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I'm a retired government worker with an old-fashioned defined benefit pension. The pension has no true COLA, but increases 1.5% annually.
Had a conversation with a younger friend whose retirement plan is (or will be one day) a combination of 401K's and Roth IRAs.
My friend said my pension's value is its annual gross payout divided by an average expected rate of return on most people's 401K and/or IRAs.
I'm not sure that's the way to look at it.
My pension has no cash value, though my DH will receive 50% of the pension if I die first. If he dies first, after my demise, my pension simply ends. Whereas, people with 401Ks and/or IRAs always have access to the whole of their monies in them, as well as the ability to bequeath those monies to their heirs. Conversely, my friend upon retirement, will spend down his 401K and IRA assets annually to live on.
To me, my pension has no value other than my annual income. But I am curious if there is an actuarial answer to this question.
The old rule of thumb was to have a 4% withdrawal rate from retirement accounts.
So - multiply your annual pension amount by 25 - THAT'S how much cash you'd need to have on hand to get the same amount of money each year from an equivalent retirement account.
to have a pension that increases annually 1.5% is too huge to give it a price in my book. Many pensions to include my two do not increase annually. Some years there is no increase like SS has had.
The old rule of thumb was to have a 4% withdrawal rate from retirement accounts.
So - multiply your annual pension amount by 25 - THAT'S how much cash you'd need to have on hand to get the same amount of money each year from an equivalent retirement account.
Thanks. I am in a defined pension and wondered the same thing. I don't get an annual increase, though. Some years we will get a COLA. 2020 will be the first one.
The problem with the 4% rule in calculating the value of a pension is that rule is meant to make the 401k or IRA last forever. With a pension there is an end date.
The true way to calculate the value is what is the actuarial lifespan of the pension group and what is the return you could get through investments.
So a pension might pay one party $50,000 and another party $50,000 and the average return of 5% some would say it is worth $1 million. You would not need $1 million to fund a $50k pension with a 5% return if the payout only needs to be for 15 years and you have zero at the end of the 15 years.
The benefit of defined benefit pensions is you pool the lifespan risk. You have to do that differently with an IRA or 401k
The problem with the 4% rule in calculating the value of a pension is that rule is meant to make the 401k or IRA last forever. With a pension there is an end date.
The true way to calculate the value is what is the actuarial lifespan of the pension group and what is the return you could get through investments.
So a pension might pay one party $50,000 and another party $50,000 and the average return of 5% some would say it is worth $1 million. You would not need $1 million to fund a $50k pension with a 5% return if the payout only needs to be for 15 years and you have zero at the end of the 15 years.
The benefit of defined benefit pensions is you pool the lifespan risk. You have to do that differently with an IRA or 401k
No. The 4% Rule applied to personal saving/401Ks etc is only good for a 30 yr survival rate. Not indefinitely.
In fact, it is for a 96% chance of surviving 30 years
Ultimately it's a probabilistic, actuarial calculation. For a single-person in poor health and already advanced age, the actual value of the pension will be low. For example, for a single person retiring at age 70, living for another 10 years, ignoring COLA and inflation (for simplicity) with a $2000/month pension - we arrive at $240,000 total payout. If an investment portfolio were to be intentionally spent down to $0 over 10 year, we'd have an equivalent portfolio of, uh, $240,000. If instead we used the 4%-withdrawal rule, which as has already been mentioned is often regarded as the "safe" rate of withdrawal, the "equivalent" portfolio is $600,000 - again disregarding inflation or COLAs. And if we downscope to a 2% rate, used by some as being commensurate with "guaranteed" stability of principal in a conservative (low stock percentage) allocation, the equivalent portfolio is $1.2M. Now assume a higher life-expectancy, or a married pension-recipient with a spouse who survives him/her by decades; the "equivalence" becomes entirely different.
So, what's wrong with these calculations? First, it's emotionally painful to dip into one's portfolio. It becomes a creature of one's obsession, and not a piggybank. A pension is by definition something to be spent, while a portfolio is for many of us something to be horded. Second, as Tom1944 pointed out, the defined-benefit pension levies the actuarial risk onto the pension-provider, while the portfolio's risk is borne by the owner. The pension offers peace of mind. How do we value that? Finally, and most important to me personally, the promise of a pension, of a monthly check, is a regular pat on the back, a testament that one structured one's life salubriously. Can a price-tag be placed on that?
Thanks for the input. I now better understand the value of my pension.
Since we're working on our taxes and have all prior years on disc, I added up my gross pension since retirement. As of the end of last year, after 13.5 years of retirement, it totals $875K.
I was lucky to retire at age 50; I'm 64 now and in good health.
I just have to hope the plan's performance and viability remains good.
To me, my pension has no value other than my annual income. But I am curious if there is an actuarial answer to this question.
Yes, there is a well established way to put a value on it. You find the present value of future cash flows using a well known formula for that. You would have to assume a depreciation rate which might be controversial but it would be around 4% I would think.
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