The Fat Pension

[newellcr]

Hello Folks,

Someone always has a comment about a fat pension, but what's it really worth? That depends on the plan, of course. A recent thread on military pensions started me thinking more about pensions and I figured I start a thread on the real value of them so there would be something in the archive. I don't think that there is a need to cover every caveat and detail. I just wanted to give folks an idea of what a pension is worth other than describing it as "fat" or "big". I'd encourage other folks to post a quick description of their plan and run through a quick set of numbers if they'd like to share.

I'm covered by the new federal pension (FERS) the basic benefit of the pension is similar to the current corporate pensions as far as I understand. Under FERS, employees are required to contribute .8% of each pay to fund a portion of the benefits. The basic pension then pays 1% of the average of your high 3 annual salaries for each year of service. 30 years equals 30% of what is typically a little less than your last years salary. There is also a "company" match for the TSP (think 401k) with a maximum benefit of 5% that is gained if 5% is contributed. TSP vesting is different than pension vesting. Nothing can be collected from the pension before the minimum retirement age (MRA). The MRA is between 55 and 57 based on your year of birth. Let's just call it 57. I plan on working in constant year dollars and a real rate of return so the math doesn't get obnoxious.

The basic benefit. An employee who makes $50k/yr, has worked the magic 30 years, and meets the MRA would typically get a little less than $15k/yr (benefit based on high three not just final year salary). Which is probably worth about $300k which would then be converted into an annuity... (I'd use the 4% SWR if this was a lump that was accessible by the retiree, but it isn't. IMO, there is a real benefit to a lump, maybe this is a good assumption, maybe not.) To have a $300k lump available in 30 years at a 6% real rate it would take about $300/mo investment.

Additional benefits. Then there are health benefits and a special supplement until SS kicks in. The health benefits are worth approx $8k/yr and the SS supplement is worth approx $12k/yr. These figures are best guesses. Both of these benefits are available until the retiree turns 62 and is eligible for Social Security. The retiree is then no longer eligible for these benefits and is expected to apply for SS benefits to replace them. So the health benefit and supplement is worth about $100k total. To have a $100k lump available in 30 years at a 6% real rate it would take about $100/mo investment.

Employee cost of retirement plan. This employee could have contributed no more than $50k/yr x .8% x 30yrs = $12k total. The typical person gets promotions and smaller raises in addition to COLAs so a wild guess might be they paid in no more than 75% of the max. This would work out to about $300/yr. Investing $300/yr on your own at a 6% real rate would give you an account of about $25k.

Then there is the TSP (401k) match that could either be considered a retirement benefit or not since it isn't tied to the same vesting requirements as the pension is. I'm deciding to exclude this as a retirement benefit, but here's what it might be worth, just for fun. Using the same type of salary figures as above in the employee cost part. The invested match is worth about $156/mo. Again using 30 years and a 6% real return, the TSP would be worth about $150k. Using a 4% SWR, this is worth $6k/yr. Since the plan requires 5% employee contribution to get the 5% match, the retiree has about $12k/yr income from the TSP.

So what's it worth? For this retiree, the basic pension is worth about $300/mo. The additional benefits are worth about $100/mo. The opportunity cost of the plan to the retiree is about $25k. So the real benefit is worth about (300+100-25) is $375/mo. And the retiree will have $39k/yr available plus any other savings or IRAs (15k/yr pension + 12k/yr SS + 12k/yr TSP swr = 39k/yr).

Is 57 early, dunno, but leave earlier and the benefits are worth less... Make more money, it's worth more... There are enough guesses and approximations here to argue with. I didn't even mention a reduction in pension for survivor benefits...

Cheers,

Chris

 

[Bookm]

Greetings newellcr:

Someone always has a comment about a fat pension, but what's it really worth?

Good post. I posed a question of a similar nature the other day on another board. Another poster supplied me with several links to a professor at Baylor named William Reichenstein on valuing assets for retirement planning and asset allocation purposes. Reichenstein suggests the proper way to value a pension to figure its value after taxes, since its value to you isn't really the $300k sitting in the account and you'll be paying for things with after-tax dollars. Here's a link to one of his papers, if you're interested.

Bookm

 

[lets-retire]

I'm not going through all of the math, because it's early and it gives me a headache. But my state retirement is 3% per year of the final 5 year average. I believe the minimum full retirement requirements are 25 years or 6 years and 55 years old. I plan to retire with only 15 years service. If I plan on receiving benefits immediately they will be reduced by 5% per year I'm short of full retirement. The redcution will cause my retirement benefit to be about $12,000 per year. This number is assuming no subtanitial increases in the pay scale, only the annual COLA and merit raises. If I don't collect until I am elegible for full retirement then the benefit goes up to about $20,000.

We do have a deffered comp program, but no department match. With the limited investment options for the deffered comp I do not see it as a benefit as an IRA has more options and returns as good.

 

[grumpy]

My pension is certainly what I consider to be fat. I retired under the Civil Service Retirement System (CSRS) at age 55 with 32 years service and 1 year of unused sick leave credited toward the retirement calculation. My pension is approximately 56% of the average of my three highest years of salary. This also provides for a 55% survivor annuity for my wife after I die. Uncle Sam continues to pay 72% of my health insurance premiums (excellent family coverage under Blue Cross).

Grumpy

 

[Mr._johngalt]

Yep, I couldn't last out my first day.

JG

 

[Michael]

I would think the main benefit of defined pensions is that they allow the option of letting the portfolio stay relatively untouched during the crucial first few years of retirement. A person with a pension, even one not indexed for inflation, is less likely to have to take out the full 4% if a bear hits early on, which improves the odds of future portfolio growth. The Pay Out Period Reset Method may then allow them future improvements in living standards, and an extra cushion in case health care costs continue to spiral out of control.

 

[Mr._johngalt]

We have no pension, nor will we. I now view our "long bonds" as a kind of pension (or maybe an annuity).
They provide a significant (to us) income and will
remain untouchable for the forseeable future.

JG

 

[Rich]

The motto, “I’d rather be luckyRe: The

The motto, "I'd rather be lucky than good," applies to me. I put twenty years in the NYPD, retired with a 50% pension of my last year's earnings in 1990 and took another law enforcement position out of NY State. In my new job, after buying back my four years of military service (cost me around $18,000 dollars), I'll have 21 pensionable years (16 actual) when I retire in Feb 2007 (51.5% of my last three years salary). And I qualify for SS, as I've paid in 26 years of "substantial earnings." As I said, I didn't plan it this way. Heck, when I joined the NYPD in 1969 I didn't even know what the salary was...

 

[unclemick]

I think 'lucky' turned out for us - the stock market from 1993 - ?? while not having to draw on our IRA/401k rollover. History gave us a cushion the first 11 yrs of ER.

Good thing - my non cola pension will continue to fade in the stretch.

 

[Eagle43]

I have two pensions; one military; one mega-corp. Both are nice, with Mega's, of course, being the fat one. The military health benefits are really fat, I think, considering what most people pay for insurance. Mega-Corp's pension is reduced when I turn 62 (next month), but... with the addition of DW's and my Social Security, not a dime's worth of difference. And, the nice thing about it is Mega-Corp's pension never appreciates, but Social Security and Military pensions do.

Michael got it right. The pensions allow us to just reinvest all dividends and basically yawn at the market ups and downs. It took a long time to get them, but from this side of the equation, they are worth it. Now, all I gotta do is outlive the SOBs.

 

[Mountain_Mike]

In my plan, we get 2% of your highest single year salary at age 55. We can retire as early as 50, but at that age you only get 1.2% per year...and I'll have 30 years at that point. They really penalize you for being young.

I want to be able to live just fine off the pension, and be in a position to keep an eye on the portfolio without major concerns. We'll see....

 

[uncledrz]

The pension as a base is nice, don't have one, although wife does, but don't think we could, nor do we plan to, live on it.
For those without a pension, the base can be built through a different stream of income (rents, dividends, interest, annuity, etc).
The key, IMHO, is to be able to see it coming and make the appropriate adjustments. So if you've got a pension you don't have to plan for that base, if not, 20 years of building equity in apartments or a portfolio of bonds/stocks can provide the same thing.

 

[MJ]

My minor pension of about $12K (noncola) will start in 8 years but due to inflation will probably be worth about $9k in today's dollars. My retirement plans did not include my pension as I don't have a lot of faith that the company will be around in time for me to begin collecting. If I am wrong (I hope), it will make very nice pocket money for a while.

MJ

 

[JonnyM]

In my plan, we get 2% of your highest single year salary at age 55. We can retire as early as 50, but at that age you only get 1.2% per year...and I'll have 30 years at that point. They really penalize you for being young.

I want to be able to live just fine off the pension, and be in a position to keep an eye on the portfolio without major concerns. We'll see....

I must be in the same plan, the percentages match anyway. I thank Newellcr for the first explanation of the FED system that I can totally understand. Now I get it. The Local Government DBP that every employee enrolls in upon first hire calls for a far higher contribution by the worker. It's between 6 and 7 percent of salary, a far cry from the .8% described above for the current Fed plan.

The upside is if you go your entire career with that amount withheld, you don't really miss it. You just remind yourself, that Gross salary has nothing to do with Net salary.

In my case my 23 years of service will net me about 33% of my highest 12 months of salary. We can opt for something like the FED SS offset, in that we can ask and receive a higher payout roughly equivalent to 1/2 of future SS earnings in exchange for a reduction of the Pension by that same amount x2, basically a wash if one applies for and receives SS at age 62. I'm still debating whether to do that. If choose not to, then I get a substantial raise at 62 of about 12k per year.

There is Deffered Compensation opting (457) that is completely optional with no match. It turns out to be a good method to shield income and lower taxes. During the working years, every $100 you save in this fashion only lowers your net income about $70 or so. I was a late starter in getting on the 457 plan bandwagon, but should still end up with something in the 100k range when I pull the plug next year at age 51. I'll use this money to fund the Fun-Fund.

Sure I would get a larger Pension for every year I remain (actuarily speaking I'm a step closer to my untimely death), but that's not what ER is about for me.

I just wanna be free.

 

[Mountain_Mike]

Johnny,

You mention 457 plans. We have them available as well. The plan used to only be for a fixed account at something like 4% interest. Last year, they expanded the investment options to about 20-25 mutual funds as well. I kept my fixed nest egg, but began diversifying into a combination of the fixed fund and 4 mutual funds. Like you, I consider the 457 money "gravy." I don't plan to pull the plug until I can live comfortably on the basic pension.

Good luck....Mike

 

[newellcr]

Cool, great posts here. I was away from cyberspace for a while. Gotta make hay while the sun shines and we haven't seen much sun around here lately.

Some individual replies below.

Cheers,

Chris


Bookm,

Thanks for the link. That paper will take a little more brain power than I can muster right now. I'll read through it at a later time. I tend to agree with the premise of the paper that we should value assets on an after tax basis, but this gets pretty hard to calculate and compare. Add the complexity of trying to figure out what the tax rates are going to be and will there be any rule changes in 20 years... Ouch.



Let's retire,

You mention one of the major drawbacks of a pension. To get the best value from a pension, you need to stay until you are vested AND you need to work until your minimum retirement age. Neither of which may be desirable, so ER folks accept the "early out" rules or defer until the penalty disappears. Usually these two figures tend to equal out using future value calculations... I doubt it's a coincidence. 3% sounds pretty good - are you covered by SS?


Grumpy,

Still grumpy with a pension like that?! Just kidding. 32 years worth would make me pretty grumpy too. Applying your percentages to the example I used above, 56% of $50k is $28k/yr (which isn't apples to apples because yours is 32 years vs 30 and your number has a survivor benefit). Subtract out the TSP swr and my example gives about $27k/yr. Interesting, I think that's how they designed FERS but it costs the employee more out of the paycheck. The CSRS retirement is a 7% employee contribution which is less than the SS, Medicare, and FERS contribution employee contribution. You raise another point. I think the FERS and CSRS health insurance coverage is the same %. That means my guess above of $8k/yr is really just 72% of the $8k.


Michael,

That's a great way to think about the pension. Another take is that the pension allows you to handle more market risk with your other assets than if you didn't have a pension.


Rich,

Oh boy, 50% with 20 years of service - that first pension has a value of about 25% of your salary for each year of that working career. The second one is more difficult to calculate with the purchased years, but of similar value. That's great!


UnckleMick,

An un-COLAed pension seems almost cruelly calculated on an employers part, doesn't it? My wife's pension is COLAed strangely. She will get a 3% raise after the first year retired. This 3% figure is then the raise that is added to pension each year and the COLA never changes. If the inflation rate is 3% she will still loose almost 30% of the value of the pension over 30 years. If the inflation rate is less than 3% maybe she will make out. If the inflation rate is much more than 3%, tough cookies. Then again, the Federal pension is COLAed strangely too. I think the COLA is CPI minus 1%. I'll worry more about getting to the pension age before I worry about how the COLA is calculated.


Eagle43,

Live long...


Mountain Mike and JohnnyM,

Someone has posted that type of DBP before. Age and years of service, collecting while you are young costs them for a longer period of time. Are you guys covered by SS? 7% sounds like a lot...


Uncledrz,

You bring out a point that I really didn't (but tried to). Over the span of a long career, a pension can be replaced by savings/investment. That is provided someone is aware what the pension is worth. My example above shows the pension is worth about $400k or $375/mo over 30 years. So someone would have to replace $400k in 30 years if they didn't want to stay with company that offered the pension. Conversely, someone who wanted to jump ship after 10 years of service covered by a pension so that they could make more money) might want really think about what the pension is worth at that point, especially if they haven't tried to save...


MJ,

I hope the company hold on.

 

[Patrick]

Compared to the Fed pension, our state plan is absolutely morbidly obese! Public Safety employees can retire with 25 years of service at any age, 20 years at 50 years old. 2.67% benefit per year of service calculated on the highest 3 years averaged together. Max benefit of 75% if hired after 1986, 90% if hired 1986 or earlier. Also, an additional factor of 15.5% is added on to the total because the whole thing is paid for by the employer (salary reductions were mandated to pay for this years ago, so it's given back when the employee retires). So, it is possible to retire and get a HIGHER amount than your salary was. Example: work approximately 34 years for the 90% max, multiply by 1.155 for the adjustment factor = 103.95% of highest 3 years averaged.

 

[Mountain_Mike]

I had the chance to opt out of SS about 20? years ago and took it! I immediately opened up an IRA and started putting the amount of the SS withholding into that. I've always preferred control of my retirement savings rather than trust it to SS.

 

[Patrick]

I had the chance to opt out of SS about 20? years ago and took it!  I immediately opened up an IRA and started putting the amount of the SS withholding into that.  I've always preferred control of my retirement savings rather than trust it to SS.

Any idea how the income from your IRA compares to the SS benefit you would have had?

 

[Mountain_Mike]

Patrick,

I only kept adding to the IRA until the IRS changed the rules and made it so I had to depoit after-tax revenue. Then, I switched to a deferred comp and 403b account.

I have not run the numbers, but even if I'm worse off (which I don't think is the case) I don't care. I can start collecting from the deferred comp as soon as I retire (no age limit) and the 403b and IRAs at 59 1/2...compared to 62 with SS at the earliest. Plus, if I croak earlier, my beneficiaries will get more than they would from SS.

 

[newellcr]

Patrick,

Wow! Using a 30 and out as I did in my example yields 92.5%, or approx 25% of your salary for each year of that working career without health benefits. The 25 years of service and any age is really nice.

The example I used in my original post had a value of about 9% of the salary (including health benefits) for each year of that working career.

Cheers,

Chris

 

[newellcr]

Hello Folks,

Thanks for the replies. There are a variety of plans out there. I'm a little surprised to see the value vary this much and that there haven't been too many details other than with the government pensions. I suspect that a lot of the industry pensions look like the federal plan I described. Mostly I think that because I'm told that the fed plan was based on what industry was doing in the early 80's.

Cheers,

Chris

 

[Patrick]

Patrick,

Wow!  Using a 30 and out as I did in my example yields 92.5%, or approx 25% of your salary for each year of that working career without health benefits.  The 25 years of service and any age is really nice.  

The example I used in my original post had a value of about 9% of the salary (including health benefits) for each year of that working career.  

Cheers,

Chris

Chris, I didn't include it in my original post, but if retirees select the State insurance plan when they retire, the former employer is required to pay a subsidy for the premiums that currently maxes out (after 20 years of service) at appx. $425/month. The current premium for just the retiree is about $500/month, so the retiree only has to contribute $75/month.

Patrick

 

[Ginger]

My husband is retiring in the Fall with a 2.7% at 55 pension. (He will be 60). Medical coverage has an off-set of $12 for each year worked so his medical coverage will be minimal. My coverage will be in the $345 range per month. All our friends who are retired or semi-retired regard medical insurance to be the biggest number one "obstacle."

 

[JonnyM]

Mountain Mike and JohnnyM,


Someone has posted that type of DBP before. Age and years of service, collecting while you are young costs them for a longer period of time. Are you guys covered by SS? 7% sounds like a lot...

In my Local Government plan (interestingly based on a law called the "Retirement Act of 1937", therefore pretty far-sighted from my perspective:

We are covered by Social Security (no opt out option), and I expect a payout of a somewhat diminished 12k per year based on my DW's current estimate, she having been ER for a year now. My estimate assumes I'll keep working and making the same dollars as present, hers is based on "no income" last year as obviously she's no longer paying into SS.

Yes the 7% plus 7 % more for Fica is significant during my entire career, but keep in mind that unlike individual savings, where literal dollars matter, the 7 percent withholding for the DBP is always proportional to my Salary. Way back when in the years I was working for peanuts (grossing about 12K per year) count just as much in the final calculation as the boom salary years here at the end, but THEY BASE THE DBP on my highest 12 months, which is right now, or acutally next year when I will have maxed for my chosen profession. I'm not dedicated enough to actually do the math, but I would "guesstimate" that my Pension's value is equal to more than 50% of my total gross earnings over my career at this agency.

Our Colas are based on the CPI in general terms, but are usually not more than 3% and this year it was just 2%.

My current thinking is if I wait until 62 to begin drawing SS that extra 12K/yr will boost my buying power to about what I will have started with 11 years earlier in 2006.