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A friend of mine who works in another state is advertising help wanted. I'm slowly improving my personal finance techniques, and it seems like this is a good month to look at total compensation and comparing fringe benefits.

My theory is that job offers with different salaries and fringe benefits can be compared by putting a dollar amount on how much extra salary I'd need to buy the benefit in the open market. So tuition discounts are easy to figure, as are employer matches to salary.

One tricky problem here is that some jobs, like the one I'm in now, are defined contribution (403b) and others, like the one I used to be in and ones I might take in the future, are defined benefit plans operated by the state. For example, the KPERS defined benefit is outlined on their website:

Final average salary x statutory multiplier x years of service = annual benefit at normal retirement age

How do I value this annual benefit at retirement? My gut instinct is to model it as an annuity, but it's paid out in the future, and some of the variables are uncertain.

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@JoeTaxpayer's answer outlines how to value it.

Some other considerations:

  • As I understand it, some public pensions may be tax-free if you still live in the state that is paying the pension. E.g. when a Massachusetts teacher receives pension, it is exempt from state taxes, but if that person moves to Vermont he will have to pay Vermont income tax on those payments. So if you plan to stay in the state post-retirement, this provides additional value.

  • Pension payments aren't fully guaranteed by the PBGC. And not all pension plans are fully funded. Depending on the political and economic environment when you hit retirement, your retirement plan could suffer. (And if you aren't working, you may not have a union vote any more when the other working members are voting on contract amendments that affect pensions.)

  • I'm not certain of all of the rules, but I hear news reports from time to time that formulas like what you've posted in the original question are changed through negotiation with the union. If you make an employment decision using the formula in year X and then the formula changes in year X+10, your expected pension payment will change.

  • Don't depend on it being tax-free in your calculations. In Michigan, we just extended income tax to all pensions (state pensions were previously exempt, as I understand it). This has screwed up a lot of peoples' planning who were counting on it being tax-exempt. Of course there's going to be all sorts of court cases, and people trying to repeal the tax and all that, but it's just too risky to include in your calculations IMo. – Adam Jaskiewicz Dec 15 '11 at 22:49
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There are two steps. First you take the age at retirement and annual benefit. Say it's $10,000/yr. You can easily look up the present value of a $10k/yr annuity starting at age X. (I used age 62, male, at Immediate Annuity. It calculates to be $147K. You then need to look at your current age and with a finance calculator calculate the annual deposits required to get to $147K by that age.

What I can't tell you is what value to use as a cost of money until retiring. 4%? 6%? That's the larger unknown.

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