Calculating the Value of a Pension

You will need a financial calculator to determine the value of your pension. Financial calculators store important formulas, such as compounded interest rates, so you do not have to know the formulas or know how to work with them. If you are a financial professional, you may already have a financial calculator or be familiar with the formulas. If not, you can purchase one from any office supply store or online retailer.

Step 1:  Getting Started - Find PMT

The first value you need to enter is the payment value, or PMT. You will need to ask your employer for this value. This stands for the annual benefit you would receive if you retried at the absolute earliest date allowed in your pension plan. Your employer will have access to this information, and they should be willing to provide it for you very quickly.

Step 2: Bridge Step - Compute FV

The first computation you will do is to find the future value of your pension, which is called FV on your calculator. To find this, you need to input the PMT you jut located into your financial calculator. You will then input the number of years the payments will be made for as N. Finally, the annual interest rate on your pension should be entered as I. If you are unsure with any of these numbers, ask your accountant or pension fund manager what they mean and which numbers to enter. Once you have entered this information, you will be given a value FV for the amount your pension will be worth at your retirement.

Step 3: Final Step - Compute PV

Next, you will want to find the present value of your pension. Here, you use the same numbers you used above, but you will be using FV instead of PMT. So, you will enter the FV you found in step one. You will then enter the same value for N, the number of years you will be paid out. You then enter the same interest rate for I. Ultimately, your calculator will give you a PV, present value.

What PV Means

PV is the value of your pension if you were to cash out immediately, either by rolling over your pension into another account or accepting an offer from your employer, such as early retirement or pension cash out. There are penalties to cashing out of your pension early, and these are mostly tax penalties. Even if your employer may permit you to do so, the IRS has specific rules regarding pensions.

The IRS allows for pensions to encourage retirement savings. When you take the funds out early, you are essentially negating the requirements to keep the funds for retirement, meaning you will lose some of the benefits. However, if you are simply rolling the funds over into a new account, you can do so without paying the fee for withdrawing early, which is typically 10%. You still may owe taxes depending on your old and new retirement structure.

Replacement Rate

The replacement rate is a measurement of how much of an individual's income will be replaced when he or she retires. This is commonly used when discussing pensions or other retirement plans. The replacement rate deals with a percentage of money in relation to how much an individual makes before retirement. For example, if a pension plan offers a 50 percent replacement rate and an individual makes $50,000 per year, that person will receive $25,000 per year upon retirement. This measurement makes it easy for individuals to tentatively plan how much they will receive when they retire.

What's the interest on vested benefits when calculating pension expense?

The interest rate you receive on your vested benefits in a pension fund will be used when you are calculating your pension. However, this interest rate is not consistent for all funds, and it may even vary on a single fund from year to year. For example, military pension interest is set on an annual basis, and retired military individuals receive the same interest as active duty members in any given year. To calculate your interest, contact your pension administrator. The administrator will be able to tell you your total vested amount as well as interest over time.

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