Pensions and the 4% rule

[MichaelB]

Even then, pension fund payouts are still based on a projection of future returns, and also the future number of participants. Back during the subprime fiasco and the resultant market meltdown, there was a lot of media coverage of pension shortfalls, and also many threads here in this forum about the subject.

Technically, future payouts are determined by the pension calculation formulas. The fund solvency and ability to meet the commitments are determined by contributions, participants and future returns.

 

[Mulligan]

Technically, future payouts are determined by the pension calculation formulas. The fund solvency and ability to meet the commitments are determined by contributions, participants and future returns.

Yes, its all about actuarial assumptions, and there are a lot of them I read with mine… The base funding is 14.5% employer contribution and 14.5% employer match, with assumed 7% rate of return. But that is only the beginning and is meaningless without other assumptions in conjunction with it. Such as percentage of retirees women and percentage men, life expectancy, age at retirement, inflation rate, etc. etc. There are a lot of categories. Mine tends to “pad” some numbers as I have read the average death of retiree has been almost 2 years less than assumed age of death. So I guess they are factoring in future longer life expectancies.

 

[CardsFan]

But when the market goes gangbuster as it has been doing the last few years, things get quiet down and people just want to forget about this. Man, it's been more than 10 years already.

I was going to correct your first comment on the timing, but then I see you corrected it yourself.

It has been a crazy time for the market, but a great time to retire .

 

[NW-Bound]

Technically, future payouts are determined by the pension calculation formulas. The fund solvency and ability to meet the commitments are determined by contributions, participants and future returns.

Yes.

I did not say it right.

What I meant was that originally, the payouts were projected to be reasonable based on the actuarial assumptions at that time. With time, these change, and are no longer valid.

An obvious example is SS, which became more and more underfunded with time, even though several aspects of the benefits have been cut back.

 

[TheWizard]

Yes, its all about actuarial assumptions, and there are a lot of them I read with mine… The base funding is 14.5% employer contribution and 14.5% employer match, with assumed 7% rate of return. But that is only the beginning and is meaningless without other assumptions in conjunction with it. Such as percentage of retirees women and percentage men, life expectancy, age at retirement, inflation rate, etc. etc. There are a lot of categories. Mine tends to “pad” some numbers as I have read the average death of retiree has been almost 2 years less than assumed age of death. So I guess they are factoring in future longer life expectancies.

I assume you mean employEE contribution, and that total amount is a LOT.

I didn't have a pension but did have mandatory 403(b) contribution of 5% of salary from me, plus 10% from my employer.
Over 40 years, that added up to a lot in my 403(b) account, the majority of which was in stock funds.

I annuitized a goodly portion of that amount (with TIAA) when I retired, so it's kinda like a pension, except for the individual accounts.

I did get around a 6.5% initial payout on the annuitized amount, not 4%...

 

[old medic]

Sorry for any trouble my question caused. Was an honest question. Not having a pension myself, I don't click on pension threads, so I was wholly unaware of the prior drama.
It certainly was not my intent to cause trouble.

As someone that is fixing to retire on a state pension, , I thank the OP for asking. It has made me investigate a few things.
Including my "Pension Spiking" plan.... By not taking vacations and rolling that into sick time for 31 years... I'll bring home a massive $181 more a month.. LOL. Had I used the vacation time and worked the extra 2 years It would had been about $350/MO....

 

[ERD50]

Statistics is much more reliable for large numbers than small. ... .

... My father ... drew a pension for 30 years, and my mother had 60 percent of it for another 4 years.

It was not indexed. Hence the purchasing power was greatly reduced by the final pension payment.

Two important points above. And if the OP is talking about private pensions, these are mostly non-inflation adjusted, which makes a big difference for the 4% rule/guideline. An inflation rate of 3.5% requires a doubling of the withdrawal after 20 years. Based on some rough estimates I made using FIRECalc, an inflation adjusted pension is worth about 2x what a non-inflation pension is, over a 30~40 year projection (I forget the details, but something like that).

So a non-inflation adjusted pension would require about half the resources of the inflation adjusted assumption (so ~ 12.5 x initial payout, versus 25x initial payout).

-ERD50

 

[Mulligan]

I assume you mean employEE contribution, and that total amount is a LOT.



I didn't have a pension but did have mandatory 403(b) contribution of 5% of salary from me, plus 10% from my employer.

Over 40 years, that added up to a lot in my 403(b) account, the majority of which was in stock funds.



I annuitized a goodly portion of that amount (with TIAA) when I retired, so it's kinda like a pension, except for the individual accounts.



I did get around a 6.5% initial payout on the annuitized amount, not 4%...

Yes, its 14.5% employee contribution, plus an additional 14.5% match from employer. Keep in mind its not just salary, but benefit package also. So if employer health insurance coverage is say $600 per person, the employee pays an additional $87 a month pension contribution from that benefit that is also matched by employer. So yes its expensive, but the pension is great, and properly funded, too though.

 

[PhrugalPhan]

Including my "Pension Spiking" plan.... By not taking vacations and rolling that into sick time for 31 years... I'll bring home a massive $181 more a month.. LOL. Had I used the vacation time and worked the extra 2 years It would had been about $350/MO....

Sounds like my pension plan. The powers that be keep saying its to your benefit to build up that sick time for retirement. I will tell anyone that asks to burn it instead, its more valuable that way. Not sure anyone has realized I am not kidding.

 

[old medic]

Sounds like my pension plan. The powers that be keep saying its to your benefit to build up that sick time for retirement. I will tell anyone that asks to burn it instead, its more valuable that way. Not sure anyone has realized I am not kidding.

BUT.... I would not be retiring 2 years earlier.... and I can make more than the difference pulling just one shift PT. PLUS ... 4% of my 401K is also more per year. Plus the added safety net should something occur to put me out of work... like falling out a tree.. LOL
Other folks will not take a vacation because they put the money into savings for retirement.... same difference IMHO.

 

[skipro33]

BUT.... I would not be retiring 2 years earlier.... and I can make more than the difference pulling just one shift PT. PLUS ... 4% of my 401K is also more per year. Plus the added safety net should something occur to put me out of work... like falling out a tree.. LOL
Other folks will not take a vacation because they put the money into savings for retirement.... same difference IMHO.

I agree. I saved up 1 year's worth of sick leave that counted towards years worked. I also saved up almost a year's worth of vacation which was cashed out and didn't count towards retirement. I timed retirement to late December so that the final paycheck with the accrued vacation was paid the following tax year. I would be able to live on the vacation cash-out for a year. If not for both those options, I too would have had to work at least 2 years longer.

 

[skipro33]

I will tell anyone that asks to burn it (sick time) instead, its more valuable that way. Not sure anyone has realized I am not kidding.

The company I worked for had rules on taking sick leave. The first rule is that you must be sick and the fact was, I wasn't very often. The second rule was 3 consecutive days out ill required a doctor's certification one was well enough to return to work once recovered.
Violations to these rules could result in disciplinary action up to and including termination.

 

[stepford]

Pension rules vary quite a lot. In my Megacorp only base salary rate determined pension. Overtime, vacation and sick leave had no effect, so no pension spiking was possible. A sort of "anti-spiking" was though. Because of the dependence on base rate alone, part time work (as low as 50%) counted the same as full time for pension accrual. So while it did not allow us to maximize the numerator in the benefit over effort ratio (a la spiking) we could certainly minimize the denominator.

 

[Eastbayboy]

The company I worked for had rules on taking sick leave. The first rule is that you must be sick and the fact was, I wasn't very often. The second rule was 3 consecutive days out ill required a doctor's certification one was well enough to return to work once recovered.
Violations to these rules could result in disciplinary action up to and including termination.

Sounds like my old company AT&T!

 

[firemediceric]

At the risk of drawing the ire of some who look down on municipal employees who will benefit from a pension, I am hoping to enjoy that reward perhaps as soon as 18 months, or maybe a few years. I am not the sharpest tool in the shed. I am often embarrassed when perusing the forum. I realize how ignorant I am of many things finance related and how short I fall from those of you who have directed your lives so much better from the beginning than I have done.

If not for my pension I would not be at all set for retirement. No one to blame for that but myself, mostly. Terrible life direction as a child. Bad decisions as a young adult. Late start in the fire service. Two failed marriages. Despite all that flashes through my mind as I type that brief history, the pension I have paid 9% of my base salary in to for the past 24 years will soon be a real savior. After 25 years I will receive 85% of my salary. That 85% is based on the average of my 5 highest years of income. No pension spiking. Overtime, saved sick time and saved vacation time do not get figured in to that 85% calculation. Just my base salary as a fire lieutenant along with my paramedic pay.

Regarding sick and vacation time, I do benefit by cashing in a surplus at the end of each year. Cashing those surpluses in is what funds my Roth IRA each year, but that's because of what I choose to do with the payout.

For me, that 85% at my current rate of pay per the actuary will be $5664 per month. At 6 years of retirement I will receive a 3% COLA each year. By benefit of a negotiated supplement I will also receive $5850 per year from day one. Also another $487 per month until I receive Medicare, at which point the $487 per month goes away. I am responsible for my own medical insurance when I leave my job. That $487 until Medicare is the only thing I'm getting from the employer towards my medical insurance. All that added together comes out to $6638 per month ($79,659/year) when I start retirement. The number will change slightly as my salary increases a little over the next year.

I will be paying Federal tax on the benefits but I'm told I will not be paying Social Security tax.

All of this disclosure leads to a question. I've been told that looking at my retirement benefit through the lens of the 4% withdrawal mantra, my pension is the same benefit to me as if I had saved $2 million due to $80K being 4% of $2M. Is that true?

Maybe it's true for my lifetime but not a reality for any heirs because there's no residual money after I die?

 

[stepford]

All of this disclosure leads to a question. I've been told that looking at my retirement benefit through the lens of the 4% withdrawal mantra, my pension is the same benefit to me as if I had saved $2 million due to $80K being 4% of $2M. Is that true?

Maybe it's true for my lifetime but not a reality for any heirs because there's no residual money after I die?

This is exactly why we often have [-]arguments[/-] discussions on this forum about whether pensions should be included in net worth. I think they should be (since we use NW as a proxy for overall availability of money), but you're right that the fact that that pensions go away when we die makes the comparison with more durable forms of NW inexact.

As far as the "value" of your pension I use online annuity calculators rather than the 4% rule, but regardless, your $2M valuation for an $80K/yr COLA'd pension is entirely reasonable.

 

[1242Vintage]

All of this disclosure leads to a question. I've been told that looking at my retirement benefit through the lens of the 4% withdrawal mantra, my pension is the same benefit to me as if I had saved $2 million due to $80K being 4% of $2M. Is that true?

If your curious to estimate what you would have needed to save to generate a $80k a year pension, use a present value calculator.

The present value calculator tallies the present value of payments made over a future period of time and based on a specific rate of return.

You’ll need to estimate how many years you’ll live … I retired at 56 and am using 30 years … and then plug in the other numbers into the calculator.

https://www.calculatorsoup.com/calculators/financial/present-value-calculator.php

 

[beernutzbob]

I was required by law to contribute 7.5% of my salary to my state pension system for the last 27 years. My employer also contributed that amount to the system. That is a lot of cheddar over a long time which if I'd instead invested in a low cost total market index fund would likely be worth what a SPIA equivalent to my pension would cost today.

I believe that seeing what an SPIA equivalent to your pension benefit would cost today using immediateannuities.com provides a better valuation of a pension benefit.

My pension benefit is determined by a combination of years of service and the average of my top 3 salary years out of the last ten times 2%. This top 3 rule has hurt me as I had some higher earning years more than ten years ago which now no longer can be used in the benefit calculation.

 

[chassis]

I was required by law to contribute 7.5% of my salary to my state pension system for the last 27 years. My employer also contributed that amount to the system. That is a lot of cheddar over a long time which if I'd instead invested in a low cost total market index fund would likely be worth what a SPIA equivalent to my pension would cost today.

I believe that seeing what an SPIA equivalent to your pension benefit would cost today using immediateannuities.com provides a better valuation of a pension benefit.

My pension benefit is determined by a combination of years of service and the average of my top 3 salary years out of the last ten times 2%. This top 3 rule has hurt me as I had some higher earning years more than ten years ago which now no longer can be used in the benefit calculation.

I just noticed your signature - Bogleheads survivor. Congratulations, that is no easy feat!

 

[brett]

In the early nineties the average 'overhead' charge for an employee at the megacorp where I worked was 51 percent.

That meant for every dollar of salary, the cost to the company was $1.51. The amounts consisted of benefits, pension, vacation entitlement, education, etc.

Fast forward 25 years and that number was down to 24 percent, $1.24 per dollar of salary. DB replaced with DC, less benefit coverage, much less employee edu, etc, etc.

 

[stepford]

In the early nineties the average 'overhead' charge for an employee at the megacorp where I worked was 51 percent.

That meant for every dollar of salary, the cost to the company was $1.51. The amounts consisted of benefits, pension, vacation entitlement, education, etc.

Fast forward 25 years and that number was down to 24 percent, $1.24 per dollar of salary. DB replaced with DC, less benefit coverage, much less employee edu, etc, etc.

Something had to pay for all those stock buybacks (and you knew it wasn't going to be reduced executive compensation).

 

[TheWizard]

This is exactly why we often have [-]arguments[/-] discussions on this forum about whether pensions should be included in net worth. I think they should be (since we use NW as a proxy for overall availability of money), but you're right that the fact that that pensions go away when we die makes the comparison with more durable forms of NW inexact.

As far as the "value" of your pension I use online annuity calculators rather than the 4% rule, but regardless, your $2M valuation for an $80K/yr COLA'd pension is entirely reasonable.

Coming up with a Present Value for a pension is mainly of use in determining how much the pension fund needs to have to be adequately funded.

But the 4% rule was devised for confidence over a 30-year retirement span, from age 60 to 90, for instance.
This is needed for many do it yourself individuals since we have no idea what our actual lifespan will be, so we need to be prepared for the long duration case.

But only a fraction of age 60 people will survive to age 90, so a pension can safely fund $80k/year COLAd pensions for a lot less than $2M per retiree, probably less than $1.5M...
*actuarial arm-waving*

 

[Out-to-Lunch]

All of this disclosure leads to a question. I've been told that looking at my retirement benefit through the lens of the 4% withdrawal mantra, my pension is the same benefit to me as if I had saved $2 million due to $80K being 4% of $2M. Is that true?

Maybe it's true for my lifetime but not a reality for any heirs because there's no residual money after I die?

I think you have grasped the essence of this. Yes, you would have to had amassed ~$2M to support your lifestyle in the same way, so your pension could be considered to be "worth" that much. But, no, a pension does not confer ALL of the benefits as having an actual $2M bucks. You cannot fund lumpy expenses, you cannot pass any residual on, etc. And most (but not all) of the time, someone withdrawing 4% per annum will die rich. OTOH, you are guaranteed not to run out of money, which is not true with the actual $2M nest egg.

It is a difficult comparison. Ask yourself: If you actually had $2M, and you had the chance to buy an annuity with that payout characteristics, would you buy it? I think most people would not go 100% into the annuity, which is a tacit admission that it is not "worth" the same.

 

[stepford]

But only a fraction of age 60 people will survive to age 90, so a pension can safely fund $80k/year COLAd pensions for a lot less than $2M per retiree, probably less than $1.5M...
*actuarial arm-waving*

The calculator at immediateannuities values a *non-COLA'd* pension paying $80K/yr starting at age 55 (the OP's projected age at retirement) at something over $1.7M. Including a COLA should significantly increase that value (I've heard factors from 1.5-2x often used).

It is a difficult comparison. Ask yourself: If you actually had $2M, and you had the chance to buy an annuity with that payout characteristics, would you buy it? I think most people would not go 100% into the annuity, which is a tacit admission that it is not "worth" the same.

Or perhaps just a tacit admission of the value of diversification?

 

[TheWizard]

The calculator at immediateannuities values a *non-COLA'd* pension paying $80K/yr starting at age 55 (the OP's projected age at retirement) at something over $1.7M. Including a COLA should significantly increase that value (I've heard factors from 1.5-2x often used).

That seems high, but then age 55 is a bit young.

And then there's the Selection Issue with annuities where someone with a serious illness history is not likely to buy a lifetime income annuity.

But pensions go to everyone in the particular organization, serious illness folks and smokers included.
So there's an actuarially different pool for pensioners vs annuitants...