# Valuing a public sector pension

A common public sector pension structure in the UK is as follows

1. You receive a payment each year from your pensionable age until you die.
2. If you die before your partner, they receive a survivor benefit - a fixed payment each year until they die. This is conditional on you having reached your pensionable age.
3. You may also receive a lump sum when you reach your pensionable age.

The annual payments are typically linked to inflation. The size of the annual payments and the lump sum are known now, but they update each year (as each additional year of work contributes more to your pension). The current size of the payments should be interpreted as the amount you would receive if you did no more work between now and your pensionable age.

Given the current values of the payments in 1, 2, and 3 above, and your current age, how should you value this pension (e.g. for calculating your net worth)?

• As a first-order estimate, HMRC considers a DB scheme that delivers an annual pension of of £X as being equivalent to 20 * £X, for lifetime allowance purposes. – AakashM Jan 18 '18 at 11:27

For the lump sum L, the calculation is relatively simple: you should calculate your net worth today in today's money, and since L will be uprated with inflation, its value today is also L, at least if you ignore any caps on the uprating and you accept that the inflation measure they use (probably CPI) is a fair estimate of the inflation in your own living costs.

For the rest, the way to value it, as you suggest in the tags, is to compare it with an equivalent annuity. There are some tables online here and here, though none for the exact equivalent scenario of both "joint life" and "index-linked". In any case the exact rates you could get would depend on the age of your partner relative to you, the age of retirement and your health at the time of retirement, as well as changing over time before you actually retire. So you'll only ever be able to get a rough estimate.

At a very rough guess if you're looking at age 65, I would put it at about 3-3.5%, i.e. I would multiply the initial payment by about 30 to get a capital value. Again given the inflation uprating between now and retirement age, you just need to think about the present level of the pension to do the calculation.

There are also various online forms you can find by searching for "annuity calculator" that you could use to get a more personalised illustration, but you'll need to push your age forward and also hand over your personal details.

Another thing to bear in mind is the risk of the pension not actually being paid in full, particularly if it's with a quasi-state scheme with a significant deficit (e.g. the Universities Superannuation Scheme), rather than with the government itself. There's at least some risk of a scheme going under before you retire and falling into the Pension Protection Fund, which would leave you with less income and less good index-linking than expected, or even worse for the Pension Protection Fund itself to fail entirely. Even with the government, if there was a serious enough financial crisis they would probably partially renege on their promises. So you should maybe reduce the notional capital value by some percentage to account for this risk.

All that said, when I think about pensions and net worth, I actually think about this the other way round: I have a defined contribution pension and I look at annuity rates from the perspective of whether the pot will give enough retirement income to live on comfortably, rather on its absolute value today.

The main portion of this question, how to value a pension, is a basic present value question. You can look HERE for the formula to calculate the present value of an annuity. This is also easily done in Excel and with any financial calculator. Assuming the growth is linked to inflation, you can estimate that inflation is around the 2% mark and go from there, or do more research and try to estimate on a longer time scale with more accuracy. Because there is no certain age for the end of your pension( ie your death) you have to estimate. You can use family history, personal health indicators, or national statistics to help you do so

As for the lump sum at the beginning of retirement, because it is based on how much you contribute you have two options:

1) If your employment future is unsure, you can update the amount every year and recalculate the value.

2) If you are stably employed and expect to be so until requirement you can work out how much that lump sum will be based on how much you expect to contribute.

When it comes to your partner dying, that is highly speculative and probably is not much use to factor in. You cannot assume or estimate year of death (assuming the person is currently healthy). If I was working on this for someone, I would not factor this in at all.

Hope this helps!

• The value of the lump sum is known (and again, will update each year as you contribute more to the pension). I have edited the question to make this clearer. The formula for the value of the annuity you link to requires that you enter the number of years it is paid for - that is not known in this case (you receive payments until you die). – Chris Taylor Jan 17 '18 at 21:33
• Okay, then you need to estimate the number of years you will have the pension for as well. You can use national age of death stats or current health indicators/family ages of death to help estimate this. As for the growing lump sum, you will need to update your calculation each year based on how much you contribute or figure out, if you remain at the same job and contribution levels, how much that will be. – Michael Hartmann Jan 17 '18 at 21:41
• The best you can do is assume a normal life expectancy, such as here: ons.gov.uk/peoplepopulationandcommunity/… It is unrealistic to assume, for planning purposes, that your expected number of years of payments will be significantly higher or lower than a normal life expectancy. There are too many unknowns. – chili555 Jan 17 '18 at 23:31