If you’re fortunate enough to be participating in a pension plan, your plan may be more valuable than you realize. While your pension may not be as tangible as your other assets, it is no less of an asset with a distinct future value. From a financial planning perspective, it would be essential to know how much your pension is worth.

Valuing a pension is a little more complicated than valuing most other assets because the formula uses several factors and assumptions to calculate its present value. Because some factors can’t be known right now, such as a reasonable rate of return and your longevity, it requires guesstimates which can make the process somewhat subjective. But you should be able to get a fair idea of what your pension is worth.

What is a Pension, and How Does it Work?

Most workers today participate in defined contribution plans through their employers, such as a 401(k) plan. With defined contribution plans, you know what is going into the plan, but you don’t know what might come out when you’re ready to begin withdrawals. You can make certain assumptions about the rate of growth of your account, but that is constantly changing.

With a pension plan, also referred to as a defined benefit plan, you know what will come out of the plan when you retire, but you don’t know exactly what is going into the plan. A pension plan pre-determines the amount of your benefit at retirement based on a percentage of your income, typically the final four or five years of earnings before retirement. So, plan contributions are based on what’s needed to provide that pre-determined benefit amount, factoring in actuarial assumptions and computations to determine how much needs to go into the plan.

Pension Plan Payout Options

Pension plans typically offer several payout options, including a lump sum payout and monthly payout options. Monthly payout options include a single-life annuity and several variations of a joint and survivor annuity.

Lump sum Payout: You could receive the present value of the future benefit of your pension payments. Essentially, the future stream of your income is discounted to a present value. The lump sum option is often selected by retirees who think they can invest it and generate better returns than the pension payout. Choosing this option also allows you to have more flexibility because you receive all of the money now. You also are no longer reliant on the company properly funding the pension. It also might make sense if you are in poor health or if you and your spouse have other sources of income that can create lifetime income sufficiency.

The downside is you assume the investment risk, and if your portfolio underperforms, it could harm your financial security. Also, you lose the protection of the Pension Benefit Guaranty Corp (PBGC)—a federal agency that backs pension fund payments up to a certain amount. However, the PBGC may not protect the full value of your pension.

Single-Life Annuity: A single-life annuity is a straightforward option that guarantees a fixed monthly payment for life. Because it is based on a single life, it produces the largest payout. This option makes sense if you are single with no dependents because it produces the highest payout. Or, if you’re married and your spouse has other sources of income, you can choose the single life option to maximize your pension benefit. Remember, the guarantee is only as good as the company that is funding the pension with the PBGC providing a little backstop potentially.

Joint and Survivor Option: This option ensures your spouse receives a benefit if you die first. The payout while you are living is reduced so the surviving spouse can receive a portion of the benefit amount after you pass. For example, if the single-life monthly payout is $3,000, a 50% joint survivor option, might be reduced to $2,500. Mean you receive $2,500 monthly while you are living and your spouse would receive $1,250 a month after your death.

With a 100% joint survivor option, the benefit amount is reduced further but your spouse receives 100% of the amount you were receiving while you were alive.

This option is most appropriate if the spouse will be dependent on the pension income and makes more sense if you are older or less healthy than your spouse.

How to Calculate the Value of a Pension

As you prepare for retirement, you’ll need to take inventory of your retirement assets and determine how much income they will produce. You can easily see how much your 401(K), IRA, and investment accounts are worth. But if you have a pension, you’ll need to add its value to your retirement assets to get a complete picture.

Calculate Your Retirement Present Value

The way to do that is to take your pre-determined benefit amount (as provided by your pension statement or HR department) and convert it to a present value lump sum. You’ll need a computer spreadsheet or business calculator to calculate present value, taking the number of years you’ll be receiving payments (your life expectancy minus your retirement age), the annual payout you expect to receive, and the current long-term interest rate.

For example, if you plan to retire at age 60 and expect to live to 85 with a $25,000 a year payout, a spreadsheet formula or calculator will show a present value of $352,348, assuming a 5% long-term interest rate.

Calculate the Current Present Value

But what if you’re currently 45 and expect to retire at age 60. Now the retirement present value of $352,349 becomes a future value. Using the same 5% long-term interest rate, subtract your current age from your retirement age (60 – 45 = 15) and apply the $352,349 as the future value. That will compute $169,486 as your current present value.

Your pension’s current or future value should be indicated on your pension statement, but if it is not your HR department may be able to run the calculation for you. You can also find pension value calculators online or check with your financial advisor.

Calculating Pension Values is Subjective

Calculations for pension value should be taken with a small grain of salt. That’s because many of the assumptions used are variable. For example, they may not account for any income increases or that you’ll remain with your employer. They also assume you’ll live to full life expectancy.

One factor to keep an eye on is interest rates. That’s because they directly impact the value of your pension. When interest rates rise, it decreases the value of your pension. When higher rates are used to discount the value of a stream of future payments, it results in a lower pensions value or lump sum. That’s why you should calculate your pension value periodically.

How to Maximize the Value of Your Pension

Another pension option to consider is often referred to as pension maximization. With this strategy, you elect the single life option for the maximum payout. You then use a portion of that payout to purchase a life insurance policy and name your spouse as the beneficiary. While your pension payment will stop when you die, your spouse will receive a lump sum tax-free death benefit that can be invested or used to purchase a single-life immediate annuity with a guaranteed lifetime income. If you’re spouse predeceases you, you can change the beneficiary or cancel the policy.

The pension maximization option offers the most control and flexibility over your money, and it can cost less than reducing your benefit for a joint survivor payout option.

How Your Advisor Can Help

Your pension is a critical cornerstone of your retirement plan. Optimizing your retirement income depends on knowing your options ahead of time and making the most informed pension payout decisions. Your financial advisor is best positioned to help you value your pension and walk you through your pension payout options to arrive at the best solution for your circumstances and objective.

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