Pension vs. Cash

[GTM]

I have met a number of people who are retiring young with real good pensions. (50k to 100K) per year. some COLA.

What do you think is more valuable

A good pension from a good source or a good nest egg invested.

 

[wabmester]

A pension is just an annuity.   Most people think they can get a better return investing on their own than the implied rate of return in a pension or annuity, but that obviously depends on both the pension/annuity and the investor in question.

 

[grumpy]

Someone would have to offer me a tremendous pile of cash in exchange for my federal pension under the Civil Service Retirement System (CSRS). Where else could I get a risk free investment backed by the full faith and credit of the US gov't that is guarenteed to keep up with the CPI?

I had to contribute 7.5% of my salary to this system during my 32 years of federal service. I haven't run the numbers but I don't see how I could have invested that 7.5% to generate the return represented by my pension.

Grumpy

 

[CyclingInvestor]

I would choose the nest egg. It would require a pretty massive pension
to replace the 401K + rollover IRA that I have built up since 1983 by
contributing 10-15% plus employer match (about 12* gross income),
and I feel much more comfortable investing the money myself.

I also doubt if most pensions would let me retire at 47, which I could
do now. Strangely, now that I can walk out anytime I feel less reason to
actually do so, since my only previous source of stress was fear of being
laid off and not finding a new job, which has happened to several friends
in IT.

 

[Patrick]

I have met a number of people who are retiring young with real good pensions. (50k to 100K) per year. some COLA.

What do you think is more valuable

A good pension from a good source or a good nest egg invested.

You can't tell which is more valuable without putting some numbers to both.  According to SG, pensions are worth about 22 times their annual value in cash investments.  I.E., $10k/year pension = $220K cash.

 

[LiveWell]

I'd prefer the nest egg. I think I'm a pretty good investor and when I pass on that nest egg (if there is any left) could go to my heirs. Also, if life throws you a curve ball (maybe good or bad) then its nice to have a nest egg around so you can draw a bigger chunk out if you need to.

 

[maddythebeagle]

Another point is the match for 401k's varies quite a bit. I suspect that some of the large state pensions like Calpers do well based on their size and leverage. Are you considering 2 different jobs and trying to compare the 2? I think that I would prefer a 401k with a solid match since pensions you usually have to be 55 to get payments. And in the corporate world, the 401k would be your money.

 

[Nords]

I had to contribute 7.5% of my salary to this system during my 32 years of federal service.  I haven't run the numbers but I don't see how I could have invested that 7.5% to generate the return represented by my pension.     Grumpy

If the federal govt would give me the lump-sum equivalent of my COLA pension payments then I'd take it in a heartbeat.

With today's low interest rates & slowly-rising inflation the actuarial calculation would drive the lump sum to a pretty impressive number. I, of course, would invest that in 100% stocks and have a much higher return than the equivalent monthly amount that I'm getting now.

You can't tell which is more valuable without putting some numbers to both. According to SG, pensions are worth about 22 times their annual value in cash investments. I.E., $10k/year pension = $220K cash.

OK, now I'm drooling. Anyone know how to convert today's $33,864/year pension with future CPI-U COLAs into a lump sum?

 

[MasterBlaster]

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

 

[smooch]

But remember - If you don't have LTC insurance and your spouse needs a nursing home, your 401(K)/403(B) is available for Medicaid. Your pension is not.

 

[Nords]

The main reason that my FIL took his pension as a lump sum was his paranoia that MegaCorp wouldn't be around to pay it as long as he'd be around to cash it. Just because he's paranoid doesn't mean that they're not out to get him...

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

For some reason I expected this to be much more complicated. I guess it's easy for the govt to assume that inflation will stay 3.3% in perpetuity. In fact it's quite a bit to their advantage.

Perhaps another way to do it would be to plug the numbers using I bond yields, currently 4.8%. But I'm sure they'd prefer to use the 4.5-3.3% approach.

Even the govt might grudgingly acknowledge my potential to make it to 75-- that's 30 years. Chou's calculator (with 1.2%) gives me a lump sum of $852,803.22. Plugging that into FIRECalc's 100% stock portfolio with an ER of 0.18 and PPI inflation gives:
"A withdrawal of about $36,329.42 is the highest withdrawal that would have survived 95% of the periods tested, using the equity split and other criteria you entered. This would be a withdrawal starting at about 4.26% of your starting portfolio, with adjustments for inflation."

So for higher volatility I'd get a minimum of an extra $2500/year. Of course I'd have no incentive to outlive my actuarial longevity goal, which in my case is to collect more retired pay from the fed govt than I collected active-duty pay from the U.S. Navy. (For extra bonus points I'll try to achieve that as inflation-adjusted dollars.)

But remember - If you don't have LTC insurance and your spouse needs a nursing home, your 401(K)/403(B) is available for Medicaid. Your pension is not.

Uh, spouse? Gee, what spouse?

Well, you raise a very good point there.

Besides having a monthly payment for life makes me worth more to my spouse alive than dead. With a lump sum there would be no such assurance...

 

[maddythebeagle]

I like that calculator Master, thanks.

 

[sgeeeee]

You can't tell which is more valuable without putting some numbers to both.  According to SG, pensions are worth about 22 times their annual value in cash investments.  I.E., $10k/year pension = $220K cash.

You have to be careful with this approximation. It was true for one case I looked at. That case assumed a non-COLA'd pension that comprised only a small part of the total retirement income. It also assumed a 50/50 stock/bond allocation for the rest of the portfolio. For a COLA'd pension, you can be pretty safe using a 25x rule.

 

[MasterBlaster]

A few Comments:

But remember - If you don't have LTC insurance and your spouse needs a nursing home, your 401(K)/403(B) is available for Medicaid. Your pension is not.

Don't count on the rules of Medicare/Medicaid staying the same. Those programs are in deep financial trouble. The rules are bound to get tougher and less generous.

like that calculator Master, thanks.

I don't know if you noticed but Mr chow must like to program calculators. take a look at his retirement and investment calculators:

http://www.hughchou.org/calc/

There's enough calculators there to analyze your stash till the cows come home.


For a COLA'd pension, you can be pretty safe using a 25x rule.

what a coincidence, the inflation adjusted pension at 25x is just the 4 percent safe withdrawel rate. The difference is that your heirs get to keep the principle.

 

[sgeeeee]

. . .For a COLA'd pension, you can be pretty safe using a 25x rule.

what a coincidence, the inflation adjusted pension at 25x is just the 4 percent safe withdrawel rate. The difference is that your heirs get to keep the principle.

That's a good point. From the point of view of personal income safety, the 25x (4% rule) is a good approximation of the value of the COLA'd pension. But there is a big difference in that valuation formula as far as your heirs are concerned.

 

[HFWR]

There's enough calculators there to analyze your stash till the cows come home.

Giving heroin to the junkies??

 

[unclemick]

Mr Hugh - was MY HERO - back in my webtv days - calculator wise. Still visit his webpage from time to time.

 

[renferme]

Pension or Lump Sum ? ?
I didn't have a choice, had to take the pension,
but, if I could have taken the Lump, I would not have been able
to invest it and get as much out each year that I now get from the
pension.
That's why it's a tough decision - you generally cannot get as much
out each month as you would with the pension.
However, with the Lump, you don't have to worry about your pension
going broke.
A way to prove my point, is to go to Vanguard and go thru the screens
to give you an Immediate Annuity. Use the amount of the pension per month,
and it will tell you how much it costs to buy the annuity. That cost is the value
of your Lump (sometimes your company won't tell you what your pension is
worth in a Lump sum format). If your company is giving you less than that,
then you're getting cheated and are better off with the monthly pension.

 

[kz]

Neither hubby or I were allowed to take the lump sum but we're certainly not complaining. Our state pensions are fairly substantial and guaranteed not to fall less than the amount at which we retired. And we could retire as early as 53. DH did just that while I technically retired at 50.

We also contributed 7.5% or our salary to our pensions each yr with a 7.5% match from our employer. (state law)

 

[Jay_Gatsby]

Strangely, now that I can walk out anytime I feel less reason to
actually do so, since my only previous source of stress was fear of being
laid off and not finding a new job, which has happened to several friends
in IT.

This is a little OT, but the foregoing statement resonated pretty soundly with me. I think this is the biggest source of stress for many people, including those who LBYM. The LBYM-types wouldn't necessarily be stressed out by the lack of a job, but rather by the effect such a situation would have on FIRE.

 

[BigMoneyJim]

The LBYM-types wouldn't necessarily be stressed out by the lack of a job, but rather by the effect such a situation would have on FIRE.

Heh, that's what's hitting me lately. I'm set for a few months of joblessness and/or a paycut but I want to keep this train moving full steam ahead and cringe at the thought of taking a lower paying job. (I'm wanting to move this year but don't have opportunities with my company in the forseeable future.)

Nords, when I used the paranoid/out to get me line in my other post I hadn't read this thread yet. Great minds think alike, huh?