Your pension isn't as tangible as your house or a car, but that doesn't mean it's any less of an asset. When you're calculating your net worth some advisers will under-value it or leave it out entirely, but that's misleading. In practice it's no different from a bond or other investment, which isn't worth much now but has a distinct future value. To account for that right now, you'll have to work out its net present value.
Net Worth Formula
The formula for calculating your net worth is Net Worth = Assets - Liabilities. Assets are both your liquid assets, such as cash in your savings account, stocks and bonds, and illiquid assets, such as your house, a partnership in a business, and your pension plan. Your liabilities are your debts, such as credit card bills, your mortgage, and bank and business loans.
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Why Your Pension Is Included
Your pension is included in the calculation of your net worth because it is an asset even if you will not derive any financial benefit until retirement. Think of it as a piggy bank that you can't break open until you reach a certain age. Even though you cannot touch the money now, you will be deriving monthly benefit payments or a lump sum payment upon retirement. Even though it will be a future payout, it has a present value that you can calculate. Some advisers suggest counting only the current value of your pension, if you were to cash it out now, but that undervalues its real worth.
Calculating The Present-Day Value Of Your Pension
Determining the value of your pension is a two-step calculation. The first step is calculating how much annuity you will receive in retirement, converting it to a lump sum if it will be monthly payments. Then you take the lump sum and bring it into present value terms. You will need a financial calculator.
Calculating The Value of Your Pension: Step One
Say you are 50 years old, and if you stopped working today, your employer tells you that when you reach 65 you will receive $10,000 a year in retirement payments. According to actuarial tables, your life expectancy is 85, so you would receive $10,000 for 20 years. With your financial calculator, plug in $10,000 for payment, 20 years for period, and use 5% (4.5% to 6.5% are typical discount rates) as the interest rate, and then press PV for present value. The PV will equal $124,622.
Calculating the Value of Your Pension: Step Two
Next, clear the calculator and plug in $124,622 for FV, or future value, put 15 years in for period, because it will be 15 years until retirement, and put 5% as the interest rate and press PV. The present value of the pension in this example is $59,945. Add the $59,945 to your asset column and you have included your pension in your net wealth calculation.
Free Financial Calculators
If don't have a financial calculator but do have a smart phone, you should be able to download one for free from an app store. Many sites also offer free financial calculators for use in your browser, or even complete net worth calculators if you'd like to automate the rest of your calculations as well. If all else fails, or if you'd just like to have an actual calculator for ongoing use, should be able to pick up one for under $20 wherever electronics are sold.
- MoneyTerms.co.uk: NPV (Net Present Value)
- Investopedia: Present and Future Value of Annuities
- Investopedia: Calculating Your Net Worth - Making Accurate Estimates
- Michael James on Money: Pensions Are Worth Zero?
- FinancialCalculator.org: Free Financial Calculators and Information
- Bankrate.com: Net Worth Calculator