Lazy Man and Money

What’s My Pension Worth?

by 15 Comments

The short answer to that question is zero, because I don’t have a pension… however, my wife does. She completed 20 years of military service in March, but continues to work (for now).

Pension - Net Worth

Earlier this month, I asked the question “Should You Include Your Pension in Your Net Worth?” and found that opinions were generally mixed. Most (61% in my small Twitter poll) believed that you should include it. This is consistent with how finance professionals and divorce courts view it.

However, there are still plenty of people who feel that a pension shouldn’t be included in your net worth. They explained that a pension is future money that you don’t have and can’t gift in an estate.

I ended up deciding that I’ll keep two logs. One log will count all the traditional assets and liabilities used in a typical net worth calculation. The other log will include the value of a pension and this website. I don’t know if there’s any great value in keeping two logs, but there’s no harm and it is a little work once you calculate the values. Also it doesn’t matter since net worth numbers don’t drive any of our financial decisions.

The first question in the comments of the article was what I wanted to write about today.

“How do you value the pension?”

If you are going to include a pension in your net worth, you have to have a number to plug in there. Fortunately, there are a couple of different methods that we can compare and contrast. For the purposes of this article, I’ll be presuming a military pension, but your pension circumstances may vary. If you are in the military, you may also be interested in “When should you retire from the military?”

1. Calculating Pension Value using Life Expectancy

The first idea that came to mind is to use the simplest math possible. My wife’s pension will be $[X] when she retires. Her life expectancy will be roughly [Y] years. The number of total pension dollar she’ll be paid is “$X * (Y – [current age])” The Social Security Administration has a life expectancy calculator that’s helpful.

Plugging my wife’s information into the calculator shows she is estimated to live another 41.7 years. That’s just as cold as I expected from the SSA. There are other life expectancy calculators that may be more accurate by factoring health and lifestyle behavior. This is good enough, especially because nothing is guaranteed.

My wife is a fairly high ranking officer (so proud!). If she retired tomorrow, her pension would be $55,462 per year. Simple math gives us: ($55,462 * 41.7) = $2,312,765.40 total pension dollars. (Since military pensions grow with inflation, we don’t have to worry about eating up the buying power.)

If my wife continues to work longer, you might think this method would value her total pension as being worth less. After all, she’ll have fewer expected years to collect. However, the pension will grow with more years of service.

2. Calculating Pension Value with with Annuities

On its most basic level, a pension is an annuity. Thus we could look at how much it would cost to buy an annuity equal to the monthly payout of the pension. I found a couple of calculators online, but they tried to get me to sign up and/or give personal information that I believe would lead to a sales pitch.

One showed that it would cost around $1,200,000 to produce the same $55,462 per year in income. I was surprised that it was so low. However, that $55,462 was not inflation-adjusted, so that $55,462 in 40 years from now is really worth $20,655 (assuming 2.5% inflation).

I next looked for inflation-adjusted annuities. Unfortunately, while they exist, they are harder to find and seemingly impossible without getting caught in the potential sales pitch.

For now, I’ll presume that the 1.2M in annuities without inflation protection would be about the same as the 2.3M number by using life expectancies when inflation protection is factored in. It at least seems plausibe.

3. Calculating Pension Value with Treasury Rates

A third way to look at a pension is by using Treasury Inflation-Protected Securities (TIPS). If someone gave you $1 million dollars and you put it in these, extremely safe investments, how much money would they generate each year. Current treasury rates between the 20-year and 30-year are very low, with an average of around 0.85%.

Thus we could say that hypothetical gift of a million dollars would yield only $8,500, a far cry from the $55,462 number we are aiming for. We need to work it backwards and take the $55,462 number and divide that by the 0.85% yield.

The result is that the pension is worth $6,524,941.18. That seems very wrong! It seems the problem is that interest rates are just too low.

What if we use another metric? The 10-year government bond rates is currently 2.33%. Using is makes the estimated value $2,380,343. Thus, if you invested $2,380,343 and were able to get a relatively safe 2.33% interest rate, you’d get $55,462 in interest.

However, the 10-year government bond rates are not inflation-protected. Twenty years from now, the $55,462 that you get back from that calculation will not have the same buying power.

4. Calculating Pension Value with a Finance Calculator

I found an interesting article on Sapling.com about calculating pension value. It uses a financial calculator, which is something that I’ve never been good at. It looks like this might be worth more value when you are looking at a point somewhere in the future when you get access to the pension. For us, it doesn’t seem to work since that date is not determined.

Final Thoughts on What a Pension is Worth

It’s hard to put a definitive number on what a pension is worth. However, considering that the first, second (after inflation-adjusting), and third calculation all came to about the same $2.3 million number, I will use that for the second net worth log.

That’s a very, very large number. It’s so big that it dwarfs much of our other financial assets – as you would expect. That’s why I’d keep it in a separate net worth log. It’s also a good time to reflect that I created this blog and have written about FIRE for the last 13 years because I knew my wife’s financial contribution wasn’t just her salary, but also a large stream of passive income. In 13 years of time, I haven’t been successful in creating $55K+ of annual passive income to match her. However, our alternative income is getting very close.

I don’t believe there’s a firm right or wrong answer to what a pension is worth. Fortunately, this is one area when a reasonable estimate is usually good enough.

Our Early Retirement Plan: Motivation, Numbers & Tools, and Conclusion (Part 5)

by 4 Comments

If you are just starting this, I suggest you start at The Introduction – Part 0. Alternatively, you can jump to Our Early Retirement Plan: Where We Are Now (Part 1), Our Early Retirement Plan: My Personal Income (Part 2), Our Early Retirement Plan: My Wife’s Plan (Part 3), or Our Early Retirement Plan: Obstacles and Expenses (Part 4).

In the end, for us to succeed, we are going to have to continue to be motivated towards our goals, continue to learn about better ways to reach them, and act on the things that matter.

Part of the learning and motivation come from reading articles like the Money Magazine one that I highlighted in the beginning. Still others may come for friends and peers like My Dollar Plan’s escape from the rat race.

In part 2, I mentioned that retirement planners suggest that you can withdrawl 4% of your retirement nest egg each year and still maintain the principle. When I looked at our finances, we aren’t close to having the funds to live off of that. However, when you add my alternative income from “retirement lifesytle jobs”, an inflation-adjusted pension, two modest retirement nest eggs (and time to grow them), two investment properties, it may turn out to be a decent income. If we continue to practice our frugal lifestyle and catch a few breaks (me doing the child care while working – if possible, and getting cheap health care from the military), I think the plan is entirely possible. It’s easy for me to sit here and speculate, but what about a real world test? Glad you asked.

One of the most useful pieces of software is Bill Sholar’s FIRE Calc. I ran some rough numbers through there to see how we’d do. Looking at the publically available military charts it like my wife should have a military pension of around $50,000 in today’s dollars indexed for inflation. At the same time, my websites and businesses should be at least at $48,000 in annual income in 11 years. This is an extremely conservative estimate as I should make $40,000 this year – and I see a lot more growth on the horizon. Next we looked at what our expenses might be. Our rent, our biggest cost, is $24,000 this year. I suspect that we could easily get by on $50,000 given our frugal lifestyle. Just to build plenty of wiggle room, allow for some great vacations, or save some money for the potential children, I estimated that we’d need $80,000 a year. These numbers disregard any potential income from social security, our investment properties, or savings my wife might make until she retires. The calculator says that we could live until age 100 with around 11 million dollars. That might sound like a lot, but it is closer to $1.5 million in today’s dollars – still not chump change.

My hunch says early retirement is possible. The FireCalc tool seems to say it’s possible. It’s going to be something that I’ll have to look at every year, but at this point it looks like we are on track.

Our Early Retirement Plan: My Wife’s Plan (Part 3)

by 14 Comments

If you are just starting this, I suggest you start at The Introduction – Part 0. Alternatively, you can jump to Our Early Retirement Plan: Where We Are Now (Part 1) or Our Early Retirement Plan: My Personal Income (Part 2).

Before I start, I should come clean. I’m going to be putting some words in my wife’s mouth. We’ve talked about things a bit and this post is a result of those conversations.

I’ve mentioned in the past that my wife is a pharmacist in the military. As such she gets a few different types of pay. She gets her base pay, a cost of living adjustment (COLA), a housing stipend, amongst others.

Tax Benefits

  • The housing stipend is paid to her tax-free. – This stipend is a pretty huge sum of money because it’s adjusted for home prices in the area of office. Since my wife works in San Francisco, one of the most expensive places to live in the US, she gets a lot of money. This money about 50% more than our actual rent. We pocket the rest – one of the benefits of living frugally.
  • We live in two states – We traveled west to settle in San Francisco, California we went through Reno, Nevada. We fell in love with it. The weather is great. It’s close to skiing, which my wife loves. It’s close to casinos, which I love (I just keep my bets reasonable). You’re wondering where I’m going with this? The military has thing called a Home of Record which can be different than your Legal Residence. It allows for the possibility of living in one state and voting or paying the income tax of another state. It’s a weird law, but we follow the rules. Plus, if the military didn’t move us around, we probably would have lived in Reno anyway. For more information see this About.com article.

Military Pension

Despite what you hear about pensions disappearing, the military pension is still strong. It’s backed by the US Government. I have difficulty imagining a scenario where congress passes something that would prevent the hard-working people of the military earning their pension. My wife is eligible for this pension after 20 years of service… around age 44.

The Military Pension is a fascinating personal finance topic. At that 20 year mark, you have the opportunity to retire, take 50% of your highest base pay (no more housing stipend or other pay). If you don’t want to retire and stay on another 10 years you would then get 75% of your highest base pay. It’s a tough choice, because you stay on your base pay is likely to grow and you get to keep more of it. Of course, you could always retire from the military, take the pension, and work elsewhere – collecting two paychecks. As a pharmacist, my wife should have numerous jobs available to her. This can be a tough decision and one that Plugged in Finance tackled recently. If anyone else wants to crunch numbers on this one, I’d be appreciative.

I should also mention that military pensions are indexed for inflation, so we will truly get the same amount of buying power each year. I’m not sure if other pensions set up that way.

Side Jobs

My wife has expressed interest in having a side job in retirement. She often jokes about having the job with the least about of thought necessary. I can’t come up with an example right now, but she did have an idea for a real job that she would like… chauffer for people visiting Napa Valley wineries. I personally wouldn’t want to be dealing with a bunch of drunk people, but I know I could make a killer blog out of Napa Valley Limo Confessions. It would make HBO’s taxicab confessions look like child’s play. I could also spin that off into a real winery review blog. In any event, the point here is that she is likely to wind down to working less, but not stop working completely. Even if she leverages here pharmacy license, she could make quite a bit of money in just one day a week. Thus some addition income can be expected from here.

Investment Income

Like myself, she’s been maxing out here retirement accounts – both 401K and Roth IRAs. We see no need to change that. It will be $19,000 a year for the next 11 years until she reaches that first retirement decision. That should be a nice nest egg by the time we are eligible to take the income.

Rental Property

I mentioned yesterday that I have a rental property. My wife has one as well. She had bought her’s before we had met. Like me, she barely makes back her expenses on it at this point. However, in 30 years it will be paid off and any income that it earns after that be a nice supplemental income.