Value of a Pension (Net Worth Additive)

OAG

OAG

Thinks s/he gets paid by the post
Joined
Jun 21, 2006
Messages
2,635
Location
Central, Ohio, USA
How does one value a Pension? Assume value of a COLA'd one is valued differently, and, if so, how does one assign multiple to them? Looking for the value to consider as part of one's Net Worth.
 
As long as you live a pension is perhaps your most valuable asset.

Unfortunately, it dies when you die. A death benefit could be added into your net worth along with insurance. Unless you have commuted the pension or taken a lump sum I don't think it would factor into your net worth.

Survivor benefits would carry on with your spouse, but after that the pension benefit is $0.
 
You should be able to value the pension by trying to find out the cost of an annuity with the same payouts and features (cola). Someone here can probably chime in with a specific url, but I believe there are a number of calculators online which will allow you to vary the payouts and features and will tell you how much that annuity will cost. If you haven't got the pension yet, whoever is giving it to you may also have a "cashout" figure which would be it's value.
 
I have seen pensions valued as follows:

--Multiply the annual amount by 12 for a non-survivorship pension
--By 15 for a pension with (full??) survivorship
--By 20 for a pension with a good COLA (like a federal govt pension) and no survivorship
--By 25 for a pension with good COLA and survivorship

I have no idea of these are correct in any case, let alone every case, but they give you a ballpark to play in.
 
I agree on calculating the "value" of a DB pension. The employer or government sets aside that amount usually in an individual account on retirement. They may estimate ~ 25 years payout and if you die sooner you subsidize those who live longer. I think astromeria's figures on a long term DB pension are accurate. A goldplated $50 000 pension X 25 means the employer/govt. would have to set aside $1 250 000.

That figure should NOT be included in your net worth. If you were to retire and you and your spouse die shortly thereafter, depending on the plan, the estate "might" get your contributions or a guaranteed 10 year payout, but definitely not the plan value.

For net worth purposes the same goes for CPP/OAS in Canada. You die and the estate gets a small ($2500?) death benefit. Your spouse gets a survivor benefit. My mother still receives a SS cheque each month. It has been a reliable steady source of income for her for many decades and some has been used to increase her net worth. On the other hand my father only collected for a very very short period.

A DC plan is under your control though, and it should be included in your net worth.
 
Old Army Guy said:
How does one value a Pension? Assume value of a COLA'd one is valued differently, and, if so, how does one assign multiple to them? Looking for the value to consider as part of one's Net Worth.
Click to expand...
A quick & easy way to value your military pension is to attempt to reproduce the annuity with the real (after-inflation) return of I bonds or TIPS.

The pension only affects your net worth as long as you're alive to spend the money.  And on this forum, where we can't even decide on a common definition of net worth, the value of a pension is way too far down in the weeds for most people's calculations.  It's nowhere near as exciting as f*zzy-b*nny futures.

However your pension's equivalence in bonds will dramatically affect your thinking about your asset allocation. 
 
I agree with Zipper that it can be misleading to use the present value of a pension in your net worth.  After all, you probably can't sell your pension if you need money now.  On the other hand, pension payments are properly accommodated in firecalc so that you can plan your needs for additional income in retirement.

Measuring the value of a pension by seeking a quote for an immediate annuity may or may not be appropriate.  Under certain circumstances, that may actually misvalue the pension, as I will explain in a moment.

I don't know your level of experience in this area, so I apologize in advance if this is too basic.

This all begins with the asssumption that a dollar today is more valuable that a dollar received one year from today.  To calculate how much less valuable, you must use a discount rate to find the present value of the future payment.  The calculation is as follows:  

p = yearly pension payment amount nomimal amount
x = discount rate, expressed as a decimal (e.g. 5% is .05)
n = years until payment received
*n means "to the nth power.  thus *2 is squared * 3 is cubed etc

PV = present value = p/(1+x)*n

As an example, if you receive $100 in 1 year and use a 5% discount rate, the present value of that money is 100/1+.05)*1 = 1/1.05 = $95.24.  If you don't get the money for two years, the value is 100/(1+.05)*2 = 100/1.1025 = $90.70.

To value of string of yearly payments, you need to present value each year's payment back to the start of the payment stream and then add up all the present values.   Thus, the present value of receiving two $100 payments, one next year and one the year after, using a 5% discount rate, is $95.24 + $90.70 = $185.24.  Theoretically, you would calculate your life expectancy from the payment date and present value each year as above.  If you assume you will receive pension payments for 25 years, you would do 25 present value calculations and add them together.  Ultimately, the sum approaches the value of PV = p/x.  So, for payments received over long periods of time (say, more than about 15 years), many people present value the total sum of payments by simply dividing the yearly payment by the discount rate.  In our example, if you received $100 per year forever, using a 5% discount rate, the present value would be $2000 (100/.05).

Now, you may think at this point "but I won't receive $100 every year, because my pension is COLA'd, so the equation won't work"  A good point, but it can be taken care of in the selection of a discount rate (see below)

Obviously, the selection of discount rate makes a substantial difference in the calculation of present value.  Use of a smaller discount rate makes the present value larger and vice versa (run the calculation above using 8% and the present value is only $1250).  There are typically three components that go into the discount rate.  To understand them, it helps to think that if you received the calculated present value today, how would you invest it to get the future value when it comes due?  As with any investment, the returns you demand for parting with your money include some real rate of return, some inflation rate and some premium to compensate for the risk of default.  A 30 year treasury bond is "risk free" because, under any conceivable scenario, the federal government doesn't default.  If your pension is a federal pension you may want to use 30 year treasuries.  If it is from a private company, you may need to add a few percent.  Find the company's bond rating (AAA, BBB, C etc) and look up the prevailing market interest rates for corporate bonds issued by companies with that rating.

Now we come to the COLA part.  As you may have noticed, both treasuries and corporate bonds incorporate an inflation component in their nominal return.  If you assume that your COLA formula will keep up with actual inflation over the life of your pension (a big assumption if it is based on the CPI), you can account for the COLA (which increases payments in the future) by removing the inflation factor from your chosen rate (which reduces the discount rate and therefore increases the present value). For a federal pension, the "real return rate" on TIP's might be a good rate to use, since it is inflation protected, risk free.  If it is a corporate pension, you might simply subtract the Treasury/TIP's spread from the risk adjusted corporate bond rate you chose.  Thus, for a federal, COLA'd pension, assuming a 2% real return on TIPS, the present value might be 50 times the yearly payment (i.e. 1/.02).

A quote for an annuity incorporates assumptions by the insurance company about your life expectancy, inflation and their expected investment returns.  They also want to make a profit.   These assumptions may or may not be appropriate for your situation.

One last thing to remember -- if you will not receive your pension for several years, once you have valued it per the above equation, you will need to present value that figure back to today.

       






 
 
The main value of a pension, especially a COLAd pension, is that it removes the burden of one having to come up with the funds to live on day-to-day while retired. If your annual living costs are $50k and your pension kicks out $40k, you are 80% home before you even have to look at your investments as a support system. And we have not consisered SS yet. This is a huge asset.

That said, I still like to semi-include the pensions that I have as part of my bond allocation to remind me that I can easily have a greater portion of my stash in stocks than the guy that does not have this kind of downside protection. My feeling is that if I have something of value, I want to have it reflected somewhere in my overall financial plan.
 
I believe it is appropriate to NPV your DB (or annuity) pension benefits for use in asset allocation calculations and cash flow needs.  Beyond that, it has no value in Net Worth calculations.  Net worth has no personal value after death....only in terms of Estate if that is important to you (and wasn't to me since spouse has survivor benefits from my pension anyway).

When I was making a decision for lump sum or annuity as I retired, it turns out the multiplier was ~13 and I chose the pension payments. Now I simply take my pension payment, multiply by 12 and use it as part of my FI asset allocation.

Edit: Agree with mickeyd. He posted while I was still typing.
 
If you want to get a value... and I agree that you should for a look at what is a 4% withdrawl rate...

Go to:

http://www.immediateannuities.com/

An example... Female, 66, not payment to the spouse, $5,000 per month.. the value is $746,547
 
Hijack time. All this talk about pensions and NPV of an annuity got me thinking about the perenial annuity debate. I happened to read a posting about an academic paper from Wharton on "Rational Decumulation." The abstract stated among other things, "...In particular, high levels of annuitization are shown to be rational under a wide range of risk aversion levels, even when stock market returns and annuity price loadings are assumed to be much greater than is generally the case. Ours is also the first study to model individual behavior under the possibility of default by the insurer issuing annuities. We find that even a little default risk can have a very large impact on annuity purchase decisions. We further find that state insolvency guaranty programs can have a big impact upon the levels of rational life annuity purchases..."

The actual paper is pretty dense (way beyond my patience) but the gist of it as far as I could decipher is that these guys believe people should always annuitize a minimum survival capability (Social Security or pensions may be sufficient for this). In contrast to the self directed/controlled decumulation model most of us follow they argue that it is entirely rational (and, according to them, preferable) to devote a large chunk of remaining wealth to a CPI-adjusted life annuity - even for people who want to leave an estate. Here is the link for those interested: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=917223

As per other postings above about encorporating pensions in allocation models, it follows that anyone who annuitized per these guys' recommendation could devote the remainder to a much riskier allocation than would otherwise be prudent.
 
donheff said:
these guys believe people should always annuitize a minimum survival capability (Social Security or pensions may be sufficient for this).  In contrast to the self directed/controlled decumulation model most of us follow they argue that it is entirely rational (and, according to them, preferable) to devote a large chunk of remaining wealth to a CPI-adjusted life annuity - even for people who want to leave an estate.  Here is the link for those interested:  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=917223
Click to expand...
DAVID F. BABBEL
Wharton School - Finance and Insurance Depts.; CRA International
CRAIG B. MERRILL
Brigham Young University - J. Willard and Alice S. Marriott School of Management

It'd be interesting to learn if this study was sponsored by someone...
 
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)

This is only an approximation since it uses the annual payment rather than your monthly pension amount. I use 4.5% for i and I use my current life expectancy minus current age for n.

I get life expectancy from this calculator from Wharton, although to be safe, you might want to use the upper quartile (which assumes that only 25% of the people in your category will outlive you).

I use this just to eyeball my total asset base so I can calculate my equity piece more accruately.
 
kcowan said:
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)
Click to expand...

From which one can see that as "n" approaches infinity, P = A/i
 
Thanks for all of the input. It always amazes me that a "simple" question on this board is met with so may great answers and information. Thank you to everyone again. Will work on those formula responses.
 
Nords said:
Au contraire, mon frere, there are many fine financial institutions more than happy to assuage your cashflow problems for merely the trouble of filling out a simple allotment form...

http://www.solvecashflowproblems.com/site/487657/page/83434
http://www.notecity.com/pension.htm

... and thousands more on Google.
Click to expand...

As far as I can tell, they all require that you have actually started receiving the pension.  I assumed that the OP is not yet receiving it, but upon review can see that such an assumption was unsupported by any facts presented.

More to the point, if you do sell a stream of payments, such as a pension, to any of these guys, they will use a very large discount rate and assign a very low present value.  There must be many better financing options than this.
 
Donheff...

I did not even go to the link... but I will give an opinino... (I have one for MOST things)...

This is probably TRUE for the vast majority of the people who do not spend any, or very little time, looking at all the options.. Why would I say that?? Because of how people made decison on a small credit risk of the company.. these people are risk averse.. and most people are...

So, it is hard for them to take the 4% and live on that.. it is much easier to have a monthly amount coming in which they can equate to a salary and live on that annuity... using the savings to buy the one offs or fix the broken down whatever...

With a person with more sophistication can figure out the to maximize their return and estate an annuity is not the way to go.. yes, it is easy for them but not the best decision...
 
Since I expect a COLAd pension this an issue I had to engage with. Despite being a vanguard diehard I do no subscribe to the theory that such a pension is not like a bond, that it only reduced the amount one needs to plan to cover with the portfolio.
I do see the pension as an income stream akin to bonds. And as Nords said, this permits (but does not require that I can hold more in equities. I expect to be able to ride out most market downturns by choosing which account to use and even working a bit if necessary.
While I am in the accumulation phase this has worked well, I didn't cringe too much when the market turned down in 2000. I saw those declines as a chance to buy. Now how I will feel once retired may be different.
 
I am just about ready to take my cola survival benefited state funded pension.

I will be 51 when it starts, about 2700 a month. I have a small amount in savings as we spent plenty over the years with college, medical school for the kids, buying homes.

We now have a small mortgage which is about 48K, the house is worth 340K, cars newer and paid, wife starts her small pension in 2 years of about 225 a month.I figure that I want to work part time for the rest of my life, selling kayaks running shoes working in a place like whole foods, heck even sub teaching to make an additional 15K a year, this is all before SS, which would start in 9 years the wife is older by 2 years and she worked over 20 years as an ICU nurse who is burned out and does not work now.

So I figure if I were to live 40 more years at 33K =1.2 million

Hey it is all good.

In addition we have medical bennies paid for with this pension for the both with small deductibles 400 a year and small co pays for prescriptions 15 dollars 90 day generic supply.
 
< Reposted from an old post... - MB >

Anyone know how to convert today's $33,864/year pension with future CPI-U COLAs into a lump sum


The Lump sum (present value) calculations must always assume a prevailing interest rate. Some people use the 30 year T-bond rate (maybe 4.50 % or so) or you can use whatever is reasonable.

For present values of annuities that have an inflation adjusted kicker then just use the prevailing rate (ie. T-bond rate) less the prevailing inflation (CPI rate - maybe 3.3 percent or so).

So if my numbers are correct the interest rate you'd use to compute your present value would be (4.5-3.3 = 1.2 percent)

You'll need to compute the present value of the annuity over your life expectancy which (of course) varies with age and gender.

So using my interest numbers numbers, and guessing a life expectancy of 25 years, I get a prese4nt value of $727,674.42 for your payout.

Here's a link to a calculator that will figure your lump sum given an interest rate

http://www.hughchou.org/calc/missing.cgi
 
You must log in or register to reply here.

Similar threads

O
Net worth calculator
3 4 5
Replies
111
Views
5K
mathjak107
M
M
Home Insurance Personal Property Values
Replies
10
Views
251
Aerides
Aerides
K
pension as part of net worth
7 8 9
Replies
221
Views
12K
brett
B
Jerry1
How to value a property
2 3
Replies
73
Views
2K
SecondAttempt
S
Jerry1
Silver Coin Collecting Question
2
Replies
43
Views
1K
Koolau
Koolau

Latest posts

Back
Top Bottom