Pension & allocation question

[ecowtent]

We are working on our asset allocation strategy. Even though we are both accountants, it is one of our struggles. DH receives a pension that is almost half of our annual budget. How do we add in the pension to our allocation strategy? We are currently about 80% stocks with the balance in CD’s and bonds.

 

[Spock]

We are working on our asset allocation strategy. Even though we are both accountants, it is one of our struggles. DH receives a pension that is almost half of our annual budget. How do we add in the pension to our allocation strategy? We are currently about 80% stocks with the balance in CD’s and bonds.

Depends on how the pension is funded and by who. But in general it's just a fixed income annuity. Personally if it's underfunded or borrowing to raise cash then I'd treat it as more risky equities.

 

[ecowtent]

It is an Illinois state pension. He was an accounting Professor. Illinois sucks, but it is a state pension which makes it less risky in my mind. Also not taxed by Illinois which is a significant savings.

 

[pacergal]

DH and I both have govt pensions, which cover majority of our spending. As such, we look at our retirement accounts for more long term and potential inheritance for kids. Our AA is about 70/30 for growth.
We have been anywhere from 50/50 to 90/10. 70/30 has become our comfort level for now. We are 67.

 

[Spock]

It is an Illinois state pension. He was an accounting Professor. Illinois sucks, but it is a state pension which makes it less risky in my mind. Also not taxed by Illinois which is a significant savings.

At the risk of getting another social demerit, I'd argue that a private pension is less risky than some state pensions. Public pensions are not backed by the PBGC and have less regulatory oversight (who other than the gov is going to regulate a gov pension?). I have no dog in the hunt as I don't have a pension, but IL is one of the states I filter out when buying muni bonds.

 

[FI_RElater]

... it's an income stream

We are working on our asset allocation strategy. Even though we are both accountants, it is one of our struggles. DH receives a pension that is almost half of our annual budget. How do we add in the pension to our allocation strategy? We are currently about 80% stocks with the balance in CD’s and bonds.

Pensions are an INCOME stream and aren't bonds, as you certainly can't rebalance out of them. Just like SS, you take your required budget and subtract pension (and SS when that starts) and figure out your still needed funds. What gets more difficult is if the pension isn't fully inflation adjusted, and even current fed pensions aren't as they are just a bit below inflation. Then you generally have a slightly higher equity tilt in the portfolio to have a chance at above inflation results, just don't need to go to very high equity levels as then any crashes could easily disrupt your plans.

ex: need $65k a year and have $25 k pension when they leave at 55, leaving a $40 k need from portfolio
At 55, I'd probably use either 3.0% or 3.5% withdrawal rate for portfolio as there's a possibility for a 40+ year retirement for they last surviving partner. So a minimum of $1.2 M at 3.5% would be needed (more if using 3.0%), probably at anywhere from 40/60 to 60/40 allocation to meet minimum needs. (a look at Firecalc shows that moving to that much higher equity doesn't help that much in success) Now that doesn't include future long term care, potential buy-in for CCRC's or the like, but likewise once both are on SS the income needs from the portfolio would drop, and potentially be added to the bucket for future care needs.

 

[W2R]

I have a FERS federal pension, SS, and I also withdraw $600/mo from my TSP "G Fund" (a stable value fund). All of this more than covers my usual ongoing expenses.

But, one never knows what the future might bring. So I'm glad to have portfolio income that I could spend if need be. I figure my AA based on only my portfolio, and the rest of it is "gravy" IMO.

 

[pb4uski]

We are working on our asset allocation strategy. Even though we are both accountants, it is one of our struggles. DH receives a pension that is almost half of our annual budget. How do we add in the pension to our allocation strategy? We are currently about 80% stocks with the balance in CD’s and bonds.

You don't.

Your annual withdrawals from your portfolio will be your planned spending less the pension, aka the gap. And then look at your withdrawal rate (gap divided by asset value) and see if it is excessive. For those who retire early, before pensions or SS start, it isn't uncommon for early year withdrawals to be more than 4%, but what is most important is the ultimate withdrawal rate once pensions and SS start.

Have you run your situation through FIRECalc? What you will find is that the success rate (probability of not running out of money) isn't all that sensitive to asset allocation (AA). Success rates are about the same for AA's between 40/60 and 90/10. So while for that broad range of AAs the success rate is similar, what is different are the terminal values (portfolio values at the end of the time horizon) with higher stock allocations generally resulting in higher terminal values.

Retired Big 4 CPA here, and I taught Intermediate Accounting at our local community college for a few years when I was working in industry in my mid-30s and really enjoyed teaching, especially the contact time.

 

[Sunset]

I think the allocation is something everyone can disagree on

(IMHO).
If you have a lot, and are taking out 2% or less of portfolio because you have pension or just have a great lot saved. Then allocation doesn't matter, either 100% stocks or bonds or anything in between will work fine.

I think where it matters is when a person has less saved and/or no pension, then statistics say 60/40 to 80/20 would work.

I do think age plays a factor, and when age 80+ , I think security and safety play a large role and and would go mostly bonds with maybe 30% stocks.

 

[jollystomper]

We are working on our asset allocation strategy. Even though we are both accountants, it is one of our struggles. DH receives a pension that is almost half of our annual budget. How do we add in the pension to our allocation strategy? We are currently about 80% stocks with the balance in CD’s and bonds.

Our approach was to determine, beyond my pension, what we would need to cover yearly expenses. then keep whatever X years of that amount (adjusted for expected inflation) one is comfortable with in cash/short term fixed income. With what is left, set the AA to whatever one feels comfortable with.

 

[skyking1]

You don't.

Your annual withdrawals from your portfolio will be your planned spending less the pension, aka the gap. And then look at your withdrawal rate (gap divided by asset value) and see if it is excessive. For those who retire early, before pensions or SS start, it isn't uncommon for early year withdrawals to be more than 4%, but what is most important is the ultimate withdrawal rate once pensions and SS start.

Have you run your situation through FIRECalc? What you will find is that the success rate (probability of not running out of money) isn't all that sensitive to asset allocation (AA). Success rates are about the same for AA's between 40/60 and 90/10. So while for that broad range of AAs the success rate is similar, what is different are the terminal values (portfolio values at the end of the time horizon) with higher stock allocations generally resulting in higher terminal values.

Retired Big 4 CPA here, and I taught Intermediate Accounting at our local community college for a few years when I was working in industry in my mid-30s and really enjoyed teaching, especially the contact time.

Thank you. That is what it is, a spending reduction, a life annuity with no COLA in our case.
As the annuitant you can't allocate a thing about it. Take it or don't.

 

[Koolau]

It is an Illinois state pension. He was an accounting Professor. Illinois sucks, but it is a state pension which makes it less risky in my mind. Also not taxed by Illinois which is a significant savings.

Yeah, most state pensions should be golden, but Illinois has had so many fiscal and financial issues that I'd be a bit leery of trusting it as my "foundation." It ain't SS!

Normally, while it's true that you don't include your pension in your AA, a reliable pension might allow you to take more risk in your portfolio. Definitely YMMV situation.

 

[Kork13]

FWIW, my thought process is that AA is all about risk management. Having a reliable pension (in my case, it'll be an immediate, federal, COLA'd pension) provides alot of security. That security allows me to accept a higher degree of risk with my investments without losing any sleep, so I intend to keep our AA mostly stocks for the foreseeable future (no less than 80% equities).

 

[Montecfo]

I would view the pension as part of my bond allocation since the income from it is analogous to that from a bond portfolio. If it were funding close to have of my spending I would probably allocate most of my portfolio to equities, other than a buffer of cash or laddered bonds for withdrawals.

This of course is subject to how much of the income from portfolio is needed for spending.

If significantly over funded, the cash/bond allocation may not be real important.

I also think the view that you just view your cash needs as being "net" of the pension has some merit. The smaller the pension is, the more that approach makes sense in my view.

Ultimately you must have ab allocation which allows you to sleep well at night.

All the best.

 

[mrfeh]

We are working on our asset allocation strategy. Even though we are both accountants, it is one of our struggles. DH receives a pension that is almost half of our annual budget. How do we add in the pension to our allocation strategy? We are currently about 80% stocks with the balance in CD’s and bonds.

You don't factor it into your AA. It's an income stream, which reduces the expenses you need to cover with your portfolio.

 

[DrRoy]

I don't do that mathematically. (My pension is about 25% of spending.) I just manage the investments to my comfort with volatility.

 

[donheff]

Ditto with others, we just subtract pensions and SS from expenses. Our portfolio allocation is based on the remaining needs and our risk profile. If the pensions were at high risk our risk profile would go up accordingly. Since they are not at high risk, we feel comfortable investing our portfolio for the long term.

 

[ecowtent]

Thanks everyone. That helped a lot. We were deducting it from our budgeted expenses, but I have questioned if that was the best way. We are only a year into retirement and still working through what we will actually spend. Budget is about $100k with half covered by pension which has a 3% annual increase. When I start SS it will cover another quarter. My spreadsheet has a range of drawdown from 3-4% depending on the year and market which works out to 80K at 3.5%. BUT I did not think about the fact that I retired before 59.5 and cant draw on my 401K. Since we have to sell a bit, we thought it was a good time to work on our AA.

 

[mrfeh]

Thanks everyone. That helped a lot. We were deducting it from our budgeted expenses, but I have questioned if that was the best way. We are only a year into retirement and still working through what we will actually spend. Budget is about $100k with half covered by pension which has a 3% annual increase. When I start SS it will cover another quarter. My spreadsheet has a range of drawdown from 3-4% depending on the year and market which works out to 80K at 3.5%. BUT I did not think about the fact that I retired before 59.5 and cant draw on my 401K. Since we have to sell a bit, we thought it was a good time to work on our AA.

Can provide more advice, but you're changing the subject now. My first 2 questions would be your age and size of your taxable accounts.

Might want to start a new thread.

 

[Cobra9777]

We have 2 small pensions that cover ~50% of expenses. Withdrawals from our 85/15 portfolio cover the other 50%. My sense is that 85/15 is a bit more equity than most ERs without a pension. The pensions provide a stable foundation against a SHTF market scenario. But of course, by electing the annuity option on both pensions, we also chose to forego some upside market potential in the long run.

Holding more equity in the portfolio shifts our overall risk profile slightly closer to the more typical no-pension ER scenario. It's a way to rebalance the 3-legged stool if you find yourself a bit heavy on the annuitization side. With 2 pensions and SS right around the corner, that definitely describes us.

Anyway, I'm not an advocate of treating pensions as a bond equivalent in the AA calculation. But I don't think it's as simple as deducting the pension from spending, and developing an AA strategy for the rest that ignores the pension. For me anyway, the preferred approach is to think about AA in the context of the overall risk profile including the pension, various market scenarios, and of course timing, age, etc.

 

[pb4uski]

Thanks everyone. That helped a lot. We were deducting it from our budgeted expenses, but I have questioned if that was the best way. We are only a year into retirement and still working through what we will actually spend. Budget is about $100k with half covered by pension which has a 3% annual increase. When I start SS it will cover another quarter. My spreadsheet has a range of drawdown from 3-4% depending on the year and market which works out to 80K at 3.5%. BUT I did not think about the fact that I retired before 59.5 and cant draw on my 401K. Since we have to sell a bit, we thought it was a good time to work on our AA.

There are various options if you need to access your 401k money before you are 59-1/2. Many 401ks allow penalty free withdrawals if you ended service after you were 55 yo. Roth contributions can be withdrawn penalty-free anytime. You can rollover some 401k money to an IRA and do a 72t/SEPP for penalty-free withdrawals.

As nother option if your house is paid off is to mortgage your house, use the proceeds to help carry you to 59-1/2 and then tap 401k money to make payments or pay down or pay off the loan.