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.)
This means:
- Annual pension is $2,000 * 12 = $24,000.
- Pension starts 15 years from now.
- Pension will be in pay status for 18 years.
In order to get a ballpark sense of the value at retirement, go to a spreadsheet such as Excel, and input the following formula:
=PV(0.025,18,24000)
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 15 years back to the present, by multiplying by (1/(1.025)^15).
If the first formula was in block A1, this formula would be:
=A1*(1/(1.025)^15)
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.
You will see that this is pretty close.
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.