How to use the pension calculator
A pension pays a monthly income for life after you retire. Before the first payment you usually have to make choices that can't be undone later, and the calculator compares each one by its value at retirement:
- Lump sum or monthly: the age you need to live to for the monthly pension to be worth more than a one-time lump sum payout.
- Single or joint: whether to take the higher single-life pension or the lower joint-and-survivor pension that keeps paying your spouse.
- Work longer: the age you need to live to for a bigger pension that starts later to beat a smaller one that starts sooner.
How is a pension calculated?
Most defined benefit pensions use a formula: yearly pension = years of service × benefit multiplier × final average salary. The final average salary is usually the average of your highest three or five years of pay, and the multiplier is often 1% to 2.5%. With 30 years of service, a 1.5% multiplier and a $80,000 final average salary, the pension is $36,000 a year, or $3,000 a month. Your plan's annual benefit statement shows the amounts for the choices below.
A defined benefit pension promises a set income and the employer carries the investment risk. A defined contribution plan, such as a 401(k), promises nothing: what you get depends on what was saved and how it grew. The 401(k) calculator projects that kind of plan.
Lump sum or monthly pension?
The monthly pension pays as long as you live, so it is worth more the longer you live. The calculator finds the age from which the pension's present value, at your investment return, is more than the lump sum. With a $800,000 lump sum, a $5,000 monthly pension rising 3.5% a year and a 5% return, the pension is better if you live to 81 or older. These are the default inputs of the Lump sum or monthly tab.
| If you live to | Monthly pension is worth | Compared with the lump sum |
|---|---|---|
| 75 | $550,469 | $249,531 less |
| 80 | $797,388 | $2,612 less |
| 85 | $1,027,167 | $227,167 more |
| 90 | $1,240,995 | $440,995 more |
| 95 | $1,439,980 | $639,980 more |
The pension suits you if you expect to live long, have little other secure income or don't want to manage investments. The lump sum suits you if your health is poor, you want to leave money to heirs, or you have other income and can invest it well. A higher return assumption favors the lump sum; a cost-of-living adjustment favors the pension. Lump sums of private plans are set with IRS interest rates, so when interest rates rise, the lump sum you are offered usually falls.
Single-life or joint-and-survivor pension?
A single-life pension is higher but stops when you die. A joint-and-survivor pension is lower and keeps paying your spouse, usually 50%, 75% or 100% of your pension. In private plans, a married employee gets a joint-and-survivor pension unless the spouse agrees in writing to give it up.
The calculator compares two ways to protect your spouse with the higher pension. In the example, with a $5,000 single-life pension or a $3,000 joint pension, your spouse would need $657,173 to replace the survivor pension if you died at 65. Investing the $2,000 monthly difference until your life expectancy of 77 grows to $514,709, more than the $428,530 survivor pension your spouse would lose, so the single-life pension is better. If your spouse is likely to outlive you by many years or has little other income, the joint pension is the safer choice.
Should you work longer for a bigger pension?
Retiring later usually means a bigger pension, but fewer years of payments. In the example, a $2,500 pension at 60 is compared with $3,800 at 65: the later pension is worth more only if you live to 87 or older. The comparison counts only the pensions; the salary you earn while you keep working, and the savings it allows, make working longer more attractive.
How the values are counted
- The lump sum and the work-longer comparison count monthly payments made at the start of each month, rising by the cost-of-living adjustment once a year.
- The single or joint comparison counts the pension by year: yearly amounts rising by the adjustment.
- Values are discounted at your investment return, so they are worth the same as money you have at retirement. To discount other amounts, use the present value calculator.
- Taxes are not included.
Pension calculations in Excel
- Benefit formula:
=30 * 1.5% * 80000returns $36,000 a year. - Value of a pension without a COLA:
=PV((1+5%)^(1/12)-1, 240, -5000, 0, 1)returns $767,833, the value at 65 of $5,000 a month paid until 85. The last argument, 1, counts payments at the start of each month.
Excel's PV has no yearly raise, so with a cost-of-living adjustment the pension is worth more: $1,027,167 with the 3.5% adjustment of the example, as the calculator shows.
Pension taxes and rollovers
Monthly pension payments are taxed as ordinary income, and most states tax them too. A lump sum can be rolled over into an IRA so it is not taxed until you take the money out; the IRA calculator shows how it grows. Ask the plan for a direct rollover: if the check is paid to you, the plan withholds 20% for tax. A lump sum you keep is taxed in the year you receive it and, before 59½, may cost a 10% penalty.
Is my pension safe?
Most private-sector pensions are insured by the Pension Benefit Guaranty Corporation (PBGC). If the plan fails, the PBGC pays your pension up to a yearly legal maximum, which is lower if you start payments early. Public pensions of states and cities are not covered by the PBGC; they are backed by the government that runs them.
Pensions in your retirement plan
A pension is one part of your retirement income. Add it, with your Social Security benefit, as other income in the retirement calculator to see how much your own savings still need to cover. The Social Security calculator finds the best age to claim, and the annuity payout calculator shows the income a lump sum could buy.