Asked by Bill  |  Submitted February 12, 2018

Social Security has a COLA but few pensions do. How do I adjust the calculation to include the self-financed COLA for the pension?

This question is based on the recent article found here. The figure of $1710/mo provided by SS+pension isn't right after the first year. The figuring of investment portfolio needs to account for a "larger than inflation" annual increase in withdrawals. The 2.5% safe withdrawal rate (citing Blanchett and Pfau's article) assumes simple inflation increases.

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  Answers  |  1

February 23, 2018

Since nobody has answered, let me offer one.

There are three alternatives:

(1) sell the pension benefit (or take a lump-sum payout in lieu of the pension) and use the cash to purchase an inflation-adjusted annuity, with increases based on CPI instead of a fixed percentage. Such things are increasingly hard to find but still exist. This would provide inflation protection but would provide only roughly 50% of the prior monthly benefit. Income from investments is now $2590/mo, or $31,080/yr after-tax, or $36,565/yr gross, and at a 2.5% withdrawal rate, an investment portfolio of $1,462,588.

(2) Engage in an interest-rate-swap transaction, converting the fixed pension payment into an adjustable payment. These can be found if the pension monthly payment is millions of dollars; otherwise its unlikely that even a vampire squid would create such a financial instrument.

(3) Ignore the pension benefit. Adjust steps "A" and "B", making the net income needed (step "C") $34,680/yr. Take 30 times that amount (allowing for 30 years in retirement before going broke), assume the same 15% marginal tax rate, and purchase $1.224M of USTreasury TIPS bonds. Method #3 is clearly better than method #1, and is comparable to the $1.293M calculated in the article.

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