Author Topic: How to factor in a traditional company pension into my savings rate?  (Read 4122 times)

missj

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I work for a private company that has a traditional pension.  I know this is becoming more and more rare.  This pension will not affect my social security eligibility (unlike some government pensions that replace social security).

Every time I calculate my savings rate and convert that into #years until I retire, I am always disappointed.  Then I remember that I still have a pension I'm not accounting for.

Also, I am now 100% vested in this plan (everyone is after 5 years, and I have 7 years with the company).  Obviously the amount of my final benefit increases with each year I work, but I already qualify for at least something upon retirement.

Any pension/defined benefit whizzes out there who can help me evaluate the "worth" of my pension?


MDM

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #1 on: July 20, 2015, 02:14:20 PM »
If in addition to having a pension at all, that pension includes a cost of living adjustment, subtract the pension income from your expected retirement expenses in the formula below.  See http://forum.mrmoneymustache.com/ask-a-mustachian/will-i-be-ready-to-retire-in-2-years/ for similar discussion.

Time in years to FI = Ln((S + i*E/WR) / (S + i*A)) / Ln(1 + i)

A = Amount currently invested in funds you will draw upon in retirement, $
E = Total (including taxes) annual expenses in retirement (today's dollars) - in your case, net after pension.
i =  Real return on invested retirement funds, e.g., 3% (conservative - we hope...)
S = Annual amount invested in funds you will draw upon in retirement, $/yr
WR = Withdrawal Rate planned for retirement, using Trinity Study definitions (e.g., 4%)

There is a version of this already coded in Excel on the 'Misc. calcs' tab of the case study spreadsheet.
« Last Edit: July 20, 2015, 02:25:33 PM by MDM »

beltim

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #2 on: July 20, 2015, 02:15:58 PM »
Here's how I would do it: each year, figure out what your pension benefit would be at retirement age, whenever you think you'll take it.  Multiply the annual benefit by 25 to get a "portfolio equivalent" - i.e. if you had to replace it using your portfolio, you'd use a 4% SWR.  Then, discount that to present dollars using an appropriate discount rate - I'd use 9-10% given that that's the historical nominal (not inflation-adjusted) stock market return.

Make sense?

missj

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #3 on: July 20, 2015, 02:58:01 PM »
Here's how I would do it: each year, figure out what your pension benefit would be at retirement age, whenever you think you'll take it.  Multiply the annual benefit by 25 to get a "portfolio equivalent" - i.e. if you had to replace it using your portfolio, you'd use a 4% SWR.  Then, discount that to present dollars using an appropriate discount rate - I'd use 9-10% given that that's the historical nominal (not inflation-adjusted) stock market return.

Make sense?

I don't really understand the discounting part.  I know WHY it needs to be done,  but I don't understand HOW.  Let's pretend my pension at age 65 would be worth $4,000 per month (probably somewhat accurate). The lump sum amount at age 65 is a little mor than a million,  I remember that much.  What do I do with that number to "discount" it properly?
« Last Edit: July 20, 2015, 03:01:22 PM by missj »

beltim

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #4 on: July 20, 2015, 03:03:56 PM »
Here's how I would do it: each year, figure out what your pension benefit would be at retirement age, whenever you think you'll take it.  Multiply the annual benefit by 25 to get a "portfolio equivalent" - i.e. if you had to replace it using your portfolio, you'd use a 4% SWR.  Then, discount that to present dollars using an appropriate discount rate - I'd use 9-10% given that that's the historical nominal (not inflation-adjusted) stock market return.

Make sense?

I don't really understand the discounting part.  I know WHY it needs to be done,  but I don't understand HOW.  Let's pretend my pension at age 65 would be worth 4,000 (probably accurate). The lump sum amount at age 65 is a little mor than a million,  I remember that much.  What do I do with that number to "discount" it properly?

Assuming you mean $4,000 per month, that's $48,000 per year, which multiplied by 25 gives a portfolio equivalent of $1.2 million.  To figure out the present value, you'd use:
X* (1 + d)^n = $1.2 million
where:
d = discount rate
n = number of years to retirement
So, for d = 10% and n = 10, for example, you'd get
X = $1.2 million / (1.10^10)
X = $462,652

Is that clear?

Also, I'd caution you to only use the benefits that you've earned to date.  That is, if at age 65 you'd get a $4,000/month pension if you worked until then, but you're currently 55, I'd only use the benefit that you'd receive if you stopped working today, since you in fact haven't actually earned the full pension benefit yet.  Plus, that way, you can track the increase in your pension each year due to working longer.

forummm

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #5 on: July 20, 2015, 03:05:52 PM »
Beltim and I were typing at the same time. Here's what I had in case it's helpful.

Here's how I would do it: each year, figure out what your pension benefit would be at retirement age, whenever you think you'll take it.  Multiply the annual benefit by 25 to get a "portfolio equivalent" - i.e. if you had to replace it using your portfolio, you'd use a 4% SWR.  Then, discount that to present dollars using an appropriate discount rate - I'd use 9-10% given that that's the historical nominal (not inflation-adjusted) stock market return.

Make sense?

I don't really understand the discounting part.  I know WHY it needs to be done,  but I don't understand HOW.  Let's pretend my pension at age 65 would be worth $4,000 per month (probably somewhat accurate). The lump sum amount at age 65 is a little mor than a million,  I remember that much.  What do I do with that number to "discount" it properly?

What's the amount of money you'd need to invest today at 10% returns to have X amount at year Y. Where X is 25 times your annual pension benefit if you took it starting in year Y. So at $4k/mo at age 65, that's $1.15 million. How much cash would you need right now to have $1.15 million at age 65 if you had a 10% return on that cash?

MDM

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #6 on: July 20, 2015, 03:06:12 PM »
What do I do with that number to "discount" it properly?

See https://en.wikipedia.org/wiki/Time_value_of_money for details.

In short, divide the future number by (1 + i)^n, where i = the assumed interest rate (aka discount rate) and n = number of years between now and that future lump sum.

This should be consistent with what beltim just posted, so if you understand both the same way you likely have it correct.

sol

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #7 on: July 20, 2015, 03:11:49 PM »
An easier method for valuing your pension is to just look at the total contributions made by both you and your employer over your working career.  That's what your employer thinks it is worth today, and already accounts for both the unknown discount rate and the unknown payout rate, assuming they are adequately funding their pension plan.

Pensions usually pay out at much higher than 4%, because they don't need or want the 95% success rate that a 4% withdrawal rate implies.  They want closer to 50% (plus their profit margin), because they're amortizing that risk across all employees and half of them will live less and more than average. 

In practice, pension systems usually assume low rates of investment return (like 4-5%) but high rates of payout (like 5-6%).  That means that for an early retiree with 25 years until they collect, and who then expects 25 years of payout, the current contributions amount should be about right.

KCM5

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #8 on: July 20, 2015, 03:13:16 PM »
I'm more conservative and just use the money I've put in. In our case, the money we put into the pension + interest is ours regardless. So we're required to put in 6%/yr, so I add 6% of my salary to my other savings, and divide by salary total. This completely ignores my employers contribution. I know this will underestimate things, but ultimately I'm just calculating the savings rate as a mental exercise to make myself feel awesome. It doesn't have any bearing on how the numbers actually shake out, due to changes in living costs and stash growth and such.

beltim

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #9 on: July 20, 2015, 03:15:06 PM »
An easier method for valuing your pension is to just look at the total contributions made by both you and your employer over your working career.  That's what your employer thinks it is worth today, and already accounts for both the unknown discount rate and the unknown payout rate, assuming they are adequately funding their pension plan.

Pensions usually pay out at much higher than 4%, because they don't need or want the 95% success rate that a 4% withdrawal rate implies.  They want closer to 50% (plus their profit margin), because they're amortizing that risk across all employees and half of them will live less and more than average. 

In practice, pension systems usually assume low rates of investment return (like 4-5%) but high rates of payout (like 5-6%).  That means that for an early retiree with 25 years until they collect, and who then expects 25 years of payout, the current contributions amount should be about right.

I have some quibbles with this, but the biggest is actually a question: do most pensions actually tell you how much they've contributed on your behalf?

sol

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #10 on: July 20, 2015, 03:23:19 PM »
I have some quibbles with this, but the biggest is actually a question: do most pensions actually tell you how much they've contributed on your behalf?

Yes there are several quibbles to be had, but we're ballparking here.

My pay stubs always report my pension contributions under deductions and my employers contributions under "benefits paid by employer" along with their 401k matching, oasdi and medicare match, and subsidized health and life insurance premiums.

MDM

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #11 on: July 20, 2015, 03:29:38 PM »
The various answers have also illustrated another point: you may have a choice between
  - taking your pension as a lump sum and investing it yourself
  - taking a guaranteed monthly payment (that may or may not increase with inflation)

There are ways to estimate/predict which would be better.  For now it's not unreasonable to assume they would be equivalent for you, so use whichever number is easier for you to get.

beltim

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #12 on: July 20, 2015, 03:33:05 PM »
I have some quibbles with this, but the biggest is actually a question: do most pensions actually tell you how much they've contributed on your behalf?

Yes there are several quibbles to be had, but we're ballparking here.

My pay stubs always report my pension contributions under deductions and my employers contributions under "benefits paid by employer" along with their 401k matching, oasdi and medicare match, and subsidized health and life insurance premiums.

Huh, I didn't realize employer contributions were tracked on an individual basis like that.  Interesting.

Agreed on the ballparking quibbles.

missj

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Re: How to factor in a traditional company pension into my savings rate?
« Reply #13 on: July 20, 2015, 05:20:21 PM »
I am not required or even permitted to contribute to my pension.
We have a 403(b) which I do contribute to...but that is separate.

I am not aware of any place that I can see my employers contributions into my pension.   I know there is a multiplier that is attributed to My hourly wage...but it's not quite accurate because I don't get any extra credit for my bonuses or overtime.  Pension multiplier only used for straight time wages.