How do you place a monetary value on a pension? For example, is it too simplistic to say that a $100,000 per year non-cola pension is equal in value to $2.5 Million in personal accounts from which you draw 4% annually?
No problem, the annuity calculator only gives the insurance company a 95% chance of financial survival!I think using the 4% rule overstates the hypothetical current lump sum value of your pension. That's because (1) at a 4% WR, you'd have a 95% chance of having residual dollars left after 35 yrs, perhaps a large amount...
How do you place a monetary value on a pension? For example, is it too simplistic to say that a $100,000 per year non-cola pension is equal in value to $2.5 Million in personal accounts from which you draw 4% annually?
Somewhere in one of the retirement planning books that I read a few years ago...and I have no idea which one....that was generally the way the author(s) put it forth. Their idea was to use your estimated future life expectancy...25, 30 more years or whatever...and use that number to cypher it all out. So, in the case of $100K/year non-cola, it would be like $100K x 25 = $2.5M.
Whether that is true & accurate I don't know for sure, but it certainly seemed reasonable to me.
In my case with a cola'd pension, when I ER'd, the pension plan folks gave me a document showing exactly how much I would receive each year for (IIRC) the first 40 years of retirement, along with a running total. So, by my guesstimates and ponderations, I figured my life expectancy to be somewhere round about 85...therefore I cyphered I had about (hopefully) 35 years of shelf life left. So I scribbled down the corresponding amount next to 35 years on that paper, and I used that for my exact, precise, ballpark figure for net worth calculations.....and IIRC again, it was somewhere about $1.2M +/-.
What it boiled down to was that I probably wouldn't have to live in a cardboard box in the park and/or eat ramen noodles!
No problem, the annuity calculator only gives the insurance company a 95% chance of financial survival!
I think of two reasons why some people would want to put a present value on their pension:I've got a significant DB pension, but I've never had a reason to put a PV on it. I do the typical year-by-year spending model, and it's just non-COLA'd income.
I think of two reasons why some people would want to put a present value on their pension:
2) Some people choose to treat their pension like a "bond portfolio" and want to use the present value of their pension as part of their asset allocation to fixed income.
I've got a significant DB pension, but I've never had a reason to put a PV on it. I do the typical year-by-year spending model, and it's just non-COLA'd income.
This is the correct way...essentially this is a discounted cash flow method. The issue is estimating life expectancy and interest rate. Also, some would argue...you must estimate standard deviation...as we all know that a big down year IN THE BEGINNING of the time horizon is more disastrous than one near the END.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)
I use this in my financial plan to assess asset allocation based on the present value of my three pensions.
Example: 4.5% average yield over 25 years life expectancy would yield an annual payment of about $9000 from a $100k investment.
Now the trickiest part of this is to decide what is your life expectancy. If it is above average, then an annuity is a good deal. My Dad lived to 95 when his average should have been 76. He made that pension really pay off!
That is the same formula as mine. Mine just solves for PV. The point about monthly versus yearly is a good one. Yearly is close enough for non-COLA. it is also close enough over a long period such as 25 or more years....
FV = PV * (1+r) raised to the n power (don't know how to do superscripts)
FV = Future Value
PV = Present Value
r = interest rate per period
n = number of periods
The critical thing is to match r and n. In other words, if you use an ANNUAL interest rate, then n must be the number of years. If you want to use n MONTHS, then you must divide the annual rate by 12 to get r.
I read somewhere that Bogle (or someone like that) recommends that you get conservative valuation of DB pension - like 8x annual - and then represent that as a "bond" or fixed-income asset in one's overall asset allocation.
Sounds logical to me.
T
FV = PV * (1+r) raised to the n power (don't know how to do superscripts)
FV = Future Value
PV = Present Value
r = interest rate per period
n = number of periods