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Question: How can I tell if my pension valuation is right?
Answer: Here's how you can get a ballpark sense of whether the result you are getting from the defined-benefit pension calculator is correct.
Let's assume the following facts:
Pension will pay $2,000 per month at retirement
Pension will start to pay when client is age 65.
Client is a male, and is 50 years old today.
Discount rate is 2.5%
No Cost of living adjustment (that is, no COLA), just to keep it relatively simple.
A ballpark life expectancy for males is to age 83. (We are not looking at this client specifically.)
Annual pension is $2,000 * 12 = $24,000.
Pension starts 15 years from now.
Pension will be in pay status for 18 years.
1. Ballpark value at retirement date.
In order to get a ballpark sense of the value at retirement, go to Excel or a Google Docs spreadsheet, and input the following formula:
This is asking for the present value of payments of $2,000 per month for 18 years using a discount rate of 2.5%.
This gives a value of $344,480.
The next step would be to discount this number back to the present, by multiplying by (1/(1.025)^15).
If the first formula was in block A1, this formula would be:
You are just dividing by 1.025 to discount by 2.5% for each of the 15 years between now and the time the person turns age 65.
The result this gives is $237,852.
You then compare this to the software's result.
Plugging these numbers in, and using the RP-2000 table, I got a software result of $242,292.
The software is also discounting for mortality, and is doing a much more sophisticated mortality table analysis.
But this gives you a ballpark.
Note that the date started in plan, and separation dates affect coverture, but they do not affect the plan's value.