In late March my wife reached 20 years of military service. This qualifies her for a pension of half of her basic pay. As she continues to work, the pension has the potential to rise exponentially.
Pensions are very rare nowadays. It seems like almost all companies have stopped offering them. Often companies have difficulties fulfilling those pension obligations. Pensions are still a part of many careers such as teaching, law enforcement, and firefighting. Typically those pensions are set by a state formula and each state is different. Sometimes states mismanage the pension fund. It seems that I’m often reading about how some corruption raided the pension fund.
Military pensions are indexed to inflation. They are also backed by the US federal government. As far as pensions go, it doesn’t get much better than that. We are grateful to have this tremendous financial benefit.
However, it does raise some interesting questions. Chief among them is:
Should we include the pension in our net worth?
I’ve been tracking my net worth with a spreadsheet since at least 2006*. What started as a very simple spreadsheet of a couple of bank and retirement accounts has expanded to incorporate my wife’s assets**, two kids assets, 3 rental properties, and a pile of formulas (liquid cash, real estate equity, and debt/net worth ratio, rule of 4%, etc.). I used to update it every quarter, but over the last 5 years, I’ve religiously updated it every month. It’s not a coincidence that I’ve been more motivated with this bull market.
It’s been a tremendously helpful tool. However, like any tools, you can choose to use it how you want.
Some people choose are adamant that you can’t include the value of the your home in your net worth. They say that since you can’t use that money, it shouldn’t count. I never bought into that argument because there are options to access that home equity such as downsizing, getting a second mortgage, or a reverse mortgage. However, the biggest reason, I include the value of my home is that, if you own it, you don’t have to pay as much for your largest living expense. It’s mostly insurance, property tax, and maintenance.
But let’s get back to pensions. They are a little trickier. That’s money coming in the future. If you don’t have a pension, you can think of Social Security as something similar. Would you include the value of your Social Security benefit in your net worth? I don’t know anyone who does that. To take it a step further, I know very few of my personal finance blogging peers who factor Social Security into their retirement plans. Almost all would say it’s the cherry on top of the sundae, not the ice cream, hot fudge, nuts, or the whip cream.
I decided I’d ask Twitter. My timeline typically consists of personal finance people, so it’s somewhat knowledgeable.
Would you include the value of a pension in your net worth? Why or why not?
— LazyManAndMoney (@LazyManAndMoney) April 16, 2019
While 44 votes may not be enough, a 61% majority gives a slight edge to “count pension in your net worth.”
I’d put myself in that 61%. A pension can save one from having to directly put as much money into their retirement savings. That can free up hundreds of dollars a month that other people would put into their retirement plans. Also as one lawyer pointed out, pensions are considered assets in divorce court.
That other 40% can make a great case. Here’s one article by Government Work FI who doesn’t count a pension as part of his net worth.
As I continued down this rabbit hole, I felt more and more confident about my position in counting it as part of our net worth. However, then I thought about this website. It’s a business that brings in income. It’s an asset. Theoretically, I could sell it. I’m not sure who would want to buy it, but there are some guidelines of how much it would be worth.
Yet, it’s never occurred to me, before now, to count this website in my net worth. I’m not sure many personal finance bloggers do… unless they sell it and unlock that value.
At the end of the day, you can calculate your net worth however you want. It’s simply a number. It doesn’t change the underlying finances.
* I remember using Quicken before that, but I was too Lazy to import and categorize everything and moved to a new system.
** We keep some assets separate, but even if we didn’t, some finances simply can’t be combined like her TSP or Roth IRA.
How do you value the pension? Look for an equivalent annuity or something like that?
My wife will have a pension too, but we don’t count that yet. I don’t even know how much she’ll get. The formula changes depending on the year served.
She’ll probably get about $1,000/m at 65 if she leaves now. It’ll improve if she continues to work.
Lazy Man says
That’s going to be part 2. I think I had three ideas. One of the methods is looking at the equivalent money to purchase annuity. Another would be to look at life expectancy and multiply it out. You might even look at it as what an inverse 4% rule (25x rule) would be.
My wife’s will change too while she’s still working. However, we can take a snapshot of it now.
So I am on the fence about this. I have always thought use the right measuring stick for the right object. I don’t know if Net Worth is the right tool for a pension. Now if you have a defined pension, which you will get regardless of death or divorce, then maybe. Otherwise it is an ethereal concept and should just be kept in the cash flow numbers for “retirement”.
So the way I look at net worth is if you kick the bucket today, what will you pass on to your heirs via will or probate. It also has to be measurable, and semi liquid. Examples are physical assets, defined life insurance policies, houses, cash/investments, etc. However things like “I’m getting half my parents estate when they die, and it is worth $XX million now” is not something you can sell off and run and hide in the hills with. Same thing in my mind goes with traditional pensions. You cannot take a loan out against it, you don’t get it until you are of age, you only get it until you die, so there is very ethereal in terms of how to quantify it.
Again .. IMHO. Numbers are numbers, and as long as you explain them, there is no reason to say one set of number is better than another.
Lazy Man says
I can see keeping this in the cash flow numbers, but it feels like it would have a net worth component as well. For example, if you used a $100,000 and bought an annuity (which is effectively like this kind of pension), your net worth would take a hit. You didn’t really lose any money and you still have something that was effectively $100,000.
I get what you are saying with it not being an asset that passes on when you die. The only argument I can think of against that (and it’s not a big argument) is that the pension allows the rest of our investments to compound. So while many others are planning to use the 4% rule to draw down on their assets, we’ll hopefully just let them grow at 8% and have more to pass on.
greg simay says
Suppose you have a defined-benefit, inflation-indexed pension which continues in full force for your spouse should you die first. From the point of view of whoever dies first, it’s equivalent to having money in a very secure investment in which you receive the earnings as income, while keeping the principal intact (and therefore earnings) for your surviving spouse. So for me the question becomes, “How many dollars would I need to have in the proverbial bank (or annuity) in order to have an annual income stream of X dollars?” Given the need for safety and lack of volatility, a real return of 4% would seem to be a defensible figure. That implies you would need to have 25X dollars in the equivalent annuity account. The only significant difference is that it’s not part of your heritable estate for the other relatives. But even here, the fact that you have a guaranteed income allows you to create such an estate; e.g., by purchasing life insurance. I personally think “net worth,” as a general term should refer to assets, including retirement-related assets, that contribute to our day-to-day economic well-being. This contrasts with “investible net worth;” e.g., liquid financial assets.
Lazy Man says
I completely agree. I wrote another related article to this about how much a pension is worth – https://www.lazymanandmoney.com/whats-my-pension-worth/. I do agree that the 4% number is very defensible given the 4% withdrawal rate rule of thumb.
Mark W. Murphy says
Agreed. A defined pension benefit plan, I believe is an absolute asset that should be included in a net worth calculation. I choose to include the snap shot value of it by calculating the net present value of a growing annuity (if its inflation adjusted) less the vested balance that may available to take as a lump sum, instead of the stream.
I include the lump sum figure as a separate line item. I also believe neither the lump sum or pension stream should be included until one can actually begin to take it.