Present value of COLA pension

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corn18
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Present value of COLA pension

Post by corn18 » Mon May 22, 2017 9:02 am

I'm just curious how I could calculate the present value of my military pension. It's $45,000 / year with COLA with 55% survivor benefit. I used immediate annuity to calculate the non COLA value, but can't find a place to get a quick quote on a COLA annuity. This is just a curiosity thing.

an_asker
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Re: Present value of COLA pension

Post by an_asker » Mon May 22, 2017 9:14 am

corn18 wrote:I'm just curious how I could calculate the present value of my military pension. It's $45,000 / year with COLA with 55% survivor benefit. I used immediate annuity to calculate the non COLA value, but can't find a place to get a quick quote on a COLA annuity. This is just a curiosity thing.
What a coincidence that this question is asked right when I started a thread on net worth being overrated!!

I am sure there are better calculators available which folks will share, but a quick back of the envelope calculation would tell me that the pension is worth $45,000/0.04 = $1,125,000. Basically, I am determining the amount of equity you need to have in the market to give you a 4% annual return of $45,000.

Am I too far off base, folks?

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corn18
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Re: Present value of COLA pension

Post by corn18 » Mon May 22, 2017 9:22 am

an_asker wrote:
corn18 wrote:I'm just curious how I could calculate the present value of my military pension. It's $45,000 / year with COLA with 55% survivor benefit. I used immediate annuity to calculate the non COLA value, but can't find a place to get a quick quote on a COLA annuity. This is just a curiosity thing.
What a coincidence that this question is asked right when I started a thread on net worth being overrated!!

I am sure there are better calculators available which folks will share, but a quick back of the envelope calculation would tell me that the pension is worth $45,000/0.04 = $1,125,000. Basically, I am determining the amount of equity you need to have in the market to give you a 4% annual return of $45,000.

Am I too far off base, folks?
That makes sense to me.

Snowjob
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Re: Present value of COLA pension

Post by Snowjob » Mon May 22, 2017 12:16 pm

Also depends on when it is accessible (could be worth a lot more!) then you would need to discount that back to your age today.

In any case, had I understood the present value of money 15 years ago I (and I expect many) would have made different employment choices

ex:

Start at 50k in the private sector with a higher ceiling
start at 40k in the public sector with bullet proof benefits and a million dollar signing bonus :wink:

Boy did most of us you folks screw that one up

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bligh
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Re: Present value of COLA pension

Post by bligh » Mon May 22, 2017 12:24 pm

I would value a federal pension higher than 25x the sum. 4% withdrawal rates are mostly safe over 30 years, but they are not 100% guaranteed. A COLAed pension from the government is worth much more in my opinion. I would personally use 30x the pension value. You could be on that pension for 50 years and it is as close to a sure thing as you can get.

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Re: Present value of COLA pension

Post by nspayne17 » Mon May 22, 2017 12:49 pm

The formula for the PV of an Annuity is as follows:

[CF/(r-g)]*[1-(1+g)^t/(1+r)^t]

where CF = annuity payment
r = discount rate
g = growth rate
t = time period

In your case, you need to estimate when you think you're going to die to determine t. The CF can be determined from your retirement pay

r and g are up to you. The COLA is tied to SS increases, which is based on CPI-W, which over the past 25 years is 2.7%. r should be the rate you can receive in the market for a reasonable portfolio, so think somewhere between 5 and 8% depending how aggressive you want to go.

You can plug the formula into Excel and experiment with different r's and t's to determine the NPV.

As for the survivorship benefit, the calculations are slightly more complicated. If you're interested you can PM me.

I did a lot of these to determine the value of a potential pension under the new and old retirement system since I'm in the sweet spot of having to figure out which to choose.

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Re: Present value of COLA pension

Post by bigred77 » Mon May 22, 2017 12:58 pm

Valuing that pension is going to be pretty tough to do with any degree of precision. I would agree with others that said 25X the yearly benefit is as good a rule of thumb as any (depending on age). If your 45 years old that might be a little low. If your 65 years old it might be a little high.

It's ironic to me that a COLA'd pension is held in such high regard around here (it's for good reason, I wish I had one in addition to SS) but it's actually a depreciating asset. The actual value would fluctuate based on a ton of different expectations (interest rates, inflation, etc) but expected lifespan is going to be the biggest factor in valuation. Once the pension holder and their surviving beneficiary (if any) pass away the value is clearly 0. That's a unique aspect compared to other retirement assets that I don't think people consider enough.

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Re: Present value of COLA pension

Post by The Wizard » Mon May 22, 2017 1:04 pm

It depends a lot on the age at which this pension begins.
If way younger than 65, then worth more than 25X, maybe 30X or more...
Attempted new signature...

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corn18
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Re: Present value of COLA pension

Post by corn18 » Mon May 22, 2017 1:10 pm

The Wizard wrote:It depends a lot on the age at which this pension begins.
If way younger than 65, then worth more than 25X, maybe 30X or more...
I am 51 and it started when I was 42. I think just using 25x-30x is good enough to satisfy my curiosity. Thanks a bunch! Corn

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Re: Present value of COLA pension

Post by alex_686 » Mon May 22, 2017 1:31 pm

nspayne17 wrote:The formula for the PV of an Annuity is as follows:

[CF/(r-g)]*[1-(1+g)^t/(1+r)^t]

where CF = annuity payment
r = discount rate
g = growth rate
t = time period

In your case, you need to estimate when you think you're going to die to determine t. The CF can be determined from your retirement pay

r and g are up to you. The COLA is tied to SS increases, which is based on CPI-W, which over the past 25 years is 2.7%. r should be the rate you can receive in the market for a reasonable portfolio, so think somewhere between 5 and 8% depending how aggressive you want to go.
This is not the formula.

(CF * Life) / ((1+r)^t)

You don't know when you are going to die. Maybe next year, maybe in 40 years. While we don't know how long we can estimate the chance of you receiving a payment for any given year. Life being the percent chance that you are alive. Here is a link to a Social Security actuarial table to help you figure out what that is. You are going to need a spreadsheet for this calculation because you are going to need to step through the calculations year by year.

We can tweak this easily for supervisor calculations.
(CF * Joint Life) + (CF * Single Man) + (CF * Single Woman) / ((1+r)^t)

We don't need to - or want to - adjust for inflation. This is just another point to introduce error. You are getting a COLA so use a real yield, not a nominal yield. The current 10 year TIPS bond is yielding .4%. While not prefect it is a good place to start.

We can dump G - there will be no growth in the portfolio.

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Re: Present value of COLA pension

Post by ubermax » Mon May 22, 2017 4:31 pm

alex_686 wrote:We can tweak this easily for supervisor calculations.
(CF * Joint Life) + (CF * Single Man) + (CF * Single Woman) / ((1+r)^t)
The OP provided some data , we should use what we can , I think the expression should be : CF(PV SLA of primary annuitant) +(.55)CF(PV SLA secondary annuitant) - (.55)CF (PV Joint Life Annuity) ; one responder seemed familiar with a military pension and said the cola was linked to SS increases and so maybe OP should use the average of CPI-W together with a reasonable nominal rate , maybe 4% .

We definitely need the age of both annuitants and then maybe someone could make a mortality assumption and build a spreadsheet to do the calculation but I don't get the impression that OP would appreciate any more precision than a simple multiple applied to the annual benefit ; he wants a Q&D I think :happy .

Good Luck OP :sharebeer

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Re: Present value of COLA pension

Post by Valuethinker » Tue May 23, 2017 3:46 am

bigred77 wrote:Valuing that pension is going to be pretty tough to do with any degree of precision. I would agree with others that said 25X the yearly benefit is as good a rule of thumb as any (depending on age). If your 45 years old that might be a little low. If your 65 years old it might be a little high.

It's ironic to me that a COLA'd pension is held in such high regard around here (it's for good reason, I wish I had one in addition to SS) but it's actually a depreciating asset. The actual value would fluctuate based on a ton of different expectations (interest rates, inflation, etc) but expected lifespan is going to be the biggest factor in valuation. Once the pension holder and their surviving beneficiary (if any) pass away the value is clearly 0. That's a unique aspect compared to other retirement assets that I don't think people consider enough.

All annuities are "depreciating assets".

An annuity carries longevity insurance. You cannot live beyond your money. There's no other way of buying that protection. An annuity is a form of insurance.

$100k for a 65 year old would buy a COLA'd pension of about $2,200 a year right now, I believe

Therefore at age 65 I would value this at 100/2.2 = about 45 times.

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Re: Present value of COLA pension

Post by Valuethinker » Tue May 23, 2017 3:49 am

corn18 wrote:I'm just curious how I could calculate the present value of my military pension. It's $45,000 / year with COLA with 55% survivor benefit. I used immediate annuity to calculate the non COLA value, but can't find a place to get a quick quote on a COLA annuity. This is just a curiosity thing.
At age 65 I would value this at about 100/2.2 = 45 x. That being that $100k should buy you about $2,200 in COLA linked annuity right now w a survivor benefit (I am using the UK numbers, but there were such products on sale in the USA by AIG through Vanguard at one point - we have discussed them here).

You would then discount back to your current age. As a poster above points out, a real yield - -currently say 0.4% on TIPS Say that is 55, choose a discount rate of say so x 1/(1+0.004)^10

Since there is no credit risk in the payment that makes it even more valuable.

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Re: Present value of COLA pension

Post by #Cruncher » Tue May 23, 2017 7:26 am

alex_686 in [url=https://www.bogleheads.org/forum/viewtopic.php?p=3378502#p3378502]this post[/url] wrote: (CF * Life) / ((1+r)^t)
... we can estimate the chance of you receiving a payment for any given year. Life being the percent chance that you are alive. Here is a link to a Social Security actuarial table to help you figure out what that is. You are going to need a spreadsheet for this calculation because you are going to need to step through the calculations year by year. (underline added)
Yes, that is the best way to do it. You forgot to include the link, Alex. I generally use the 2013 SSA Period Life Table along with this longevity estimator spreadsheet to do the year by year calculations and compute the present value.
alex_686 in same post wrote:We can tweak this easily for supervisor [superior ?] calculations.
(CF * Joint Life) + (CF * Single Man) + (CF * Single Woman) / ((1+r)^t)
OK, bearing in mind that
  • "CF" isn't the same for all three cases. The original posts say "55% survivor benefit". We need the original poster (or someone familiar with military pensions) to say whether this means
    1. Pension drops to 55% when either annuitant dies or
    2. Pension drops to 55% only if primary annuitant dies first. I.e., if secondary annuitant (spouse) dies first, it remains at 100%.
  • "t" is 1 for the first year of the pension, 2 for the second year, etc.
alex_686 in same post wrote:We don't need to - or want to - adjust for inflation. This is just another point to introduce error. You are getting a COLA so use a real yield, not a nominal yield. The current 10 year TIPS bond is yielding .4%. While not prefect it is a good place to start
Yes, discount rate should be based on real yields -- assuming that "COLA" means completely inflation-indexed. (For some pensions "COLA" means a fixed percent increase each year. And for others it means indexed to inflation but with an annual or cumulative cap.)

Assuming the following, here is what I estimate as the pension's value using the longevity estimator with the 2013 SSA Period Life Table.
  • Original poster is male and spouse is female.
  • Spouse as well as OP is age 51.
  • Benefit drops when either dies. (From $3,750 per month to $2,062.)
Discounted at 0.4% : $1,310,000
Discounted at 1.0% : $1,180,000
Discounted at 2.0% : $1,010,000

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Re: Present value of COLA pension

Post by Ketawa » Tue May 23, 2017 7:59 am

#Cruncher wrote:The original posts say "55% survivor benefit". We need the original poster (or someone familiar with military pensions) to say whether this means
  1. Pension drops to 55% when either annuitant dies or
  2. Pension drops to 55% only if primary annuitant dies first. I.e., if secondary annuitant (spouse) dies first, it remains at 100%.
This is the Survivor Benefit Plan. The pension only drops if the primary annuitant dies first. While both are alive, premiums are due for the SBP. If the spouse dies first, premiums are no longer due and the SBP is in a suspended status. Based on my brief research, a 55% survivor benefit is full coverage and premiums costs 6.5% of the pension amount. It isn't clear from the OP if the $45K pension is net of SBP premiums.

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Re: Present value of COLA pension

Post by bigred77 » Tue May 23, 2017 8:03 am

Valuethinker wrote:
bigred77 wrote:Valuing that pension is going to be pretty tough to do with any degree of precision. I would agree with others that said 25X the yearly benefit is as good a rule of thumb as any (depending on age). If your 45 years old that might be a little low. If your 65 years old it might be a little high.

It's ironic to me that a COLA'd pension is held in such high regard around here (it's for good reason, I wish I had one in addition to SS) but it's actually a depreciating asset. The actual value would fluctuate based on a ton of different expectations (interest rates, inflation, etc) but expected lifespan is going to be the biggest factor in valuation. Once the pension holder and their surviving beneficiary (if any) pass away the value is clearly 0. That's a unique aspect compared to other retirement assets that I don't think people consider enough.

All annuities are "depreciating assets".

An annuity carries longevity insurance. You cannot live beyond your money. There's no other way of buying that protection. An annuity is a form of insurance.

$100k for a 65 year old would buy a COLA'd pension of about $2,200 a year right now, I believe

Therefore at age 65 I would value this at 100/2.2 = about 45 times.
I don't think that's the price of a COLA'd pension in the US. I'm not at that stage of life where I've looked into such a product myself but I thought I had seen posts around here indicating you could purchase one that started around (or maybe even slightly above) an initial payout of 4% of premium (assuming age 65). Maybe someone who's priced one recently can chime in?

If I remember correctly there are limitations now like a cap on annual COLA increases or something similar? So you can't really purchase ones with identical terms to SS or other US government issued pensions. Should be close enough for comparisons sake though.
Last edited by bigred77 on Tue May 23, 2017 9:36 am, edited 1 time in total.

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CyberBob
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Re: Present value of COLA pension

Post by CyberBob » Tue May 23, 2017 8:07 am

William Jennings, a professor of finance at the Air Force Academy, along with William Reichenstein, a professor at Baylor University have written an academic paper on how to calculate the value of a military pension.

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Re: Present value of COLA pension

Post by Valuethinker » Tue May 23, 2017 9:55 am

bigred77 wrote:
Valuethinker wrote:
bigred77 wrote:Valuing that pension is going to be pretty tough to do with any degree of precision. I would agree with others that said 25X the yearly benefit is as good a rule of thumb as any (depending on age). If your 45 years old that might be a little low. If your 65 years old it might be a little high.

It's ironic to me that a COLA'd pension is held in such high regard around here (it's for good reason, I wish I had one in addition to SS) but it's actually a depreciating asset. The actual value would fluctuate based on a ton of different expectations (interest rates, inflation, etc) but expected lifespan is going to be the biggest factor in valuation. Once the pension holder and their surviving beneficiary (if any) pass away the value is clearly 0. That's a unique aspect compared to other retirement assets that I don't think people consider enough.

All annuities are "depreciating assets".

An annuity carries longevity insurance. You cannot live beyond your money. There's no other way of buying that protection. An annuity is a form of insurance.

$100k for a 65 year old would buy a COLA'd pension of about $2,200 a year right now, I believe

Therefore at age 65 I would value this at 100/2.2 = about 45 times.
I don't think that's the price of a COLA'd pension in the US. I'm not at that stage of life where I've looked into such a product myself but I thought I had seen posts around here indicating you could purchase one that started around (or maybe even slightly above) an initial payout of 4% of premium (assuming age 65). Maybe someone who's priced one recently can chime in?
Interesting. The days when you could do that in the UK are long gone. Note, however, that you would get about 4% if you had a fixed (ie non COLA'd) annuity.
If I remember correctly there are limitations now like a cap on annual COLA increases or something similar? So you can't really purchase ones with identical terms to SS or other US government issued pensions. Should be close enough for comparisons sake though.
Interesting. Thank you.

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Re: Present value of COLA pension

Post by EATaxGuy » Tue May 23, 2017 10:15 am

Ketawa wrote:
#Cruncher wrote:The original posts say "55% survivor benefit". We need the original poster (or someone familiar with military pensions) to say whether this means
  1. Pension drops to 55% when either annuitant dies or
  2. Pension drops to 55% only if primary annuitant dies first. I.e., if secondary annuitant (spouse) dies first, it remains at 100%.
This is the Survivor Benefit Plan. The pension only drops if the primary annuitant dies first. While both are alive, premiums are due for the SBP. If the spouse dies first, premiums are no longer due and the SBP is in a suspended status. Based on my brief research, a 55% survivor benefit is full coverage and premiums costs 6.5% of the pension amount. It isn't clear from the OP if the $45K pension is net of SBP premiums.
Premiums are only due for 30 years, after that SBP is paid up.
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Re: Present value of COLA pension

Post by Nords » Thu May 25, 2017 8:51 pm

EATaxGuy wrote:
Ketawa wrote:
#Cruncher wrote:The original posts say "55% survivor benefit". We need the original poster (or someone familiar with military pensions) to say whether this means
  1. Pension drops to 55% when either annuitant dies or
  2. Pension drops to 55% only if primary annuitant dies first. I.e., if secondary annuitant (spouse) dies first, it remains at 100%.
This is the Survivor Benefit Plan. The pension only drops if the primary annuitant dies first. While both are alive, premiums are due for the SBP. If the spouse dies first, premiums are no longer due and the SBP is in a suspended status. Based on my brief research, a 55% survivor benefit is full coverage and premiums costs 6.5% of the pension amount. It isn't clear from the OP if the $45K pension is net of SBP premiums.
Premiums are only due for 30 years, after that SBP is paid up.
To be excruciatingly technically correct, SBP premiums are due for the greater of 360 monthly payments *and* the retiree is older than age 70. However your statement is correct for the vast majority of military retirees.
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Re: Present value of COLA pension

Post by tigermilk » Thu May 25, 2017 9:58 pm

I consider my future COLA pension in my NW calculations, and iin doing so I use a very conservative value. I assume I'm gone and my wife has the survivor benefit (50%). Further, I assume a modest 15 year period and also derate by 10% to account for what I'd have to pay for the survivor benefit.

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Re: Present value of COLA pension

Post by drbhb » Wed Jan 10, 2018 3:50 pm

You can do quick actuarial calculations on the calculator at: http://valueyourpension.com

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