Author Topic: Need help with factoring in pension to early retirement  (Read 2070 times)

Snezzle

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Need help with factoring in pension to early retirement
« on: November 27, 2017, 12:54:44 PM »
I'm relatively new to this gig and would appreciate some help with how to factor pension into early retirement. I have to pay into a private pension via my employer (working at an international school in Europe). Fortunately, my contribution is matched by a 2x employer contribution so that's positive. I'm also using a roboadvisor with a highly diversified profile that I invest in each month. I have a target in mind for the investment using the 4% rule, but I'm not sure where the pension comes in. I can access the pension fund earlier than the country's pension age, but not as early as I would like to retire. So my question is how do I calculate how much I need in my investment? Let's assume I retire at 50 and have 1,000,000 (amount necessary to receive required income for me and husband applying 4% rule). However, Let's say at the age of 60 we can start drawing healthy pension amounts (won't be enough to fully cover all living costs, but still good). Once the pension kicks in, I have more than I need in savings; quite nice, but I'd rather retire earlier than just have lots of money. Alternatively, should I aim to save less (thereby potentially retiring even earlier) because I will eventually get my pension to supplement the amount. However, that would mean that from the age of 50 (or age I retire) to when the pension starts, I would either have to consistently draw less than 4% (not what I want) or draw the amount that I need and watch the investment amount reduce. I'm not sure which is the best option and really how to calculate this? There's also the possibility that my next job may provide no pension and the pension I'll be able to draw in future will be much smaller as a result. Either way, same question. How do I calculate for this? Thank you!

Snezzle

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Re: Need help with factoring in pension to early retirement
« Reply #1 on: November 30, 2017, 11:11:47 PM »
Anybody there? .....


headwinds

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Re: Need help with factoring in pension to early retirement
« Reply #2 on: December 01, 2017, 04:24:05 AM »
The way I account for this is by tracking my pension by it's present day lump sum value. IE, if I quit my job today and took the pension as a lump sum, how much is it worth? If you can simply look this number up on a given day it's easy. For me I had to figure out the formulas used to calculate the value. I then simply track this value as an asset along with all my other assets. It doesnt really matter if you can't take it until a certain date, you still need ~25x your total annual expenditure in order to retire, even if you have to use some assets sooner and some later.

keyvaluepair

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Re: Need help with factoring in pension to early retirement
« Reply #3 on: December 01, 2017, 01:09:06 PM »
@headwind is correct, and here is a little math to explain why:

(1) Let X(t) be a time series of monthly payments of your pension. So X(t) = 0 for t < T where T is the time when you can withdraw fixed payments. You know what T is.
(2) You have monthly income from the 4% rule, let's call this Y(t).  Let T* be the date after which you start withdrawing - your choice again. So Y(t) = 0 for t < T*
(3) Your total monthly income (ignoring taxes - you need to account for this) is X(t) + Y(t).
(4) If R(t) is the amount required to live, then you want R(t) < X(t) + Y(t). Note: X(t) + Y(t) = 0 if t < min(T, T*). Assuming T* < T, your income looks like:

0 if t < T*,
Y(t) if t T* < t < T => Y(t) > R(t) to maintain your living during this period. You have to figure out the appropriate withdrawal rate to hit R(t)
Y(t) = R(t) - X(t) for t > T. You then just need to calculate your withdrawal rate Y(t) to hit R(t) - X(t). Since I'll assume that R(t) and X(t) are fixed and inflation adjusted, this means all you have to do is to calculate the amount of withdrawal to match R - X where R is the amount needed to live and X is the pension amount.

Therefore:

(R-X) should be at least 24 times your stash as the last poster indicated. I'm just showing why @headwinds's statement makes total sense. It ignores taxation and assumes that all payments are inflation adjusted.

HTH.
kv

robartsd

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Re: Need help with factoring in pension to early retirement
« Reply #4 on: December 01, 2017, 04:08:59 PM »
If the pension adjusts for inflation between separation and withdraw as well as during withdraw, you can ignore inflation. Use 25x estimated annual pension to calculate a 4% rule value for the pension at standard retirement age. Then use a 4% annual interest rate (to match the 4% rule) to reduce the value at standard retirement age to its present value. Add the present value of pension to your other investments then apply the 4% rule.

annual withdraw = .04 * (other investments  + (annual pension payment * 25 / 1.04^years until pension))

There is more sequence of return risk between ER and collecting your pension in this model than in a normal 4% SWR model because you are taking out a larger portion of your investments (partially mitigated by the safety of the pension later).

headwinds

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Re: Need help with factoring in pension to early retirement
« Reply #5 on: December 02, 2017, 12:07:58 AM »
@headwind is correct, and here is a little math to explain why:

(1) Let X(t) be a time series of monthly payments of your pension. So X(t) = 0 for t < T where T is the time when you can withdraw fixed payments. You know what T is.
(2) You have monthly income from the 4% rule, let's call this Y(t).  Let T* be the date after which you start withdrawing - your choice again. So Y(t) = 0 for t < T*
(3) Your total monthly income (ignoring taxes - you need to account for this) is X(t) + Y(t).
(4) If R(t) is the amount required to live, then you want R(t) < X(t) + Y(t). Note: X(t) + Y(t) = 0 if t < min(T, T*). Assuming T* < T, your income looks like:

0 if t < T*,
Y(t) if t T* < t < T => Y(t) > R(t) to maintain your living during this period. You have to figure out the appropriate withdrawal rate to hit R(t)
Y(t) = R(t) - X(t) for t > T. You then just need to calculate your withdrawal rate Y(t) to hit R(t) - X(t). Since I'll assume that R(t) and X(t) are fixed and inflation adjusted, this means all you have to do is to calculate the amount of withdrawal to match R - X where R is the amount needed to live and X is the pension amount.

Therefore:

(R-X) should be at least 24 times your stash as the last poster indicated. I'm just showing why @headwinds's statement makes total sense. It ignores taxation and assumes that all payments are inflation adjusted.

HTH.
kv

This went over my head TBH which has always been my problem in math - intuitively arriving at a correct answer without being able to explain why doesn't hold water with math teachers.

Snezzle

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Re: Need help with factoring in pension to early retirement
« Reply #6 on: December 02, 2017, 12:19:16 AM »
Indeed the math did go over my head, too, but I'm actually going to sit down and do it as some stage as it (eventually) helps me get my head around things. However, from what I can understand so far: Let's say I save 800,000 in investment before retiring at 50 at which time I also have 200,000 lump sum value in my pension (because I won't still be paying into it if I've retired early). I then start taking how much I need to live on from the 800,000 investment. This means that this investment will start to decrease a bit because I'll be taking out say 40,000 and with the 4% rule only accruing 32,000. This means each year my 800,000 investment is decreasing by 8,000 because I'm withdrawing more than the interest I'm getting. If I do that for 12 years until the pension kicks in at 62 then I'm down 96,000 overall. However, at this time, my pension then kicks in so I won't need to over withdraw from either account because the pension will compensate for the 96,000 that I'm now down overall? I appreciate this is all very simplified and doesn't account for things like me becoming a part time model and uber driver or an incredible time with the markets meaning a 10% return on everything, but am I along the right track?

headwinds

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Re: Need help with factoring in pension to early retirement
« Reply #7 on: December 02, 2017, 02:38:53 AM »
In short, yes, assuming your pension appreciates at approximately the same rate (we're assuming 4%) as your other investments. If you retire with 800K in investments and 200K value in pension, you should be fine for a yearly cost of living of 40K. My pension actually appreciates at 6% guaranteed (written into the plan), however I plan to take the lump sum disbursement on the day I retire in order to mitigate the risk of my employer going bankrupt before I collect the disbursement. Thus, for me the situation really is as simple as counting the lump sum as any other investment, given that I can roll it into a traditional IRA without having to pay tax on it at that time.

robartsd

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Re: Need help with factoring in pension to early retirement
« Reply #8 on: December 04, 2017, 12:17:17 PM »
This thread inspired me to compare my current lump sum to the current value of the pension benefits I've already accrued (if I quit today, what pension payment would I be eligible for later). My pension plan allows retirement payments to begin as early as 50 and the benefit factor increases quarterly until age 63. If I separated from employment now, I could roll a lump sum of $27,887.62 (contributions+interest) into an IRA or take $303/month until both DW and I die starting at age 50 ($541 at age 60, $646 at age 63). I calculate the present value of taking monthly payments at age 50 as $53,025.48 (age 60: $52,866.51, age 63: $53.002.73) assuming 4% rule for monthly payments and 6% APY between separation and withdraw. Using 4% APY between separation and withdraw gives me present values of $63,241.99 for age 50 (age 60: $76,282,82, age 63: $80,977.05).

Edit - corrected last assumed APY.

« Last Edit: December 04, 2017, 02:14:06 PM by robartsd »

Retire-Canada

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Re: Need help with factoring in pension to early retirement
« Reply #9 on: December 04, 2017, 01:56:22 PM »
How do I calculate for this? Thank you!

You can run some cFIREsim simulations using the expected pension amounts and various retirement portfolio values. It will give you an idea what combination of investments and pension meet your needs.