But if I choose to not take the annuity the pension functions as
a very good bond surrogate in my AA in the meantime.

It very much depends on the terms of a pension for how it is best categorized
in an overall retirement plan.

 

[jollystomper]

I keep things simple. I don't count it in my AA. For retirement planing I treat it more likely "income" to cover my expenses and, if anything is left over, to be invested into my AA.

 

[nun]

I don't count my DB pension in my AA, but when I bought into it with 15% of my portfolio I determined to let my equity allocation increase.

Right now I'm at

Equities 65%
Bonds 20%
TIAA Traditional 5%
Stable Value 7%
Cash 3%

If we add in the pension that becomes

Equities 55%
Bonds 17%
Pension 15%
TIAA-Traditional 4%
Stable Value 6%
Cash 3%

 

[pb4uski]

How do you handle Pensions and Annuities in your asset allocation. DW and I have separate 401K's. She has two of them. Today I combined all of our accounts in order to determine our overall asset allocation.

In the process, I came to consider my pension. It's a defined contribution plan. When I leave, I can take a lump sum or an annuity. It's obviously pretty safe and I wouldn't consider it a stock, however, is it a bond or cash? Or, is it not considered? It represents about 20% of our nest egg.

I also have a small annuity where I have the same question. It's only about 2% of our nest egg.

So it seems like two time periods are in play - before and after retirement. Before retirement, I guess it doesn't matter how I classify it as long as I recognize that it dilutes the risk in my overall nest egg. After retirement it will become something (likely to take the lump sum) and then there won't be this question. At that point, for today's purposes, it matters for planning purposes, i.e., what I put into retirement planning calculators.

Thoughts?

Thanks.

If it is a DC plan where you select what your balance is invested in, then I would include it based on the attributes of the underlying investments... my DC plan was like that... like a 401k. If it is a DB plan without a lump sum option, then I include the benefit as an income item (or offset to spending). If it is a DB plan with a lump sum option then as fixed income if you expect to take the lump sum or as a income or a reduction in spending if you plan take a lifetime payout.