Present Value of a defined benefit pension
Many people seem to either over or under value their pension payments. It’s always arguable if any given pension will survive the test of time and such discussions can be incredibly complex. Calculating the present value on the pension payment however is extremely simple. The only decision you have to make is the choice of a withdrawal rate. For a personal retirement account that you have funded yourself the recommended rates are 3 to 4% as ‘safe’ values that you should be able to withdraw each year and never run out if invested reasonably. I believe 4% is a good choice. The guaranteed pension payment is basically a perpetuity and it’s PV can be valued using that methodology.
Present Value of a perpetuity = cash flow divided by rate. or PV = C/r .
For an example assume a $1000 monthly payment or $12000 per year. Using the 4% mentioned earlier:
PV = 12000/.04 = 300000. Stated another way, the pension payment may be treated as 300K in retirement account balance when figuring the total amount of retirement funds you need for a given lifestyle in retirement.
