Author Topic: Calculating Pension vs Salary Now  (Read 1792 times)

Cowspot28

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Calculating Pension vs Salary Now
« on: August 16, 2016, 09:47:56 PM »
Hello,

I am trying to calculate the difference in overall net worth between earning a higher salary now and investing the difference vs earning a lower salary now but getting a pension later. We are currently a two earner household and one of us would like to quit now (to stay with kid), but we're having trouble determining what makes most financial sense.

Me (30): 100k, FERS retirement at age 65 (not sure if I will even be there long enough to collect)
Him (32): 40k + housing allowance, 10 years until earns pension of $26k/yr (2 yrs left on contract)

We are currently saving >60% take home and can retire in 8ish years if we continue along this current path.

If I quit now, we won't be able to save as much, but we would have the pension later.

If he quits in two years, we can save more of my salary, but we wouldn't have the pension later.

How do I calculate the net worth gain in these situations? How important is the pension?

Thanks for your help!

doggyfizzle

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Re: Calculating Pension vs Salary Now
« Reply #1 on: August 16, 2016, 10:26:14 PM »
How many years of FERS service do you have?  If you have at least 5 years of service, you can draw a pension at 62, or at your MRA (57) with 10 years of experience (with a penalty though for drawing pre-62).  If you are in the "old" FERS like me, you are only contributing 0.8% of your salary towards your pension, so it's a pretty good deal.  If you're part of one of the two "newer" FERS cohorts with a 4-5% employee FERS contribution, it's still a decent deal to draw the annuity at 57 or 62, BUT if you don't stick it out to 5 years you'll end up with a significant amount of money refunded to you if you don't choose to keep your FERS contributions with OPM.

Given the generally excellent benefits of Federal employment (TSP, healthcare, pension, access to FSA/DCA, I'd suggest (if you're set on having someone stay home) you keep working.  If you elect to set up a DCA during the open season each fall, you can elect to have some of your paycheck withheld tax-free to pay for childcare so you husband could still work part time (if his earnings are greater than childcare cost).

MDM

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Re: Calculating Pension vs Salary Now
« Reply #2 on: August 17, 2016, 12:17:11 AM »
1) How do I calculate the net worth gain in these situations?
2) How important is the pension?
1) Combination of care and guesswork, probably helped by using a spreadsheet (see below for more on this).
2) You won't know until you do the calculations.

You may want a spreadsheet in which you have a separate row (or column) for each year.  Then the columns (or rows) could include things such as
- starting balances for investments, loans, pension vesting
- gross income
- normal expenses
- special expenses
- traditional, Roth, and taxable investments
- taxes as a function of income, expenses, and investments
- pension vesting gain
- returns on investments
- ending balances for investments, loans, pension vesting

If you can do these calculations for one year, it is then relatively easy to set the next year's starting balances equal to the previous year's ending balances, and copy the rest of the calculations.

Once you have that, you can play "what if...?" to your heart's content.

Filliteracy

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Re: Calculating Pension vs Salary Now
« Reply #3 on: August 17, 2016, 07:05:07 AM »
A pension of 26K/year is equivalent having 650K and taking 4% a year indefinitely.
You didn't mention whether your current earned income of 100K and 40K respectively is pre or post taxes. Assuming not, and that you pay 30% tax on your 100K and 25% tax on your 40K, you net 70K and 30K after tax. If you are saving +60% of that income, then that means your expenses are max 40K a year.

OPTION A: If you quit, you likely aren't going to be able to save anything substantial while maintaining current expenditures. Therefore, unless you already have 350K to generate that other 14K a year in FIRE to complement the pension your husband will collect in 10 years, this course of action may not be the most optimal, unless you eventually intend to return to work full or part time to earn the remainder.

OPTION B: If he quits, (is the pension all or nothing? does he get a portion or at least a return of contributions?), then you have 40K of expenses on your 70K. You can probably maintain a saving rate of 40%, and save about 30K a year. In 10 years, you'd have 400K (assuming 5% return yearly compounded) which could generate 16K a year.

Hence, depends on your current net worth, (if it is less than 600K, OPTION B won't let you reach FIRE, if it is less than 350K, neither options will lead you to FIRE).

I'm Canadian so I have no clue what FERS is. Housing allowance not factored in as you didn't quantify it.

TL;DR: Pension is worth quite a bit and is the better option.