The mode of pension benefit calculation differs from case to case depending on if it is a
- defined-benefit plan (aka: a traditional pension)
- A defined-contribution plan (aka: a 401k, 403b, etc.)
The defined-benefit plan adopts a set formula, common to everyone in that plan. The latter is more cumbersome, involving extra complexities due to the difficulty in forecasting the future rates of interest. The calculations will have to include assumptions on interest rates, contribution amount and period of contribution. If you follow the instructions below, you will be able to arrive at the Defined-Benefits easily with the help of a few things like a pension formula and salary information and a calculator.
- You have to consider the information for calculating retirement benefits that the pension plan shows. If any doubts arise on the formula, get in touch with your plan’s service provider to clarify your doubts.
- Calculate your amount of average salary based on the highest three paid years during which time you were a part of that membership plan. (Note: This could vary based on your plan, it could be based on your highest annual income, the average of your last 5 year, your highest 5 years, or any other number you plan decides on.) Your service provider can help you with the formula based on the highest salary in three years (it could also exceed that figure). Take a three-year average. For example, If your salary for the first year is $50,000, for second year is $60,000 and for the third year is $70,000, you obtain the average by adding the three years amount and dividing it by three, works out to $60,000.
- You further multiply the obtained average salary by a special percentage factor applicable to the plan. If you have put in 30 years of service and the percentage factor is 0.02% (the percentage value varies with the years of service), the total amount works out to $60,000 multiplied by 0.02 which is $1,200.
- Multiply this result by the years of service. This works out to $1,200 multiplied by the years worked, say 30 years, which results in $36,000 annually. To get the pretax amount on a monthly basis, divide this amount by 12, equaling $3,000.
- Plan your money resource based on the monthly amount obtained on retirement. Make a proper estimation of your tax liabilities (Tax rules vary state-vise on pension and check federal pension rules). Further, calculate your expenses per month to estimate the amount you must put away for retirement.
- The next step will decide your life pattern, disability, health and insurance needs, acquiring property and planning your future savings.
- Make a periodic calculation of your benefits for money resources and planning retirement. This will help you to estimate the right quantum of insurance for you, and disability insurance if any, while planning for self and family future.
You hopefully will also have additional sources of income to supplement your pension in retirement. For example, in the United States and many countries in Europe, you will receive social security, or a government pension in addition to your company pension. Further, you may have other savings in either taxable or tax-deferred accounts that you may be able to draw on.
What planning did you do for your pension? Did you have a lifestyle in mind that you wanted in retirement and work so that you could support that lifestyle, or did you have the pension you retired with and have had to fit your retirement into your income? Share this article!