Author Topic: Value of pension vs. salary  (Read 8757 times)

pennyhandlebar

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Value of pension vs. salary
« on: June 12, 2017, 11:26:23 PM »
I am in the application process for a state job (Oregon), which will likely pay less than my current job but does offer a pension, and trying to figure out how I should value pension vs. salary.

I'm not sure that NPV or standard calculators for valuing annuities apply here because the situation is a little bit different - I'm trying to evaluate a future stream of payments vs. a salary which will itself be invested over time.

Any suggestions for how to approach this? Here are the parameters:

-For the sake of discussion, assume a $100 monthly pension, payable starting in 23 years, and continuing...haha indefinitely, I'd like to say, but let's say continuing for 30 years.

-If I invested $8,325 today and got 6% annual return with no withdrawals, after 23 years I would have about $30k; applying the 4% rule, that would yield $1200 in annual income. The notional value of the $8,325 investment will increase because it will continue generating 6%/year (I hope), while I suppose the pension will also have a cost of living adjustment, though I don't know the details.

So...the naive approach described above says that $100 monthly pension in 23 years is worth $8,325 in annual salary today, but this kind of neglects the FIRE side of things - a pension at retirement age doesn't help you retire early.

Any other thoughts on how to approach this question?

Seppia

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Re: Value of pension vs. salary
« Reply #1 on: June 13, 2017, 12:28:58 AM »
I think it's optimistic at today's valuations to expect a 6% real return on investments made today.
Aside from the math aspect of it, you would want to keep into account the risk factor.
A pension can be 100% guaranteed (depending on who commits to pay it to you), while equities are volatile.

pennyhandlebar

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Re: Value of pension vs. salary
« Reply #2 on: June 13, 2017, 12:57:21 AM »
Sure, but the 6% is just an assumption, my question is about the process to evaluate the value of a higher salary vs. a future pension. The Oregon state employee pension system is not in great shape, so the pension may not be 100% guaranteed either.

clarkfan1979

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Re: Value of pension vs. salary
« Reply #3 on: June 13, 2017, 01:03:53 AM »
I teach at a college and I'm in a pension system. The trick to a pension is to take a really high paying and often less desirable position during the last 3 years of your career. I will probably top out as a faculty around 110K. However, it is my hope that I can get an administrative job around 150K during the last 3 years of my career. If that happens, I think a pension can be better than a 401K.

radram

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Re: Value of pension vs. salary
« Reply #4 on: June 13, 2017, 06:08:16 AM »
I treat a pension as an easily revocable promise, because that is exactly what it is. The ease of revocation varies from state to state, and job by job.

I valued my pension at exactly $0 while planning for FIRE, which is the same amount that I valued social security. Will both go to zero before I collect? Of course not, but I do not at all rely on them for FIRE calculations. Whatever I receive from them will just be a bonus.

I value 401k funds much higher, as they are in my name, are controlled by me, and have rules that allow me access (like the Roth ladder approach).

Pensions today are regarded as the scourge of state budgets, and are seen as the greatest threat to a balanced state budget. I see an almost zero chance that your starting benefit projection will be anything like what you actually see. Rely on them at your own peril.

MommyCake

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Re: Value of pension vs. salary
« Reply #5 on: June 14, 2017, 04:32:44 AM »


So...the naive approach described above says that $100 monthly pension in 23 years is worth $8,325 in annual salary today, but this kind of neglects the FIRE side of things - a pension at retirement age doesn't help you retire early.

Any other thoughts on how to approach this question?

I have no idea how to figure out the math on this question.  I do have another perspective on something though.  I disagree that a pension at retirement age doesn't help you retire early.  As a federal employee, if I retire early, I can elect to defer my pension until retirement age.  As long as you have five years of service, you are eligible to collect your pension.  Granted, the earlier you retire, the smaller the pension will be.  But still, this additional income decreases from the total amount needed to retire.

For example, if you know you have 1k a month pension starting at age 60, and you need 25k a year total, you will not be factoring in a need for 25k a year in your plan.  For hopefully many years, you will need only 13k from your retirement accounts instead of 25k.  This can be a significant benefit. 

frugledoc

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Re: Value of pension vs. salary
« Reply #6 on: June 14, 2017, 06:30:47 AM »
I think it's optimistic at today's valuations to expect a 6% real return on investments made today.
Aside from the math aspect of it, you would want to keep into account the risk factor.
A pension can be 100% guaranteed (depending on who commits to pay it to you), while equities are volatile.

Or it could be pessimistic.  If people could reliably tell they would make a lot of money on the markets.

For what it's worth,  my guess we shall see higher than 6% on the all world long term 10 years.

maizefolk

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Re: Value of pension vs. salary
« Reply #7 on: June 14, 2017, 07:37:14 AM »
The math on this can be worked out, but it's going to require some judgement calls from you about risk (for example: how likely do you think it is that the oregon pension panel goes away, is cut significantly, or receives a silent cut through changes to how inflation is considered?) and about priorities.

A couple of questions to think about/look into as you start pulling together the numbers:

Do you have a spouse, children, or charitable causes that you'd get satisfaction out of leaving money to? If so, this decreases the value of the pension and increases the value of the nest egg, since when you ultimately kick the bucket the steam of income from the pension will stop, while the principal you've saved up in your stash can go to support people or causes you care about. For some people this is a big factor. For others it doesn't matter all all.

How does your potential pension handle inflation? (Both before drawing the pension and while receiving payments.) For example, I believe many government pensions aren't indexed to inflation during the time between when you retire and when you start drawing payments. For someone who retires a couple of decades before traditional retirement age this can drastically erode the value of the pension.

BFGirl

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Re: Value of pension vs. salary
« Reply #8 on: June 14, 2017, 11:05:16 AM »
I think anyone who is accepting a pension plan as part of their compensation package needs to research the individual pension, how it is funded, if there is a shortfall, how returns are estimated, etc. 

I am expecting a pension and it will be one bucket that I rely on for retirement and I definitely include it as part of my FIRE plan.  However, my entity is legally required to fully fund every year and the pension system has adjusted it's annuity calculations for contributions going forward in the expectation of lower investment returns in the future.  My pension plan is based on contributions and matching and not on providing a percentage of final salary.  I feel fairly confident that my entity will be able to meet its pension obligations for the foreseeable future.

However, I do have other buckets to draw from.  If I were to lose my pension in the future, I would not be happy and would have to adjust my spending expectations, but I wouldn't be impoverished on the street either.


itchyfeet

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Re: Value of pension vs. salary
« Reply #9 on: June 14, 2017, 11:46:38 AM »
Without thinking too hard, I reckon the maths I'd do would be similar to your approach.

I will get a small pension from an old job that I quit years ago.  I value that pension in my NW.

Basically I calculate what it will be worth per year at the time I start receiving it (55), multiply that amount by 25 to give it a value from that point on and then discount it by 7% a year back to today.i include the discounted amount in my NW.

In effect every year from now till 55 I will receive 7% growth in this asset on my balance sheet as I unwind the discount, and this 7% return will help fund my FIRE until I actually start receiving my pension. Sure it's not cash, but if I draw down on other buckets, whilst this bucket increases in value it's just the same.

Why 7%..... it's 3% inflation + 4% real return. Quite arbitrary I suppose, but who can predict the future. 4% return above inflation would be an acceptable long term return for me on my stash.

I have thought about using a multiple greater than 25, given the pension isn't exposed to sequence of return risk and is govt guaranteed, but given it gets cut in half when I die, and DW will most likely still be living, I didn't want to get carried away with over valuing it.

I think it's awesome that I will receive a small indexed annuity from 55 till death. I just wish it was a bit bigger. I didn't realise how great it was until after I had quit the job. I certainly undervalued it.


PapaBear

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Re: Value of pension vs. salary
« Reply #10 on: June 14, 2017, 01:35:09 PM »
If you try to tackle this problem from the math end, you will see that it strongly depends on your assumptions (life expectancy and discount rate).
In the attachment, you can see different NPVs for pension payment periods of 10-40 years and 2-7% discount rate. All calculations are based on an annual pension of 1200 USD. Pension adjustments, inflation and taxes are not factored in for the sake of simplicity.

What you see, is that the NPVs strongly differ depending on the assumptions. To be honest, I would go with the assumptions of 30 years payment period and a 3-4% discount rate. This would equate an NPV today of 8.500 - 12.000 USD.

I am assuming a lower discount rate, since a pension is a lot less volatile than stocks and rather behaves like bonds. Thus, it might be not apples to apples to compare it with stocks.
However, if you take a look at your total asset allocation, the pension can play a vital part in it. You can replace parts of your bond allocation with the pension and thus move your other investments to a more risky, stock-heavy allocation. Additionally, it acts as an insurance in case you exceed your life expectancy.
« Last Edit: June 14, 2017, 02:04:53 PM by PapaBear »

Babybalrog

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Re: Value of pension vs. salary
« Reply #11 on: June 16, 2017, 08:08:11 AM »
I don't value my pension in my FIRE calculations. I wouldn't be able to claim it for 15 years after I plan to be FIRE ready. This is the same as social security. My state pension is one of the well funded few, but that's not a guarantee it'll still be here. The legislators are trying to mess with it, and not for the better. So I just view it and SS as a additional guarantee against future cost, lifestyle inflation, and poor market returns.

Also, check with your pensions inflation and COL calculations are. I don't get ANY! and Dallas/Huston are suffering because they gave too much.

 

Wow, a phone plan for fifteen bucks!