Pensions and other income in the plan

Almost no real plan is a portfolio alone against the world. There is Social Security, and a pension if you have one, arriving one day. Sometimes rent (Real estate in a FIRE plan (your home, and rentals)). Work in small doses (Barista, Coast, side income: work you choose). An annuity, and maybe a distant inheritance. How you count those flows matters more to the plan than most portfolio choices do. Sensitivity work ranks the pension second among the variables of a plan, right behind spending.

This chapter is the accounting manual for that income. It opens with the taxonomy: guaranteed, near-certain, hoped-for, three treatments that people confuse at their own cost. Then the mechanisms, the ways a flow transforms a plan. A flow does not merely cut withdrawals. It shortens the horizon at risk, crushes the longevity tail, and counts as an implicit bond allocation. Next comes the modeling itself, inside a plan with real numbers in it: net real amount, start year, end year, pension assumptions, and the traps waiting in the entry. Then the awkward cases: rent, annuities, delicate inheritances, a spouse's income. And last the counter-check, because a plan can also lean on those promises too hard. When the promised flows dominate everything, their own risk (political, tenant, the health of the work) becomes the risk of the plan.

What a flow does to a plan: the four mechanisms§

$15k a year of income in a plan that spends $50k does not "cut withdrawals by 30%". It does four things, and three of them run against intuition.

1. It cuts net withdrawals, but only once it starts. That much is obvious, and the timing is the subtle part. A pension that starts in year 17 cuts nothing during the bridge. That is why an early retirement runs in two regimes: an uncovered phase, the bridge years, then a covered phase (Horizon, life expectancy, and 50-year retirements). And that is what sets up the next mechanism.

2. It shortens the horizon at risk. This is what a pension really buys you. The "50-year plan" becomes a 17-year bridge with the rest already covered. Sequence risk and the cliff of the fixed rule then bear on the bridge alone (Sequence of returns risk: the retiree's real enemy). That is why adding the pension to the model often divides failure by two to four, and why leaving it out is the most expensive omission there is (The ten mistakes that wreck a FIRE plan). The pension shows up precisely in the long scenarios, the ones where the portfolio is running out of breath.

3. It crushes the longevity tail. A lifelong flow (a pension, an annuity) covers the one risk capital covers badly: living a very long time (Annuities and safety first: buying a floor, Horizon, life expectancy, and 50-year retirements). Look at mortality-weighted failure. The scenarios that read "alive, broke, 95" become "alive, down to the pension floor, 95". That is a completely different event.

4. It is an implicit bond allocation. This is the TPAW reading (Amortization-based withdrawal (ABW/TPAW): the actuarial approach). A pension of $20k a year, discounted, is worth $300k to $450k of inflation-linked government bonds inside your total wealth. At the same overall risk, the visible portfolio can therefore carry more stocks (The stock and bond allocation in retirement, on covering the floor). The fifty-year-old with a pension coming who holds 40% bonds out of caution is usually under-invested. The caution was already in the pension.

Modeling a flow: three numbers and their traps§

Three numbers describe any outside income. An annual amount, a start year, an end year. Enter the amount net and in constant dollars, so after tax and assumed to follow inflation, like everything else in a withdrawal plan (Inflation and the withdrawal rate: the exact link). The arithmetic that follows is disarmingly simple. Each year the flow comes off the need, and the portfolio funds only the difference. Two shapes cover everything. The lifelong flow has no end year: that is a pension or an annuity. The dated flow has one: rent on a property you will sell, a stretch of work, unemployment benefits. Any serious simulator offers both, and running without them means running a plan that is not yours.

Enter the pension three ways, never one. In go the public pension with its haircut, any annuity already paying, and a weighted survivor benefit, each on the date it starts. The amount stays uncertain twenty years out, so good practice is to run the plan under three sets of assumptions. One stressed: the pension shaved by 20% to 30% and the age pushed back. One made only of what you have already earned, the floor you would get if your career stopped today. One taken from the official estimate on your own statement. A public pension is indexed and most private ones are not, so read each for what it actually promises (US health coverage and Social Security: the two ends of the gap). Three entries, three failure probabilities, one range. What informs you is the spread between the three, not the middle number.

Three entry traps wait along the way. First, the gross figure copied straight off the statement, when what you need is the net one with its haircut. Second, a start year that flatters you: assume the later claiming age rather than the earliest one allowed, unless you have done the calculation. Third, the forgotten second pension in a couple. Add up the household's flows, each on its own date, weighting a gap of a few years into a single average start if that is simpler.

Side income is modeled as a dated flow. What goes in there: net rent with its haircut on a property you will sell, the structural work of a semi-FIRE, and unemployment benefits during the transition. Work counts only in that case, when it is an assumed parameter of the plan (Barista, Coast, side income: work you choose). There is one trap here and it is serious: slipping the hoped-for income of category 3 into the box. The simulator will then tell you what you want to hear. That is p-hacking with scenarios, exactly (Simulator traps: independence, US bias, survivorship).

The start year matters as much as the amount. A dollar of side income is not worth the same thing depending on when it lands. In the first five years it saves you from selling shares into a decline, so it attacks sequence risk right where sequence risk is decided (Sequence of returns risk: the retiree's real enemy). In year 25 it is a comfort supplement, because the fate of the plan is largely settled by then. A small, early income therefore buys more safety than a much larger pile of extra capital. It is the best sequence insurance available, and this one mechanism explains why semi-FIRE and a gentle half-time work as well as they do (Barista, Coast, side income: work you choose).

And then read the output properly. Sensitivity gets tested: move the pension by plus or minus 20% and by plus or minus two years. If failure swings, the plan is a bet on the pension (see the counter-check below). A solver that prices equivalent moves puts these trades side by side (The one-more-year syndrome). You get to see "$500 a month of side income for five years" sitting next to "$80k of capital", a menu that puts the magnitudes back in proportion.

The counter-check: the over-backed plan§

Everything in this chapter pushes you to lean on these flows. Clear thinking sets the bound on the other side. A plan whose floor rests 70% to 80% on promised flows has concentrated its risk on those promises. A public pension carries political risk: that is what the 10% to 20% haircut is for, and a plan that breaks when the haircut goes to 30% deserves a hard look. Rent carries regulatory and management risk. Structural work carries the risk of health and of appetite: the 48-year-old Barista may not still be the Barista at 61.

The robustness test applies at design time and at every review (The annual review: the retiree's checklist). Run the plan without each flow, one at a time, that flow set to zero, two minutes per test. The failure probability that comes out does not have to stay under your threshold, since covering the plan is the whole point of the flows. But it has to stay in recoverable territory, the zone the playbook has steps for (When to worry, and when to let it ride). If losing a flow makes the plan unrecoverable, that flow is not a margin of the plan. It is the plan. It then deserves the treatment of a core asset: diversification, upkeep, a written plan B.

The essentials§

Going further§