Author Topic: Help with pension math  (Read 2638 times)

CommonCents

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Help with pension math
« on: April 14, 2014, 09:17:04 AM »
I'd like to be able to put a "figure" to my pension so I can visualize it as part of my stash.

There's an entire grid, but for one stat, if I work 10 years, I can collect 15% of my last salary at age 65 55.  (Or 32 years working, I could retire after hitting my 65th birthday a few months later, but that's way too long working.)  http://www.mass.gov/treasury/docs/retirement/retirementchart.pdf 

I could calculate this as (.15 x Salary)/.04 to get a figure that if a stash instead of a pension, my stash would be expected to throw off that amount every year.  Except...my pension is not indexed for inflation and I'm not sure the best way to capture the decreasing value of the pension in the calculation.  Suggestions?
« Last Edit: April 14, 2014, 10:06:34 AM by CommonCents »

warfreak2

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Re: Help with pension math
« Reply #1 on: April 14, 2014, 09:51:15 AM »
There's a few similar threads around. What you want to do is calculate the net present value of the income stream. Since it's not linked to inflation, you're going to have to adjust each payment down by the expected value of inflation, so you need an estimate (3%/year is typical). You're also going to need to know your life expectancy, as that determines how many payments you expect to receive. After you have those details, it's a geometric sum:

NPV = (ps)(1 + i)a - r(1 - (1 + i)r - e - 1)/i

Where
p = 0.15 (your percentage of final salary)
s = ? (your final salary)
i = 0.03 (expected inflation rate)
r = 65 (the age you retire)
a = ? (your current age)
e = ? (your life expectancy)

The 4% rule is inapplicable here because that calculates an inflation-adjusted income stream, which doesn't necessarily end when you die.
« Last Edit: April 14, 2014, 09:57:28 AM by warfreak2 »

CommonCents

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Re: Help with pension math
« Reply #2 on: April 14, 2014, 10:06:07 AM »
Thanks!

Brian Romanchuk

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Re: Help with pension math
« Reply #3 on: April 14, 2014, 10:57:10 AM »
Another easy way to do it is to look up the prices of annuities. That tells you how much it would cost to buy your projected pension stream now. You then need to "discount" that value to present (in Canada, you could use the price of strip bonds - bonds that do not have coupon payments) to directly read off how much $100 at a future date is worth now.

The advantage of this method is that the annuity provide embeds life expectancy into the calculation, as well as an appropriate interest rate. The disadvantage is that annuities are an expensive product, so the pension may be worth less to you than this method indicates.

I used to build fixed income pricers. I like simple methods when I can use them.

ToughMother

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Re: Help with pension math
« Reply #4 on: April 14, 2014, 11:06:35 AM »
Hey CommonCents,

I'm a MA gov employee too, looking at the 10 yrs/55 version of the math (I'll be 56 at 10 years service).

Anyway, here's the retirement calculator: http://www.mass.gov/treasury/retirement/retirementestimator/estimate.html

This way you can include whatever survivor option you choose and it adjusts your expected pension accordingly.