Calculating a pensions value

[1962colreb]

Assuming one is retiring immediately, how would you calculate
the value of a lifetime pension ?

[Mr Mark]

Assuming one is retiring immediately, how would you calculate
the value of a lifetime pension ?

Sort of depends on a few things you don't state, i.e. is it tax free? Currency? Country? Risk of default? Spousal survival benefit?

I'll assume money is pretax US$ in USA just for you, then:

1/ The quick and dirty route.
Does the pension get adjusted for inflation?
If so and you are using a 4% SWR then annual pension x 25 = "FIREstach equiv $"

2/ Doing it properly.
On a more median economic basis you should NPV the expected cashflow, based on your life expectancy, today's* annual pension payment and expected real rate of portfolio return (say 7% p.a.). Easy to do in excel using NPV function. *again assuming the pension will be adjusted for inflation

More conservative estimates would be replace 25x with 20x in method 1 and 5% p.a. in method 2

[1962colreb]

I just wanted to start with a basic formula before adding in the variables, even though it really
isn't much more than a ballpark estimate . Both of your answers are clear and helpful. Thanks,
I'll run some numbers this afternoon.

[bobechs]

Go to any of the various online annuity calculators and determine how much the purchase price would be for a life annuity with similar features to the pension; survivor benefits or what have you.

Eg.,   https://www.immediateannuities.com/annuity-calculators/

According to this, a 60year old male would need to put down $100,000 to buy a single life annuity of about $500/ mo. Or $6,000/yr., so that is just about what a pension is worth, since you could buy a pension of that amount for that premium.

[dogboyslim]

Most plans have an option to get an estimated benefit before you take your distribution.  Honestly this is your best bet to get a ballpark of its worth.  Pensions have many different terms and conditions and benefit calculations.  Some are easy...x% of highest(or last) 3-5 years for each year of service.  Some are very complicated and may differ based upon COLA terms or other benefits.

[MDM]

For a defined benefit pension, I use a formula of: N * 18,000

Where each $100/mo the pension pays= N

E.G. a $2000/mo pension (N=20), 20*18000=360,000

Granted, I'm neither a math nor finance wizard and have no idea where I go this equation from, so take it with a sizable grain of salt!

It may have come from the Present value of a perpetuity, if one assumes a 6.67%/yr interest rate.

[Mr Mark]

The annuity prices show how conservative a 4%WR really is for 'old' people. If you're 30 I doubt they would give you such a deal.

[dogboyslim]

For a defined benefit pension, I use a formula of: N * 18,000

Where each $100/mo the pension pays= N

E.G. a $2000/mo pension (N=20), 20*18000=360,000

Granted, I'm neither a math nor finance wizard and have no idea where I go this equation from, so take it with a sizable grain of salt!

It may have come from the Present value of a perpetuity, if one assumes a 6.67%/yr interest rate.

You have to include the mortality rate in the calculation, so this would likely overstate the value.  The IRS approved mortality table is here: https://www.irs.gov/pub/irs-drop/n-16-50.pdf  For simplicity sake, (most people don't want to deal with mortality and interest discounting) I would assume an estimated date of death and an estimated return and discount it that way.

Lets say I have a pension of 20,000 a year and assume a portfolio return of 5%.  If I'm 62 now, I'll estimate I die at the end of my 85th year.  That means 25 payments, the first occuring now.  The one I get next year will be worth 19,047 in today's dollars (20,000/1.05) and so on until my death after the 25th payment.  Add these up and you'll get a value of ~$296,000.  You can add or subtract years based upon when you will might die, and you can vary the interest rate.  The lower the rate you choose, the greater the present value of the income stream and vice-versa.

[MDM]

It may have come from the Present value of a perpetuity, if one assumes a 6.67%/yr interest rate.

MDM, you're very kind, but I assure you that I wasn't the one to do the math on that. I have an MA in cultural studies, which qualifies me to perform or analyse an interpretive dance to convey the idea, but not to derive a mathematical equation. Surely I read it somewhere - likely on this forum.

Also, I agree that a weakness of the valuation that I posted is that it doesn't consider longevity. Still, until I see a better model it's what I'll use to figure the value of my pension when estimating my pension's contribution to my NW.

Valuing things like pensions vs. lump sums, when to take SS, etc., that depend on the future are really very simple.  All you need know is the future return on your money and how long you'll live - simple, eh? ;)

The N * 18000 could have come from assuming infinite lifetime and a 6.67% interest rate, or a 15 year lifetime and 0% interest rate, or something else.  It gives a result that is probably "in the ballpark" and thus probably good enough for rough estimates.  Enjoy!

[dogboyslim]

Value of a perpetuity is = payment / interest rate for the period.  If the payment is $1 per month, and the annual interest rate is 6.67%, the nominal monthly interest rate is 0.5556%.  1/.0055556 = 180.  180 time your N value of 100 = 18000.  If you want to add in the length of your retirement, use these:

Code: [Select]

Years   6.67%           6.00%           5.00%           4.00%
5   5,786   5,894   6,061   6,234
10   9,240   9,542 10,022 10,536
15 11,718 12,247 13,108 14,059
20 13,494 14,252 15,513 16,944
25 14,769 15,739 17,387 19,307
30 15,682 16,841 18,847 21,242
35 16,338 17,658 19,985 22,828
40 16,808 18,264 20,871 24,126
45 17,145 18,713 21,562 25,189
50 17,387 19,046 22,100 26,060
55 17,560 19,292 22,520 26,773
60 17,685 19,475 22,847 27,357
65 17,774 19,611 23,101 27,835
70 17,838 19,712 23,300 28,227

Note that all of these express the value of the payment stream as of the beginning of the month PRIOR to the first payment.  The years = years of retirement until the payment stops.  The first row is the portfolio return assumption.

[aperture]

Calculate internal rate of return for what the pension pays year by year.  https://www.kitces.com/blog/how-to-evaluate-the-pension-versus-lump-sum-decision-and-strategies-for-maximization/ 

[MDM]

Calculate internal rate of return for what the pension pays year by year.  https://www.kitces.com/blog/how-to-evaluate-the-pension-versus-lump-sum-decision-and-strategies-for-maximization/

All you need know is the future return on your money and how long you'll live - simple, eh? ;)

E.g., see the chart near cell M94 on the 'Misc. calcs' tab of the case study spreadsheet.  For Kitces' example of "Jerry, a 65-year-old male, is eligible for a pension of $50,000/year (on his life only), or he can receive a lump sum payment of $600,000. How does Jerry choose?", the result is

[Michael in ABQ]

I was just about to post a thread on this same topic. I'm in the National Guard and assuming I stay in about 6-7 more years I will be eligible for a pension once I turn 60. Unfortunately there's a lot of variables involved in calculating what it will be as it's mainly dependent on my rank when I retire, how much time in service I have (i.e. a deployment for a year would mean a big increase), and how military pay is increased over the next 25-30 years. The formula is 2.5% per year based on my annual base pay when I turn 60. For active duty it's a simple 50% if you put in 20 years. After 20-30 years in the National Guard I'll only have accumulated the equivalent of say 5 years of active duty so it would work out to 12.5%.

In present dollars I figure it will be around $8,000 - $10,000 per year. However, since it will be calculated on the base pay for my rank/time in service when I turn 60 I figure it will be closer to about $15,000 per year with inflation. My life expectancy is 99 according to an online calculator and when I run out 39 years of payments increasing 1.5% per year for COLA, then discount it back at 8% I get a NPV of about $210,000. If I then discount that back to present at 8% I'm coming up with about $26,000. Seems rather low. Obviously if I use a lower discount rate these numbers will go up but I think that's unrealistic as I expect to earn more than 4-5% on any money invested now over a 30+ year period.

I guess the problem is that it's so far out. At 32 any income collected in my 70's or 80's is discounted to almost nothing. As I get older and closer to that date the present value will increase so by the time I'm ready to FIRE in say 10-20 years it may be worth $100-200k.

[gggggg]

I have a majorly hard time with retirement calculators because of my pension. Our state's pension is all over the place. It is a solid pension, in the top 5 state pensions in the US; the problem is that the state drastically alters what it contributes every year. Some years they actually withdraw from it, instead of adding; some years they contribute large amounts. I only count my own contributions when figuring my net worth, as this is what I'd get if I left the job early.