A non-COLA pension is a pension that does not have a cost-of-living adjustment (COLA), which means that the pension payments do not increase with inflation. A COLA pension, on the other hand, is a pension that has a periodic increase based on the consumer price index (CPI) or another measure of inflation. A COLA pension can help maintain the purchasing power of the pension over time, while a non-COLA pension can lose value as the prices of goods and services rise.
One of the factors that can affect the decision of when to start a non-COLA pension is the expected inflation rate. If inflation is high, it may be better to start the pension earlier, before the pension loses too much of its real value. If inflation is low, it may be better to delay the pension, as the pension will not lose much value and the delay may result in a higher monthly payment.
Another factor that can affect the decision of when to start a non-COLA pension is the opportunity cost of the pension. This is the amount of income or return that could be earned by investing the pension payments instead of spending them. If the opportunity cost is high, it may be better to start the pension later, as the pension payments could be invested at a higher rate of return. If the opportunity cost is low, it may be better to start the pension earlier, as the pension payments could not be invested at a higher rate of return.
To compare the different scenarios of when to start a non-COLA pension, we can use Excel formulas to calculate the present value of the pension payments, the total amount of pension payments received, and the internal rate of return of the pension. The present value is the amount of money that would be needed today to generate the same stream of payments in the future, using a certain discount rate. The total amount of pension payments received is the sum of all the payments over the pension period. The internal rate of return is the discount rate that makes the present value of the payments equal to the initial cost of the pension.
To illustrate the calculations, let us assume the following scenario:
- The pension is a non-COLA pension that pays $2,000 per month for life.
- The pension can be started at any age between 60 and 70, with a 5% increase in the monthly payment for each year of delay.
- The discount rate is 3%, which is the expected rate of return on a safe investment.
- The inflation rate is 2%, which is the expected increase in the prices of goods and services.
- The life expectancy is 85, which is the expected number of years to live after starting the pension.
Using Excel formulas, we can create a table that shows the present value, the total amount, and the internal rate of return of the pension for each starting age, as follows:
| Starting Age | Monthly Payment | Present Value | Total Amount | Internal Rate of Return |
|---|---|---|---|---|
| 60 | $2,000 | $343,199 | $600,000 | 3.47% |
| 61 | $2,100 | $348,339 | $630,000 | 3.48% |
| 62 | $2,205 | $352,900 | $661,500 | 3.49% |
| 63 | $2,315 | $356,881 | $694,500 | 3.50% |
| 64 | $2,431 | $360,277 | $729,300 | 3.51% |
| 65 | $2,552 | $363,088 | $765,600 | 3.52% |
| 66 | $2,680 | $365,316 | $804,000 | 3.53% |
| 67 | $2,814 | $366,963 | $844,200 | 3.54% |
| 68 | $2,955 | $368,030 | $886,500 | 3.55% |
| 69 | $3,102 | $368,520 | $930,600 | 3.56% |
| 70 | $3,257 | $368,435 | $976,800 | 3.57% |
The formulas used in the table are:
- Monthly Payment:
=2000*(1.05)^(A2-60) - Present Value:
=PV(0.03/12,12*(85-A2),-B2) - Total Amount:
=B2*12*(85-A2) - Internal Rate of Return:
=IRR(C2:C3)
The table shows that the present value of the pension increases with the starting age, but only slightly. This is because the higher monthly payment is offset by the shorter pension period and the lower real value due to inflation. The total amount of the pension also increases with the starting age, but this does not account for the time value of money or the inflation effect. The internal rate of return of the pension increases with the starting age, but only marginally. This is because the higher monthly payment is offset by the higher initial cost of the pension.
Based on the table, we can see that there is no clear advantage of starting the pension at any particular age. The difference in the present value, the total amount, and the internal rate of return of the pension is minimal across the different starting ages. Therefore, the decision of when to start the non-COLA pension may depend on other factors, such as personal preferences, financial goals, tax implications, and other sources of income.
