How do you value a pension?

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squirm
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How do you value a pension?

Post by squirm » Sun Feb 19, 2012 5:18 pm

A 401K is easy to value, as there is an absolute value for it, but when someone ask what is the value of your net assets, how do you place a value on a pension? There has to be a way, my best guess is the yearly income from it at retirement, divided by 0.04, does that make sense?

kontango
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Re: How do you value a pension?

Post by kontango » Sun Feb 19, 2012 5:23 pm

Take the present value of your expected pension cash flows. That is the value. You'll need to find a discount rate (but that shouldn't be too hard) and make an assumption about the number of years you will be drawing from the pension.

Sidney
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Re: How do you value a pension?

Post by Sidney » Sun Feb 19, 2012 5:32 pm

I don't value the pension. I use it to offset projected expenses.

As a general rule, I don't include anything in my asset base that cannot rebalanced into or out of within a relatively short time (days, not weeks). So I exclude real estate, pension, personal property etc (that I own), but, I do include the value of our charitable gift trust account (which I don't own).
I always wanted to be a procrastinator.

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bob90245
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Re: How do you value a pension?

Post by bob90245 » Sun Feb 19, 2012 5:32 pm

A pension has value because it reduces the income needed to be generated from your retirement assets. Let's call that "income reduction". How much is that? Then multiply that by a number like 25 (as in, safe withdrawal rate of4%). That's how much your pension is worth. If you didn't have that pension, your retirement assets would have to be exactly that much more.
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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bertilak
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Re: How do you value a pension?

Post by bertilak » Sun Feb 19, 2012 5:43 pm

Sidney wrote:I don't value the pension. I use it to offset projected expenses.

As a general rule, I don't include anything in my asset base that cannot rebalanced into or out of within a relatively short time (days, not weeks). So I exclude real estate, pension, personal property etc (that I own), but, I do include the value of our charitable gift trust account (which I don't own).
+1

Somewhere I read something like this:
  • If you ask an American how much somone is worth you will get an answer like "2 million dollars."
    If you as an Englishman the same question you will get an answer like "20,000 pounds a year."
    The Englishman gives the better answer because in the final analysis it all boils down to cash flow.
Converting a cash flow into some kind of pseudo bond only to have to convert it back to cash flow when deciding if your assets will meet your needs adds a couple of unneeded steps and only adds room for error.

And as you say you can't re-allocate into or out of it. For example, let's say you value your pension at $2,000,000 and you have $200,000 in your IRA for a total of $2,200,000. How do you get a 60/40 stock/bond split out of that?

Another point. Actual assets can be left to heirs but a pension/annuity cannot. (Except for pensions/annuities that continue payments to a surviving spouse -- and that's still cash flow.)
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet

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jeffyscott
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Re: How do you value a pension?

Post by jeffyscott » Sun Feb 19, 2012 6:18 pm

bertilak wrote:Converting a cash flow into some kind of pseudo bond only to have to convert it back to cash flow when deciding if your assets will meet your needs adds a couple of unneeded steps and only adds room for error.
Yes, we know the pension is worth $X per year, the only question being whether or not it is fixed or indexed to inflation.

With a pile of assets we don't really know if that will turn out to be worth 4% per year or some drastically different amount, like 2% per year or 6% per year.
Time is your friend; impulse is your enemy. - John C. Bogle

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archbish99
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Re: How do you value a pension?

Post by archbish99 » Sun Feb 19, 2012 6:21 pm

squirm wrote:A 401K is easy to value, as there is an absolute value for it, but when someone ask what is the value of your net assets, how do you place a value on a pension? There has to be a way, my best guess is the yearly income from it at retirement, divided by 0.04, does that make sense?
Get a quote for a single-premium annuity with the same terms as the pension (starting date, survivorship benefits, inflation protection, etc.). That will give you a very accurate ballpark for the current value of the pension.
I'm not a financial advisor, I just play one on the Internet.

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bertilak
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Re: How do you value a pension?

Post by bertilak » Sun Feb 19, 2012 6:27 pm

jeffyscott wrote:Yes, we know the pension is worth $X per year, the only question being whether or not it is fixed or indexed to inflation.

With a pile of assets we don't really know if that will turn out to be worth 4% per year or some drastically different amount, like 2% per year or 6% per year.
Agreed. Things start to get fuzzy if you convert your pension to an asset and then try to mix it's cash value in with assets having less-predictable returns. That's what I meant by "room for error."
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker (aka S.O.B.), the Cowboy Poet

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bob90245
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Re: How do you value a pension?

Post by bob90245 » Sun Feb 19, 2012 6:39 pm

archbish99 wrote:Get a quote for a single-premium annuity with the same terms as the pension (starting date, survivorship benefits, inflation protection, etc.). That will give you a very accurate ballpark for the current value of the pension.
That was going to be my second answer!
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.

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BruceM
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Re: How do you value a pension?

Post by BruceM » Sun Feb 19, 2012 8:14 pm

squirm wrote:A 401K is easy to value, as there is an absolute value for it, but when someone ask what is the value of your net assets, how do you place a value on a pension? There has to be a way, my best guess is the yearly income from it at retirement, divided by 0.04, does that make sense?
As previously stated, calculate its present value. However, this requires that you make an assumption on the discount rate (the average annual rate of return you'd expect over your life expectancy) and your life expectancy. And if the annuity is inflation adjusted, you'd have to make an assumption on the annual average inflation rate. Hence, like all such calculations, it is an estimate, not a hard value. And even with a good estimate, it is really academic, as you cannot treat it as an asset, unless, of course, the DBP offers a lump sum cash option in-lieu of a life annuity, which it sounds like it does not, as that would have answered your original question.

BruceM

ourbrooks
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Re: How do you value a pension?

Post by ourbrooks » Sun Feb 19, 2012 8:37 pm

Okay, here's my entry in the quicker answer category:

Pick a retirement age, say, 65. Go the SSA site and get your life expectancy from their table. If you pick 65, the answer is 17.19.

Use 5.1% as the discount value (interest rate). That's the long term average for 10 year T bonds and it seems to fit fairly well the payout rate used by commercial single premium annuities. This is much higher than the current rate, but, in theory, your employer is setting aside pension money throughout your career.

Use the PV function in Excel to calculate the present value. Remember to put the percent sign after the percentage rate and to do everything in years.

The main use I can think of for the result is to impress your relatives with the financial value of having taken a job at company which still offers a traditional pension as versus your sister in law who keeps trying to impress people with the size of her defined contribution plan balance. Don't try use it to convince your broker than you have enough money to be allowed to sell uncovered calls; they only consider liquid assets for that determination. :D

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GregLee
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Re: How do you value a pension?

Post by GregLee » Sun Feb 19, 2012 10:16 pm

bob90245 wrote:A pension has value because it reduces the income needed to be generated from your retirement assets. Let's call that "income reduction". How much is that? Then multiply that by a number like 25 (as in, safe withdrawal rate of4%). That's how much your pension is worth. If you didn't have that pension, your retirement assets would have to be exactly that much more.
This is the rule I like. It's simple and makes sense, though of course people can quarrel about whether the conversion rate should be 4%, or a little more, or a little less. Often, people will wind up at the commencement of retirement, with a mixture of cash flow assets like SS, and capital assets, like a portfolio of securities or a lump sum retirement settlement. So long as you have a way of converting back and forth from one to the other, you don't have to decide which is the one true way: cash flow or capital. Do both.
Greg, retired 8/10.

rmark1
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Re: How do you value a pension?

Post by rmark1 » Sun Feb 19, 2012 10:21 pm

Go to http://www.immediateannuities.com/ and price a similar annuity. A pensions value may affect the amount of equities you need to hold to offset inflation losses over time. It's not something to just ignore.

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Re: How do you value a pension?

Post by rmark1 » Sun Feb 19, 2012 10:24 pm

The 4% safe withdrawal rate assumes a portfolio including equities for long term growth, which are not present in a fixed pension.(IIRC fixed pensions are valued about 14 times annual payment.)

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fishnskiguy
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Re: How do you value a pension?

Post by fishnskiguy » Sun Feb 19, 2012 10:29 pm

I value my pension a lot! :lol:

Chris
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rmark1
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Re: How do you value a pension?

Post by rmark1 » Sun Feb 19, 2012 10:41 pm

As an example, if I was to retire today with a fixed pension paying $1000 per month, immediateannuities.com shows a price of $225,000. If I wish to spend that $1000 AND maintain my purchasing power, under the 4% rule I need a portfolio with at least 25-30% equities. I need a $75-100,000 portfolio to go with my fixed pension.

Default User BR
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Re: How do you value a pension?

Post by Default User BR » Mon Feb 20, 2012 10:39 am

squirm wrote:A 401K is easy to value, as there is an absolute value for it, but when someone ask what is the value of your net assets, how do you place a value on a pension?
I don't. When I die, that pension evaporates. I don't try to "value" Social Security either. Neither are an asset and they don't belong in any listing of my assets.


Brian

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GregLee
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Re: How do you value a pension?

Post by GregLee » Mon Feb 20, 2012 10:50 am

rmark1 wrote:The 4% safe withdrawal rate assumes a portfolio including equities for long term growth, which are not present in a fixed pension.(IIRC fixed pensions are valued about 14 times annual payment.)
By "fixed pension" you mean not COLA'd? Valuing a pension or SS using the 4% conversion rate does assume that the annuity has a COLA, since the 4% SWR assumes that withdrawals will increase with inflation. But if there is a COLA, 25 times annual payment should give a reasonable approximation of what the equivalent portfolio size would be. Considering a possible tax advantage could change that some.
Greg, retired 8/10.

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Re: How do you value a pension?

Post by Buckeye » Mon Feb 20, 2012 10:52 am

I would think the value of a pension is what is the market cost would be to go out and buy one with a lump sum of cash. Purchasing an appropriate annuity could be a close approximation depending on all the details involved but is generally not a trivial comparison unless you just want a ballpark one.

If reasonable I'd probably would consider half of it as guaranteed fixed income in my asset allocation. The other half (which could disappear someday) I would ignore and use that as bonus money every year to do whatever.

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Re: How do you value a pension?

Post by jeffyscott » Mon Feb 20, 2012 11:07 am

With a fixed pension, you would need to escalate withdrawals from your assets at a rate that exceeds inflation, this would mean reducing the initial 4% to something less. As an example suppose initially 1/3 or retirement spending will come from SS, 1/3 from a fixed pension, and 1/3 from your portfolio. Let's say it is $20,000 from each source and we have 3% inflation, after 10 years you would be spending about $80,600 with $20,000 from pension, $26,900 from SS, and $33,700 from assets. So instead of withdrawals increasing by the 3% inflation, they would have increased by about 5.4% per year.

I am not sure what the means the initial "safe withdrawal rate" should be in this sort of scenario, but obviously it would be something less than 4% in order to allow it to increase at nearly 2x inflation. I could be wrong, but I don't think coming up with a supposed present value for the pension and SS helps to answer this question. For myself, I've used a spread sheet to answer this sort of question of: "how much do I need in assets to supplement SS and pension?"
Time is your friend; impulse is your enemy. - John C. Bogle

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desertbandit442
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Re: How do you value a pension?

Post by desertbandit442 » Mon Feb 20, 2012 11:15 am

I treat my pension like it is on the Bond side of my Stock/Bond Asset Allocation (AA) for investments. My pension is fairly secure because it is from military retirement, so I don't have the worries of it just disappearing like airline or auto company pensions. I value the pension like I had a lump sum invested and was withdrawing 4% a year out of that investment. So, for example, if my pension income is $40,000 a year I value it as $1,000,000 invested on the Bond side of my Stock/Bond AA.

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Re: How do you value a pension?

Post by rmark1 » Mon Feb 20, 2012 2:55 pm

Valuing a fully COLA'd pension is easy since it by contract it maintains its purchasing power, its simply annual payment x life expectancy. It can be excluded from your allocation decision (as can Social Security if it continues to be inflation adjusted).

A fixed pension payment loses purchasing power to inflation - assuming your goal is a level standard of living, you either build a portfolio that covers the value lost to inflation OR spend less of the pension payment, investing the unspent portion fopr future growth.

The value of a fixed pension (or annuity) declines to zero at death, something a bond doesn't do. If I buy a treasury bond and drop dead in the parking lot, it's value doesn't change. The same sequence with an anniutiy has its value go to zero. If you price an annuity through immediateannuities.com over time you can see the price decline.

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Re: How do you value a pension?

Post by jlq39 » Mon Feb 20, 2012 3:56 pm

Default User BR wrote:
squirm wrote:A 401K is easy to value, as there is an absolute value for it, but when someone ask what is the value of your net assets, how do you place a value on a pension?
I don't. When I die, that pension evaporates. I don't try to "value" Social Security either. Neither are an asset and they don't belong in any listing of my assets.


Brian
This may be true in your case, but not all of us. For instance, my pension contributions (paid monthly from my salary) plus the interest they make get returned to me in the event that I leave my employment or I die, for which my wife will receive them. I also have survivor benefits, so the monthly income that is generated will continue after I die for my wife if she outlives me, which is pretty common in our society, plus she has much better genes than I when it comes to longevity. So, basically as far as my net worth is concerned, I value my pension at what my total contributions plus interest are, because that is an asset to me, because I will get that back tomorrow if either of the previous mentioned conditions are met. Now, if I make it to my retirement age, which is 53, and start collecting my pension, then I will no longer be able to get my contributions back, but I can value it on my monthly payout, which in my case will be roughly more than 50% of my monthly income at retirement with a COLA each year. Obviously if I figure what my pension is worth to me right now, compared to what I would have to have in a 401k at this point in my life to be equivalent, it's a substantially larger amount, than what I've contributed over the years, but like I said, my contributions are a real asset to me that can be collected. That money did not just disappear, like SS does. To me, SS is not the same as my pension and I can't look at it that way. So bottom line is, do I put the present value of what my pension would be worth today for what I will receive down the road? The answer is no, because I don't know if i'll ever receive that or not, but I do like to know what that number is so I can equate it for a total financial picture to see if i'm on track to having enough. But you better believe that I include my total contributions and interest into the pension plan because that's a real asset to me that either I or my wife will get back in the event that I never draw a cent in monthly payouts down the road.

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Re: How do you value a pension?

Post by millewk » Mon Feb 20, 2012 8:53 pm

Desert Bandit has it right. Sometimes we attempt to overthink these things!

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Ketawa
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Re: How do you value a pension?

Post by Ketawa » Mon Feb 20, 2012 9:08 pm

I used the TSP Annuity calculator here to figure out how much a pension/annuity is worth. You can compare level payments vs. inflation-indexed payments, different starting ages, single/joint. The inflation increase is capped at 3% per year, so this may slightly undervalue a pension that has full COLA adjustments. It also depends on the current interest rate, so the market value is inflated relative to historical norms.

You can also download the calculation guides and play around with the numbers in Excel, trying out different interest rates. That's not possible through the web-based calculator.

https://www.tsp.gov/planningtools/annui ... nput.shtml

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