A pension that is based on your final salary is usually a defined benefit plan. This is based on contributions to the pension plan were made by your employer while you were working. Some plans require contributions from employees, as well. The plan defines how pension benefits will be disbursed upon your retirement. These are the common factors in most defined benefit plans. However, the exact rules, stipulations, ratios etc. that define the retirement benefit can vary.
To calculate your final salary pension you'll use the following formula: years of creditable service multiplied by a pension multiplier and then multiplied by your final average salary.
Determining Retirement Eligibility
Determining if you are eligible to retire is the first step in determining the final salary pension. Factors such as age and years of credited service or a combination of the two are required for full retirement benefits in most pension plans. Additionally, if these age and years of creditable service requirements are not met then some plans offer a reduced benefit for early retirement. Years of creditable service is a part of every typical pension plan formula that looks at the time you put in with a specific employer that counted toward your retirement.
For the typical pension plan formula, you'll need to find out the retirement age for your plan, as well as the years of credible service, which are the total time you worked. You'll also need to determine if you'll be paid a lower amount for retiring early, if that applies.
Final Average Salary
Your final average salary is used to calculate a final salary pension; however, the number of years of salary that are averaged in will vary according to your plan. Some will include as much as ten years of service, while others may average the last few years before retirement or even the years of highest salary. Generally, a shorter final average salary period leads to a higher benefit.
Finally, consult your pension plan documents to see if alternative income such as stock options and bonuses are included in your final average salary pension multiplier. Determine what the final average salary calculation is for the pension plan and apply that to your salary records.
Exploring the Multiplier
Each defined benefit pension plan also has a defined pension multiplier used to calculate your final salary pension. A multiplier is applied to the years of creditable service to create a percentage that gets larger as your years of creditable service increases. This percentage is multiplied by your final average salary at retirement to find your pension amount. The multiplier can be stable for your entire employment period or can gradually increase or decrease the longer you work.
With a typical pension plan formula, a multiplier that increases after working a set number of years would reward longevity because the percentage would increase at a faster rate. A multiplier that decreases after working a set number of years would discourage longevity because the growth of the percentage would slow. Discover what your multiplier is by comparing the pension plan documents to the number of years of employment.
Assessing Other Terms
In addition to the items mentioned above there are governmental limits such as the IRS section 415(c) limitations on maximum pension benefits. Also, each unique pension plan may have additions to the pension payments, caps on the pension payments or other specific items such as deferred retirement options.
Knowing the terms of each pension plan is very important as you think through calculating a final salary pension. Before a final salary pension is computed, you should review pension plan documents and contact pension plan administrators so that you understand the terms of your pension plan.
Completing Your Calculation
Once you know the years of creditable service, multiplier, final average salary and any other additional pension stipulations by looking through the pension plan documents or contacting representatives of your pension plan, you can easily calculate your final salary pension. Most plans structure the calculation in similar terms: years of creditable service multiplied by a pension multiplier and then multiplied by final average salary.
As an example, If you have worked 35 years, have a defined benefit pension plan that uses a multiplier of 2.3 percent per year of credited service and earned a final average salary of seventy-five thousand dollars, the calculation would be 35 years times 2.3 percent times $75,000 equals $60,375 per year.
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