# Calculating Commuted Value of a DB Pension



## HackNSlash (Apr 3, 2009)

Hey all,

My wife's employer has a DB pension, and we're thinking of maybe switching jobs, but haven't made any final decisions. We asked their HR department to estimate the commuted value of her pension and they refused to provide that information unless she ACTUALLY quit. That was a bit odd. Is there a way to estimate this value on our own with our pension statement? It doesn't have to be accurate down to the penny, just a ball-park figure would be helpful.

Thanks!


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## OptsyEagle (Nov 29, 2009)

It would be difficult but doable within a large variation of results.

Companies can be resistant to give "commuted values" for accrued pension benefits because the final number can be so large, many believe it to be better to quit and take the cash and run, then to continue to work and accrue the monthly benefits. Obviously this is the exact opposite reason that companies offer these benefits in the first place. 

The actual result is that the commuted value of the pension is not BETTER or WORSE then the benefits themselves ... it is exactly the SAME as the benefits themselves. Unfortuneately, Canadians are not overly good at math and hence make mistakes in this area, quite frequently.

Anyway, if you want a ballpark number, you would need to take the current monthly benefit accrued to date and find out what the cost of a life annuity would be, TODAY, to provide the same number. That cost, would be the commuted value. Sounds simple, but there are more issues. First of which, getting the annuity quote, but even if you have access to this, you need to factor in a few things:

1) what age is this monthly benefit offered.
2) is it indexed in any way (no index, indexed at a fixed percentage, indexed to CPI with a maximum, indexed to CPI)
3) does it integrate with CPP (does the monthly benefit drop at age 65).
4) Does it have a survivor's benefit to a spouse and if so, what is the amount they get?


Without annuity quotes, one can use an approximate 3% as the internal rate of return. Fairly close from most annuities I have calculated lately. The next issue is, how long will it pay? Without an annuity quote you need to figure out what life expectancy they would use. Keep in mind that annuities will use the life expectancy of either male or female, depending on the annuitant, however, most pensions are gender neutral (which hurts men here but, who else is in the position to take one in the kahoonies). So with that being the case, I would use age 85, as the life expectancy for the calculation.

So, for example, if the pension offers $2,000 a month, no index at age 65 and you are 50 today. I would then do a calculation of what the amount of capital that would be required to provide $24,000 per year for 20 years with a 3% internal rate of return and $0 value at the end of the time period. Once I had that number, I would then calculate what lump sum amount of money one would need to set aside today to see it grow into the previously calculated number, in 15 years at 3%.

As you can see, it is pretty complicated already and we have no indexing or CPP integration, etc. Computers will help a lot and can factor in the fixed indexing and CPP integration. The CPP integration would require you to do two numbers, if the pension is going to change over its lifetime. As for spousal survivor benefits, I would just ignore it and feel good knowing that whatever number you get, the real number will be higher. The amount higher would be the cost of buying a life insurance policy that would buy an annuity for a spouse, to pay him/her the reduced benefits. It is probably too complicated to try to calculate this yourself, so I would ignore it.

Anyway, good luck with all that. lol.


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## moisimplementmoi (Oct 20, 2014)

Did your wife get a CV with her last pension statement? if yes long term rates have not changed significantly, so you could use a proportion of current benefit/benefit at that time as a floor of the CV. Since you would also have some aging since then, the actual CV maybe a bit higher, but you would be within 5%. 

as for not providing value, well they would likely have to pay their actuary to get it, so this might me why they wouldn't with how much they charge.


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## HackNSlash (Apr 3, 2009)

THANK YOU. All that made sense to me, but I just needed someone to explain how the stupid math worked.

One question though: how do they figure out the IRR for the period between now and when the pension payments starts for the purposes of discounting the present value? I believe they use the current 10-year treasury yield for the annuity payments part, but wouldn't the IRR used be higher to account for the fact that they can make more aggressive investments.


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## OptsyEagle (Nov 29, 2009)

The IRR would be the 10 year treasury yield. Since you are asking for the commuted value, they would no longer have any or your money left to make any kind of investments, aggressive or not. So they simply figure out the lump sum value that you would require today to buy the same benefit. Most insurance companies are going to use very conservative and probably fully guaranteed investments for doing this, so the commuted value would use those as well.

So all that being said, the IRR will be the same between now and when the benefits kick in, as it would be after the benefits kick in.

By the way, when it comes to commuted values, lower interest rates are a good thing. The lower the prevailing interest rate, the higher the commuted value.


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## Eclectic12 (Oct 20, 2010)

http://www.milliondollarjourney.com/pension-basics-the-commuted-value.htm


Cheers


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