How Much Is A Pension Worth?

Somewhere between a little and a very large amount.  It depends.

There are reasons for the difference even when circumstances appear similar.

One reason is that pension plans come in several flavors.  An employer can define how much you put in and then they match it, or an employer can define how much they will pay you when you retire.  You put in some money and they put in whatever it takes to make the promise happen.  The technical terms if you want to search about these are  “defined contribution” and “defined benefit”

In a defined contribution plan you put in money, the employer does too and then the money is invested.  At retirement, you receive a pension of whatever the pot of money will buy.  Starting at 30 with deposits of  5% from you, 5% from your employer, salary inflating at the CPI and all invested at inflation plus 2.5%,  the final pot of money will be around 5.5 times your ending salary and about  18 times your beginning salary.  Start at 30 with a salary of $50,000 and own $900,000 of capital at retirement.

Your house is probably not your biggest investment.

At today’s interest rates, $900,000 would buy a pension of roughly $60,000 per year, $50,000 with inflation protection.  $60,000 is about 37% of your final salary.  I’ll bet you would have thought more.

To get to 70% of final salary as a payout, the deposit rate will be 9.5% or the investment rate will be 5 3/4% over inflation with deposits of 5% of salary.  If yield falls short, so does your pension.

Advice:  Pay attention to how your plan is invested.  The accumulation rate matters. A lot.

The other alternative pension plan, and there are fewer of them every year, pays some percentage of your salary each year and the employer is responsible to make sure the money is there to support it.

In a “defined contribution” plan, you take the investment risk.  In a “defined benefit” plan, your employer does.  That is why most of these plans are going away.  Employers don’t like writing post-dated blank checks.

If you have a defined benefit plan, you can expect the employer will want to end your employment well before 65.  Their contributions are not exactly matched as they are in a defined contribution plan.  They are very curved to be higher at the end of the period.  Their solution, make the last part of that curve go away.  For a 64 year old, it is possible that the pension obligation for that year is close to being as much as the salary.  When they dismiss you at 57, don’t take it personally, it is just business.

Don’t ignore government benefits either.  $1,250 per month of these would cost nearly a quarter million dollars to replace.

Retirement planning should start much earlier than most people believe.  Time matters, small changes in yield matter, contribution rates matter, if you have a defined benefit plan, could the employer afford to fund any shortfalls and will they dismiss you in your 50′s?

You should have a decent awareness of how it all works.

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.