How Much Is My Pension Worth?

A few weeks ago I saw a tweet that said that Tim Walz, the Democratic vice presidential candidate, had a net worth of around $330,000. I didn’t know much about Walz at the time, but I did know that he had a considerable amount of pension income. As a result, the $330,000 figure seemed low to me.

And it was. Forbes estimated that Walz has a net worth was closer to $1 million when valuing his pensions correctly. This got me thinking: what is the right way to value a pension? If you have a pension, you might often wonder: how much is my pension worth?

Well, you’ve come to the right place. Today I am going to walk you through how to value a pension so you can get an accurate gauge of its contribution to your net worth. But before we do that, let’s briefly review the kind of pensions that exist and how they typically work.

What Kind Of Pensions Are There?

When it comes to pensions, the two most common structures are defined benefit and government pensions. Let’s review how each works.

• Defined Benefit Pension: Defined benefit pensions are the most common kind of pension and make lifetime payouts based on your salary while employed.
  • Payout: Typically, the payout is based on either your final salary an average of your salary over some period of time. For example, you might get 70% of your final year salary as a payout or 80% of your average for your final three years of employment. There are many different ways that payouts can be calculated, but keep in mind that there is a formula that your employer uses to do so. The payout will either be fixed or have cost of living adjustment (COLA) over time.
  • Length: Many defined benefit plans will pay out until you die. At that point, payments stop unless you have a spouse with survivorship benefits. If so, this would entitle them to receive some sort of payment until they pass as well.
  • Pros: Payout is guaranteed by employer and is for life. There can be cost of living adjustments and spousal benefits, depending on your pension. Lastly, you don’t have to select or manage any of the investments. Your employer does all of that for you.
  • Cons: Defined benefit plans offer less control, less flexibility, and less growth potential compared to defined contribution plans (e.g. a 401(k)). If your employer mismanages your funds or gets into financial trouble, your benefits could be at risk. Additionally, unlike a 401(k), your benefits can’t be transferred to a new employer. This can create a sense of golden handcuffs where you stay for the pension though you would leave otherwise. Lastly, since your benefits are based on your salary, you may end up getting paid out less than what you would’ve earned if you had managed the money yourself.
• Government Pension: A government pension is a defined benefit pension that is paid out to federal, state, or local government employees. 
  • Payout: The payout structure for government pensions is similar to that of defined benefit plans. It’s typically based on your years of service and either your final salary or an average of your highest-earning years. For example, an employee might receive 2% of their average salary for the highest 3 years of earnings, multiplied by their years of service. Many government pensions include inflation-adjustments (COLAs) to help maintain purchasing power over time.
  • Length: Government pensions usually provide lifetime benefits. Like other defined benefit plans, they often include survivorship benefits for spouses or dependent children, which continue payments after the retiree’s death.
  • Pros: Government pensions are considered more secure than private defined benefit plans, as they’re backed by the full faith and credit of the government. They also tend to offer generous benefits compared to private sector equivalents. Many include health insurance benefits that continue in retirement and some even allow for full benefits when retiring early. This is something that is rare for defined benefit plans in the private sector. Additionally, some government employees may be exempt from paying into Social Security, which can boost your earnings during your working years.
  • Cons: Government pensions tend to be less flexible and require longer vesting periods (i.e. years worked) than private defined benefit plans. And while government pensions are generally more secure than private ones, certain government pensions may be underfunded, leading to reduced future benefits. Lastly, government jobs tend to pay a lower salary than the same role in the private sector. This explains why government pensions tend to be so attractive.

While some individuals would classify defined contribution plans as pensions, I am excluding them from our discussion. Not only do defined contribution plans function very differently from defined benefit plans, but they are also easy to value.

Now that we have reviewed the types of pensions that are out there, let’s determine how much your pension is worth.

How To Value Your Pension

If you want to value your pension, I recommend trying a few different valuation methods so that you have a more holistic view of its value. These methods include:

• NPV Method: To use the NPV method, you will need to know your annual pension payout, your estimated life expectancy, and an appropriate discount rate. With this information, you can then calculate the value of your pension using a financial calculator (such as this one). 
  • For example, if your pension pays out $40,000 a year, you expect to live 30 years, and your discount rate is 4%, then your pension would be worth around $692,000 today. You can get this value by plugging all of these values into a financial calculator [Payment = $40,000, Future Value = $0, Interest/Year = 4%, Periods = 30, Periods/Year = 1] and then solving for the Present Value. In other words, if you had $692,000 today (Present Value) that was earning 4% per year, you would be able to withdraw $40,000 per year for 30 years before running out of money.
  • If we believe that the cashflows from our pension are a bit riskier because the company might go under, then we can use a higher discount rate. For example if we used a 10% discount rate instead of a 4% one, then your pension would now only be worth $377,000 [Payment = $40,000, Future Value = $0, Interest/Year = 10%, Periods = 30, Periods/Year = 1]. This is why the discount rate is so important for determining your pension value.
• Annuity Equivalent Method: Besides calculating the value of your pension, you can go into the marketplace to see what an annuity with the same payout is selling for. For example, if an annuity paying $40,000 per year for the rest of your life were selling for $500,000, this would give you useful information on how much your pension might be worth.
• 4% Rule Equivalent: Lastly, to value your pension you can use the 4% Rule to back out what an equivalent defined contribution plan would need to be worth to make the same annual payment as your pension. For example, if your pension paid you $40,000 with annual inflation adjustments, you would divided $40,000 by 4% (or multiply by 25) to get a value of $1 million. In other words, if you had $1 million today, the 4% Rule states that you should be able to withdraw $40,000 (inflation-adjusted) for the next 30 years of your retirement.
  • The idea with both the Annuity Equivalent Method and the 4% Rule equivalent is to find the value of the pension by recreating its cashflows. As the phrase goes, “pricing is replication.” So, if you can replicate a financial instrument in some way, then you can also find its price.

The three valuation methodologies above won’t necessarily agree on the value of your pension. And that’s okay. The idea of using multiple valuation methods isn’t to come to the perfect answer, but provide a range of reasonable answers so you can value your pension and have a clearer picture of your true net worth.

Now that we’ve tried to answer the question: how much is my pension worth? Let’s wrap things up by discussing where things can go wrong.

The Devil Is In The Details

Any time you try to value an asset, the devil is always in the details. Depending on what you assume about your life expectancy or your discount rate, you can get wildly different values for your pension. For example, here is the valuation (using the NPV method) for a $40,000 annual pension for 30 years based on different discount rates:

What is the right answer? No one knows. Of course, the purpose of valuation isn’t to be perfect, nevertheless, you should be mindful about the assumptions that you make. As Mark Twain was known to say:

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.

Unfortunately, knowing what “just ain’t so” is easier said than done. This is why I recommend using multiple valuation methods  to determine how much your pension is worth. In doing so, you will get a more holistic view of your pension’s value which will help you make more informed financial decisions.

So, if you are one of the rare few that still has a pension, take the time to run the numbers. Because until you know what it’s worth, it’s hard to make a plan for what’s next. Trust me, your future self will thank you.

Until then, thank you for reading!

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