Someday I’ll write a blog post with the same title and I’ll wax poetic on the piece of mind that comes from fixed income, or the weak bonds that keep the pension system together (thanks PBGC). But today, I’m actually talking about the dollar value of a pension.
You’re a teacher, and you’re about to retire at 65 and get a $50,000 pension. You also saved some money in your 403(b), maybe half a million bucks. If you include your pension, how much have you saved?
In what is surely not a surprise, with a little clever math, we can put a value on it.
The first step is to figure out what you’ve got — a guarantee of $50,000 per year until you die, and usually increasing by the CPI each year. An inflation-adjusted pension.
Someone who worked somewhere that doesn’t have a pension isn’t out of luck, they can buy what you’ve got. It’s called an immediate annuity. They can even buy one with an inflation adjustment. What would they have to pay? Right around $1,200,000.
That’s similar to another rule of thumb we could use to back into a value — how large of a portfolio would you need to be able to withdraw $50,000 per year using the 4% rule? $1,250,000.
So then, we have a value. What does that mean? Well, if we want to, we can reverse-engineer an estimate for what you would have had to have saved over time to get that lump sum.
Let’s imagine you started saving for the last 30 years of your career, from 35-65. If your savings had compounded at 2% per year (quite low), you’d have been putting away $29,580 each year to have $1.2 million at age 65. On the other end, if your savings compounded at 10% per year (quite high), you’d have been putting away $7,295 each year.
That $50,000 per year pension you’ve got was worth something like $7,000-$30,000 per year. Probably quite a hefty portion of your salary.
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