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).
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.
Wow, that’s a huge amount. Congratulations and thanks for her service.
That pension is really good.
My tiny pension from my old company will be around $350/month. I could get a lump sum instead, around $23,000. I guess it’s hard to value because the pension becomes more valuable if you continue to work.
I’d say a military pension is worth the same as social security for the same payment amount. My wife and I will draw $71,000 when we start taking social security. I do think the military pension is more secure for younger people but for those who can already draw social security there is only ther tiniest chance their payments will be reduced. They will be grandfathered in.
That’s a very good point about Social Security. One could view the value of SS using the same ideas.
It is pretty simple. Here is the excel formula: =B2*((1-(1+B3)^-B1)/B3)
B1 = Estimated years (Ie. her life span)
B2 = Pension amount in present dollars
B3 = COLA (ie. cost of living or inflation)
This will give you the present day value of the annuity assuming COLA goes in once a cycle (ie. one change a year). I did not calculate the monthly payments, but you don’t need to as this takes the value of the annuity/pension, based on expected COLA, and takes it to PV.
Look here for more formulas: http://financeformulas.net/Present-Value-Annuity-Factor.html
This gives me $1,426,215.25, which is seemingly close to the annuity that I mentioned in #2. It seems like this is not inflation-adjusted like the military pensions. In this case the COLA is effectively zero which brings the numbers back up to the $2.3 million number (plugging in 0.00001 for the COLA)
The COLA or Inflation are the same value in the equation. You just cannot have both. Another way to do it is to find the Future Value of an annuity (with the calculation added on the value that it will go up each year, like a COLA or something like). Then do a Present Value of that with the value of inflation as the interest rate.
I think we are saying the same thing. Because the annuity is inflation-adjusted the COLA is essentially zero. Usually, people plug in a real COLA because they see it and obviously COLA isn’t going to be zero in the real world.
There are other calculations (if you look at that website) that do things like the difference between the rate of the annuity, and COLA, which will give you the Present Value. So you can have the 3% Inflation, and XX% of the annuity, then take those back to the present value.
An example would be you have a $100 annuity, 10% for 3 years. You get 3 payments of $100, $110, $121. You can get Present Value of this is to sum up the payments, and do a 3 year Present Value on it assuming 3% Inflation (or COLA). So that would be $302.91.
Maybe I missed it in the article, but I didn’t see anything that accounts for taxes. If you’re talking net worth, I’d think you’d want to account for that. So depending on the tax bracket, you’re talking a few hundred thousand to half a mill shaved off the $2.3 mill.
It’s true that taxes aren’t taken into account in this article. Taxes can vary with other income sources and state to state. For example, some states tax military pension, some do not. I think it adds too many variables that are different for everyone to factor in.
Over time, taxes will certainly shave off some of the $2.3 million like any earned income. However, we’ll have other money live off for awhile and can invest some of the $2.3 million ballpark figure to raise the value up.
I don’t know if there’s a perfect answer here, but my hope is that you can apply these tools to your own situation and that you find them helpful.
I wonder what you think about the calculations used on this page which appear to be quite straightforward. https://www.financialsamurai.com/how-do-i-calculate-the-value-of-my-pension/
Assuming you have a pension that rises with inflation and the value calculated here holds. This seems most closely aligned to your treasury bill based calculation but uses the more of a 2.5% or 3% return in which to compare the value to what someone would need to invest in order to produce the cashflow equal to the pension and these numbers seem to be on track with your other calculations without much pain.
However, I am not clear where or how the type of calculation I am sharing here takes into account how long one will receive the pension or how long one will live. For example if your pension will start today or 10 years from now. Thoughts?
2nd question/comment: My major grief on this topic is when looking at networth comparisons when determining where you might stand in the pecking order relative to others. It is my understanding that most of these sites like these: https://dqydj.com/average-median-top-net-worth-percentiles-by-age/
don’t use the value of a pension in their calculations.
What is strange about this is that I assume those at the higher ends of these scales are the ones most likely to -have- pensions. If that is true and that is not taken into consideration, it means that the wealthy are even -more- wealthy than they appear and it takes -more- wealth to really be in the top 20% or higher than it would appear at merely looking at the numbers they give you. It implies that the wealth gap between that group and those below it (who I am assuming are less likely to have a pension) is even more wide than it appears.
Another factor is that I believe 80% of those already in retirement have pensions, but that number will drop off precipitously as more people hit retirement and older individuals pass away.
So where does that leave one? If it takes ostensibly 2.5 million USD networth to be in the top 10% of those approaching retirement age, and you have a pension that increases your networth in a very real sense to nearly 5 million dollars, then that would catapult you into the the top 5%… unless all of those people -also- have pensions. If that is taken into consideration, someone with 2.5 million USD in networth and a pension may just be holding steady at the 90th percentile and if they don’t have a pension, they are not really anywhere near the 90th percentile.
Last quick point, someone had mentioned taxes and yes, that is very difficult to consider here because taxes on pensions differ… but there is also the question of where your money is being held. Someone with a Roth based balance of 1 million dollars -really- has that 1 million dollars. Someone with a taxable account balance of 1 million dollars, realistically only has 700,000 dollars, though in understanding where you stand relative to others, none of this is taken into consideration.
Imagine the situation of someone with 1 million dollars in Roth like savings and a military pension with a 2.3 million dollar value in a tax friendly state to military pensions compared to someone with 3.3 million dollars in taxable investments. It would seem to me that in terms of value that you can eat and buy things with, the first person is in a vastly superior position.
Obviously the important thing is whether you have what you need for your own happiness and what others have does not matter, but these complexities are frustrating if you are just trying to get a general idea if you have squandered your life away compared to general trends or not when your calculations may result in a 40% difference depending on these factors.
Thanks for the detailed comment Louis.
I looked at Financial Samurai’s calculations and they are interesting. I like a lot of his work and this isn’t an exception. I don’t know where his reasonable rate of divider number of 2.55 comes from. As you say, I think it’s similar to the treasury bill calculation.
For my wife’s military situation, I calculated the numbers starting now. If it was 10 years from now, her pension would grow (more time served) and probably get a promotion, which would be a big step up. However, her years of earning a pension would be shorter, as her life expectancy would be 10 years less.
For military pensions, working longer will give you a better pension, even factoring the lower life expectancy. The downside is obviously working longer. Some people quit to get their pension and get another job. This double dip of income can lead to some impressive earning years.
With regard to your second question/comment, I agree that those sites probably don’t include the value of a pension. I’m not even sure how they would.
However, I’m not sure the people at the top of the scales are more likely to have pensions. I think of the people at the top the C-level executives who get a lot of shares of stock. Much of it could also be from real estate appreciation. Some of the people getting pensions are police, fire fighters, military, and teachers who are probably not typically at the top pay ranges.
I’m sure there are wealthy who get pensions. I think pro athletes do for example. I just don’t know if it is a majority, or enough to skew the numbers towards the wealthy.
I agree with all those points about being in the 90th or 95th percentile depending on the pension. I think an individual might have to adjust and create some assumptions if they were trying to get a specific percentile calculation. The good news is that if you have 2.5M or 2.5M and a 2.5M million pension, you are probably doing fine.
I’ve been looking into the differences of taxation on accounts a lot lately. I actually like taxable accounts because you can get qualified dividends at a potentially low tax rate – perhaps even zero. It’s not as good as a million-dollar Roth IRA, but those are hard to get to. First, they are after-tax money, which makes them tougher than 401k millionaires. Second, most Roth’s (except for 401K kind) are limited to $6000 contributions per year or so. You need a lot of years of good compounding. I might get there at 70 with some great gains and I’ve been maxing them out since I was ~20.
I think I’d take the 2.3M in military pension or the 3.3M in taxable investments over someone with 1M in a Roth. It would be far too hard to try to calculate the potential tax differences in net worth. At that point, it might be worth asking if someone had a potential inheritance – as that could make a big difference in net worth. I would drive myself crazy trying to factor all that in.
Thank you so much for your detailed reply. I will keep this one brief.
I should have noted that I am on a military pension and dealt with those exact considerations you mentioned. Stay in an get a larger pension (but also risk that anything that happens under your command might sink your whole career) or get out while the getting was good and get a follow-up job (which is what I did and I was very fortunate to get a great job at a wonderful, ethical and friendly company). Not a day goes by where I do not a pause to consider how fortunate I am to have served for so long and still have all of my fingers and toes and at least some of my mind and to have a pension.
It is so sad that a real defined benefit program is no longer the norm. I suppose that is a story for a separate day, but clearly the military pension is the thing that makes me know that everything is going to be “okay” regardless of whatever else happens and it is fulfilling to know that whether or not I change the world in my current job, I can proudly look back at my service as a life well-spent. I want to absolutely slap someone in the military who has 11 or 12 years in and decides to get out on their own accord. It is hard to imagine that one can match the advantage of earning a pension unless they can transfer their military service years into other federal work etc. It is guaranteed money and adjusts for inflation. It starts when you leave the service and goes until you die. It is hard to beat that!
Happy you mentioned about C-level employees vs the regular folks that are very likely to have pensions. That may be the case or at least, many of the people with pensions are in the lower percentiles of networth and so maybe it is not disproportionately a benefit of those already at the higher end.
Take care and keep squirreling that money away!
My wife is fortunate to have a desk job in health care, so we don’t have to worry about fingers and toes and such.
I’ve been writing more about our retirement lately. If you go to the home page you’ll see an article about our expenses over 5 years. I am publishing a more in-depth article about my wife’s retirement on Monday.