Conventional, employer funded pension plans, known as defined benefit plans, are designed to pay a fixed, pre-established benefit when you retire. If there’s a defined benefit plan where you work, you’ll probably be included in it if you work full-time. And chances are you won’t have many options about how the plan works or how the money is invested. That’s the trade-off for the advantages the pension plan may provide.
Defined benefit plans generally pay you a regular monthly benefit for your lifetime after you retire, and sometimes for the lifetime of your surviving spouse. In some cases, you may be able to choose a lump-sum payment when you retire, which you can reinvest. With a generous plan, you might expect an annual income equal to between 30% and 50% of your final salary. But there’s no law about how much a pension has to promise to pay, and some workers end up getting very little. And some plans may be ended if the company is in serious financial trouble, reducing or eliminating the pension you were expecting.
LONGER IS BETTER
One common formula for finding your pension amount is to multiply the years you’ve been on the job times a certain percentage, such as 1.5%, and then multiply the result times your final salary.
(Years on job x .015) x Final salary = Pension
Example: (30 x .015) x ($72,000) = $32,400 annual pension
CALCULATING YOUR PENSION
The way your employer figures the amount you are eligible for is spelled out in the plan itself. In some plans, for example, there is a standard pension for everyone who meets minimum years-in-service requirements. In others, the annual amount you receive reflects what you were earning, with better-paid employees eligible for higher pensions. The rules are clear, though, so you can often calculate ahead of time what your pension will be. Usually the major factors in determining the amount you’ll receive include:
- Your final salary
- The time you’ve been on the job
- Your age at retirement
GETTING ADVICE
Since defined benefit pension plans vary, you need to understand the fine print of any one you’re depending on. Your employer’s benefits officer should know the answers to questions like these:
- Is your pension based on your average compensation, your final year’s salary, or some other amount?
- Do different length-of-service requirements apply to employees who were hired at different times?
- What’s the normal retirement age? What happens to your pension amount if you retire sooner?
- Is there any advantage to working past age 65?
- Is there a COLA, or cost-of-living allowance?
STAYING PUT
Even if you can count on defined benefit pensions from a couple of earlier jobs, you may wind up with less money than if you’d been with the same employer for your entire career. That’s one reason some workers prefer the more portable defined contribution plans.
BEING VESTED
Being vested means you have the right to collect a pension benefit at a specific age, even if you’ve left the job before then. Without vesting rights, you would have forfeited any benefit when you left, and the money would have become part of the employer’s general fund. With a defined benefit pension, federal law requires that you must be either:
- 100% vested after five years, or
- 20% vested after no longer than three years and fully vested after seven years
With some employers, you are vested more quickly, and in certain cases immediately. In a defined contribution plan where your employer makes a matching contribution, you must be fully vested after three years or 20% after two years and 100% after six years. Of course, money you contribute is always yours. Some other plans — such as those for government workers and many teachers — may require you to be on the job for a longer period before you’re fully vested.
WHAT’S IN A COLA
Once you retire and your pension is calculated, the amount is usually fixed. Fewer than 5% of private US pensions come with COLAs, or cost-of-living adjustments, that increase the amount of your pension to keep pace with inflation. Some employers voluntarily increase pensions for retired workers from time to time. Government pensions, on the other hand, are generally adjusted annually to make up for increased living costs.
501 HOURS
If you leave your job before you’re vested, you usually lose the credits you’ve built up toward a retirement pension. But there are ways to keep up your ties and your benefits. One is part-time work. In most cases, working 501 hours a year, the equivalent of 12½ weeks, is enough to keep you on the pension books. However, if you end your career working part-time, your pension will probably be quite small — since your final salary often determines the amount you’re eligible to receive.
You should not lose pension credits, either, if you take up to 501 hours of family leave to care for a new baby or a sick family member and then return to work.