Monday, 24 September 2018

Accumulating the American dream pension

A defined benefit (DB) pension is most common in the Netherlands but defined contribution (DC) pensions are becoming increasingly popular. Here you can find a guest post I wrote for explaining why I love the DC pension at my current employer and how I moved one of my DB pensions from an earlier employer to my current DC one. This post discusses why I allow myself to include the value of my DC pension into our net worth which speeds up our journey to FI. 

Withdrawal rate of a DC pension
A DC pension is like a 401k in the USA. At least mine is, I have full control in the sense that I buy a low-cost ETF every month and I can login to check the current net worth of my portfolio. Most Americans striving for FI include their 401k in their net worth calculations. I do the same with my DC pension.

On specific websites like this one you can check how much pension you can purchase from a lump sum that you have saved in your DC pension throughout your working career. By modifying your date of birth you can mimic different retirement ages. E.g. if you have €100,000, the best deal I can currently find pays €5448/year from 68 years of age onward. Applying the 22.95% after-pension tax bracket will leave you €4198 in hand. In other words you have a withdrawal rate of 4.2%. It is perfectly save as it will be paid until you die. Nothing left for your heirs afterwards though. Sounds pretty similar to the 4% you are supposed to maximally withdraw yearly from your personal stock account after reaching FI.

Adding up the numbers
To see how far we are in the journey towards our FI number I add up our emergency cash fund, our personal ETF position, AND the value of the DC pension (consisting of an ETF). Like many, I consider a 4% withdrawal rate on the total position safe. I could access the DC fund earlier than at 68 but this will be taxed in a higher bracket so this is not the plan. 

By the time we reach FI the personal stash is twice the size of the DC pension and there is around 15 years to bridge before the pension payments kick in. So if we would ignore the DC pension, I am withdrawing 6% from the personal stash which has a 99% chance of being OK for 15 years in a 50% stock - 50% bond portfolio according to the Trinity study. We’ll  be fine until the DC pension kicks in! At least the chance of dying at work accumulating more money is bigger than the chance of ever running out of money, time to take the plunge! Especially considering the fact we are still ignoring state pensions (AOW) and DB pensions we have as well. We just made the journey to FI shorter!

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