NPV of a COLA pension

[BigNick]

I was tweaking the numbers in my signature the other day and I got to thinking about how to evaluate the cash equivalent of my company pension (defined-benefit, COLA, 1.2% of monthly payout as contribution for worldwide no-deductible health insurance, all that good stuff).

If I retire on my 50th birthday, I would get 2500/mo immediately, 4000/mo if I deferred taking the pension until age 60, and some pro-rata amount if I start to take it at a point in between. If I w*rk till I'm 60 (ha ha ha), I would get about 6000/mo.

So the 750K value in my signature corresponds to 30K/year now, and a 4% withdrawal rate from some hypothetical pile of money. Is that a reasonable number to be using?

This is an entirely theoretical, navel-gazing, net-worth exercise, of course.

 

[Emeritus]

for a quick and dirty analysis price an annuity at
Immediate Annuities - Instant Annuity Quote Calculator.

gives about 500,000 for a non inflation protected annuity for a male at age 50. Usual rule of thumb is that inflation protection for under 60 year olds costs about 25% more so my guess is about 625k.

no inflation protected 4000 a month at age 60 is worth 700,000 by same site.

FWIW that is a 3.6 rate of return over the next 10 years. Pretty good but not fabulous

Valuing pensions is routine in divorce and estate planning so there is much better software out there.

 

[donheff]

Emeritus: was that a individual annuity or did it provide a survivor benefit?

 

[MichaelB]

I was tweaking the numbers in my signature the other day and I got to thinking about how to evaluate the cash equivalent of my company pension (defined-benefit, COLA, 1.2% of monthly payout as contribution for worldwide no-deductible health insurance, all that good stuff).

Nords has an excellent thread covering this here http://www.early-retirement.org/forums/f28/estimating-present-value-net-worth-44560.html

 

[Emeritus]

Emeritus: was that a individual annuity or did it provide a survivor benefit?

Individual

you can also calculate some survivor events
a joint life annuity of 100% adds about 10% to the value

 

[Emeritus]

To Hijack the thread a bit, we had an interesting defined benefit "equalization problem". DW and I both have defined benefit pensions. Mine is self only. DW's will give me a 25% survivor benefit. (peculiarity of state versus fed retirement and health insurance systems)

Her salary has always been bigger but my pension is bigger since she is in the FERS/TSP. We share all assets equally. Unless we did something I would much better off financially than she would be if the other party died. We wanted to equalize our situation. We have term life insurance on me up to age 72 that would purchase an annuity sufficient to make up the difference. But when I am 72 it expires. We can bridge half the gap by deferring DW's social security to age 70. We then expect to buy a joint life annuity for the other half of the difference out of our joint assets. That way we are in exactly equal positions no matter who might die first.

 

[BigNick]

for a quick and dirty analysis price an annuity at
Immediate Annuities - Instant Annuity Quote Calculator.

gives about 500,000 for a non inflation protected annuity for a male at age 50. Usual rule of thumb is that inflation protection for under 60 year olds costs about 25% more so my guess is about 625k.

no inflation protected 4000 a month at age 60 is worth 700,000 by same site.

Valuing pensions is routine in divorce and estate planning so there is much better software out there.

The Vanguard calculator gave me 966K (!) for 2500/month with inflation adjustment and 2/3 survivor benefits.

 

[ronin]

We have unequal pensions as well. Equal is good, but in our case, that would assume exactly equal need, which isn't necessarily so. Also for us, the timing as well as sequence of shedding the mortal coil is a factor. Investigated a penmax solution but figured we are better off dealing with whatever comes our way when it comes. No particular major worries, so it's not a big deal for us.

 

[LARS]

Not really sure the point of NPVing a pension.

Its value will vary widely depending on current interest rates. So to say today I have $x, and then use that capitalized number to spend could get you into trouble (especially as interest rates are at zero--which dramatically increases the current NPV).

 

[MasterBlaster]

here's the best calculator for estimating pension NPV that I have seen:

https://www.pensionbenefits.com/calculators/cal_main.jsp?sub_item=lumpsum_cal

 

[MasterBlaster]

Not really sure the point of NPVing a pension.

Its value will vary widely depending on current interest rates. So to say today I have $x, and then use that capitalized number to spend could get you into trouble (especially as interest rates are at zero--which dramatically increases the current NPV).

Sometimes you are given several options of which to take your pension. Lump sum, annuity, inflation adjusted annuity, delayed annuity. Sometimes one of the options is the far better choice but it can be difficult to tell which it is.

The NPV attempts to level the playing field so that they can be compared apples-to-apples.

As usual all of the caveats apply in terms of rates and lost opportunity etc. Nonetheless NPV can be enlightening.

 

[BigNick]

Not really sure the point of NPVing a pension.

My initial reason was to put a big ol' number on our total net worth.

But there is another good point in the post by Nords, linked to above, which is to do with AA. If you just have 1.6 million in a portfolio, you might want to have 60% stocks/30% bonds/10% cash. If you have 1 million in a portfolio and a government-backed COLAed pension which is the equivalent of "between 500K and 900K" in rock-solid, inflation-proof bonds, then whether it's 500K or 900K should make a difference to how aggressive you are with the million.

 

[Emeritus]

The Vanguard calculator gave me 966K (!) for 2500/month with inflation adjustment and 2/3 survivor benefits.

Vanguard is designed to tell you how much you need. It rests on assumptions The annuity site is supported by companies who will sell you the annuity at that price so IMHO it is a better guide.

the inflation adjustment is the tricky one. Vanguard may use the TIPS rate with inflates the capital needed

 

[MasterBlaster]

But there is another good point in the post by Nords, linked to above, which is to do with AA. If you just have 1.6 million in a portfolio, you might want to have 60% stocks/30% bonds/10% cash. If you have 1 million in a portfolio and a government-backed COLAed pension which is the equivalent of "between 500K and 900K" in rock-solid, inflation-proof bonds, then whether it's 500K or 900K should make a difference to how aggressive you are with the million.

That's the whole "phantom" bond analysis. This approach has many fans (including John Bogle - of Vanguard fame) and opponents.

here was one discussion of the pahntom bond topic:

http://www.early-retirement.org/forums/f28/phantom-bonds-redux-48997.html

 

[Emeritus]

Not really sure the point of NPVing a pension.

Its value will vary widely depending on current interest rates. So to say today I have $x, and then use that capitalized number to spend could get you into trouble (especially as interest rates are at zero--which dramatically increases the current NPV).

the reason is asset allocation. Our DB pensions are essentially bonds. Yes of course you have to take the long view, but its the same as analyzing your home as imputed income. In our case our total financial structure is approximately 20% real estate, 55% inflation protected DB pensions and 25% equities.

To check the imputed value of a home you look at rentals adjusted for taxes, and the auction value of the house, which is generally about 3/4 of what most people think their house is worth.

You can convert either to an assets or a stream of income approach, but you have to be consistent.

FWIW as interest rates drop the value of existing bonds go up. Its no different.

 

[ziggy29]

Not really sure the point of NPVing a pension.

There are at least four reasons I can think of:

1) Divorce proceedings where the value of the pension has to be considered in the division of marital assets;

2) A desire to include it in a net worth calculation;

3) To decide whether a lump sum payout offer is worth taking instead of the monthly income;

4) A desire to consider the pension's value as "fixed income" investments in one's asset allocation.

 

[akck]

As a side issue, should medical benefits resulting from a pension be included in the NPV calculation too? For instance, my pension includes medical coverage at 60, which then becomes supplemental when Medicare kicks in. I've never included it in any NPV calculation, but it does offset an expense I won't have to pay in retirement.

 

[MasterBlaster]

As a side issue, should medical benefits resulting from a pension be included in the NPV calculation too? For instance, my pension includes medical coverage at 60, which then becomes supplemental when Medicare kicks in. I've never included it in any NPV calculation, but it does offset an expense I won't have to pay in retirement.

That would be up to you to include it or not.

My personal take is that it's a real benefit that you would have to pay for were it not there so I would include it.

Along those lines you could add in an imputed rent to your paid for house if that is applicable.

 

[rayvt]

It is not valid to include things like this (NPV of pension, value of house, imputed rental income, etc.) when assessing your asset allocation. All you are doing is fooling yourself, and this will lead you to make faulty decisions.

The reason is that you can only spend a liquid asset. The NPV of a pension isn't spendable. What is spendable is the $X per month you receive.

Ditto for the house. You can't spend the equity in your house. All you can do is convert it to cash by selling it, and then spend that cash. (You can tap the equity with a loan but that doesn't help, because you have to pay it back.) But, unless you are willing to live in a cardboard refigerator box under the overpass then selling the house doesn't do you much good. You have to live somewhere.

 

[ziggy29]

It is not valid to include things like this (NPV of pension, value of house, imputed rental income, etc.) when assessing your asset allocation. All you are doing is fooling yourself, and this will lead you to make faulty decisions.

The reason is that you can only spend a liquid asset. The NPV of a pension isn't spendable. What is spendable is the $X per month you receive.

I think more to the point is that a pension has the characteristics of a fixed income investment in terms of generating steady, secure income streams, leaving more room to take equity risks with your "liquid" assets because neither a severe drop in the stock market or in interest rates on cash will severely damage your total income.

In other words, without a solid pension there's no way I'd put 80-100% of my portfolio into equities. But if I had a pension which, together with SS, provided at least 100% of my expenses I could easily afford to take that risk.

 

[Purron]

In other words, without a solid pension there's no way I'd put 80-100% of my portfolio into equities. But if I had a pension which, together with SS, provided at least 100% of my expenses I could easily afford to take that risk.

I think in opposite terms. With a solid pension and SS providing 100% of expenses, I'd be less inclined to take a risk. The higher risk, and presumably higher income, would not be necessary to fund living expenses. Therefore, I'd be more prone to take a very conservative, capital preservation approach.

 

[obgyn65]

NPV in Excel

hello - may I recommend this site for NPV calculations :

NPV - Excel - Microsoft Office

 

[Alan]

hello - may I recommend this site for NPV calculations :

NPV - Excel - Microsoft Office

Welcome to Er.org

Thank you for the link.

 

[Emeritus]

It is not valid to include things like this (NPV of pension, value of house, imputed rental income, etc.) when assessing your asset allocation. All you are doing is fooling yourself, and this will lead you to make faulty decisions.

The reason is that you can only spend a liquid asset. The NPV of a pension isn't spendable. What is spendable is the $X per month you receive.

Ditto for the house. You can't spend the equity in your house. All you can do is convert it to cash by selling it, and then spend that cash. (You can tap the equity with a loan but that doesn't help, because you have to pay it back.) But, unless you are willing to live in a cardboard refigerator box under the overpass then selling the house doesn't do you much good. You have to live somewhere.

?

Assume I have an absolute right to receive a million dollars in 5 years. That is an asset.

There are many kinds of illiquid assets. restricted stock, gold coins some bonds some real estate. They are still "Assets"

Some assets are income producing, some are not.

 

[Nords]

In other words, without a solid pension there's no way I'd put 80-100% of my portfolio into equities. But if I had a pension which, together with SS, provided at least 100% of my expenses I could easily afford to take that risk.

I think in opposite terms. With a solid pension and SS providing 100% of expenses, I'd be less inclined to take a risk. The higher risk, and presumably higher income, would not be necessary to fund living expenses. Therefore, I'd be more prone to take a very conservative, capital preservation approach.

You guys have stated a conundrum which I've been struggling to resolve for 10 years. Maybe we can come up with an answer this time.

Right now I'm mostly in Ziggy's camp, but it can get awful volatile there during a bear market. Notice the date on that NPV thread? It was an attempt to [-]rationalize[/-] cheer me up that the equity portion of our present net worth was too small to get frustrated about.

Part of it is stewardship, too. If you don't need it, then why not take prudent risks for profit? To take it to extremes, you'd expect Buffett & Gates to be in 100% Treasuries. Yet they keep on investing for the sake of making more money to give away as fast as they can.