Pension with stepped COLA

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brlr2000
Posts: 1
Joined: Thu Feb 04, 2010 7:17 pm

Pension with stepped COLA

Post by brlr2000 » Thu Feb 04, 2010 7:31 pm

I have a pension with a stepped cola. Years 1-3=0% cola, yrs 4-6=2% cola, yrs 7-9=3% cola, yrs 10-12=3.5% cola, yrs 13-14=4% cola, yrs 15-death=5% (capped by the Consumer Price Index average for the three preceding years). I'll begin collecting at age 50. How do I enter this info?

jimr
Posts: 520
Joined: Thu Feb 28, 2008 6:48 pm

Re: Pension with stepped COLA

Post by jimr » Thu Feb 04, 2010 8:12 pm

To get a "close enough" estimate, I'd suggest using the additional inputs option and creating two pension cashflow entries. One with no cola for the first 3 years, then one with the cola for the rest of the plan. The planner will automatically apply the inflation rate to the payment if the normal pension option (cola assumed) is used. This isn't perfect, but it should give you a decent estimate.

To configure this, click the additional inputs button on the top right of the main planner window. Then on the new popup window, look at the bottom section where it says "specify additional cash flows."

Start by creating a cashflow type "pension no cola" with a start year of age 50 and an end year of age 52. Enter the amount for your starting annual pension payment. Next, create another cash flow with a type of "Pension" (which implies a CPI cola) starting at age 53 and continuing until the end of plan.

This may seem rather imprecise, but it's probably close enough. There's nothing preventing you from pre-calculating all of the pension payments for the first 15 years and entering each one as its own cashflow that starts and ends in the same year.

I don't recommend that though. In addition to being a ton of work, it really wouldn't change the validity of the end result very much.

Tools like the FlexibleRetirementPlanner are designed to give you an estimate of your retirement plan's likelihood of success, but there's a large degree of uncertainty built into the process. There are so many variables that estimating each one perfectly is not possible. I find it's more useful to focus energy on "stress testing" the plan by checking the result when you margin inputs down. For example, cut you pension income by 10 or 20 percent and see how that affects you plan's chances for success.

Also, to provide an idea of the "estimation error" that's inherent with these tools, financial planning author William Bernstein suggests that due to this built-in uncertainty, there's really no meaningful difference between an 80% probability of success and a 99% probability of success.

Hope this helps,

Jim

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Re: Pension with stepped COLA

Post by Guest » Fri Feb 05, 2010 1:17 pm

Jim,

Thank you for your detailed reply. One more quick question. Do I still enter my 'initial pension" amount on the main page - under Annual Retirement Income?

jimr
Posts: 520
Joined: Thu Feb 28, 2008 6:48 pm

Re: Pension with stepped COLA

Post by jimr » Fri Feb 05, 2010 4:20 pm

It would be redundant to enter your pension income again on the main page. Entries on the main page are merged with entries on the additional inputs page when the simulation is run.

Just to be sure the planner is doing what you expect, it's a good idea to review the year-by-year data that's presented in the table at the bottom of the "detailed view" tab.

Jim

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