A recent Family Finance column in the Financial Post showed something strange about the way that financial planners calculate a person’s net worth. Apparently, having a defined-benefit pension plan does not add anything to your net worth.
The article profiled Doris, a grandmother with a simple balance sheet. She has a car worth $3000, owes $10,000 on her line of credit, and can begin drawing a $1400 per month pension in two years. For some reason, her pension just doesn’t count and her net worth is listed as -$7000. This isn’t an isolated case; I’ve seen this in many other net worth statements as well.
With a negative net worth at age 63, Doris appears to be in dire circumstances. However, a pension of $1400 per month plus CPP and old age security are more than enough to give her a modest but comfortable life. Without the pension, Doris would be far worse off, so why doesn’t the pension count as part of her net worth?
To value her pension we would need more details about the pension than the article gives. Let’s approximate its present value at about 15 years’ worth of payments, or about $252,000. This would make her net worth $245,000, which better reflects her true financial condition. We could add in the present value of CPP and old age security as well, but since most people get these payments, this doesn’t add much to our ability to compare Doris’s financial condition to other people’s financial conditions.
We could come up with a number of possible justifications for ignoring pensions on net worth calculations. Let’s try a few:
1. Pensions are hard to value accurately, so we don’t try.
The present value of a pension is somewhat tricky to value. You have to take into account indexing, current interest rates, mortality rates, and other factors. However, just about any kind of guess is better than guessing zero.
2. Doris’s pension payments are not guaranteed because she might die before receiving the first monthly cheque.
This is true, but Doris is seeking financial planning out of concern for her future. If she knew she was going to die soon, she wouldn’t be too worried about her monthly cash flow. In fact, if Doris wants to be sure that she will be okay financially until age 95, she should value her pension at even more than just 15 years’ worth of payments because she is presuming that she will collect for 30 years.
3. The value of Doris’s pension is not available to a financial advisor to increase his or her assets under management.
This is a pretty cynical possible reason, but it gets to the heart of the potential conflict here. From Doris’s point of view, her pension is very valuable, but to others such as financial advisors and heirs, the pension has little value.
What do you think is the real reason why pensions are not valued in some net worth statements?