Winnie and Winston each worked 40 years before they retired. They both made the same income in their final year: $70,000. But their defined benefit pension plans used different formulas. Who gets the bigger pension?
- Takes the average of her best three years of earnings with the company: $65,000
- Multiplies it by 1.2% (the plan formula): $65,000 x 0.012 = $780
- Multiplies that number by the total number of years with the company: $780 x 40 years = $31,200.
The result: Winnie's payment from her pension will be $31,200 a year, or $2,600 per month (before taxes). That comes to almost half of her final income when she retired.
- Takes the average of his last 10 years of earnings with the company: $60,000
- Multiplies it by 1.2% (the plan formula): $60,000 x 0.012 = $720
- Multiplies that number by the total number of years with the company: $720 x 40 years = $28,800.
The result: Note: These examples are for simple illustration only. They do not reflect any tax savings or the impact of inflation and salary increases.
Winston's payment from his company pension plan will be $28,800 a year, or $2,400 a month (before taxes). That's much less than half of his final income before he retired.
The formula a defined benefit plan uses can have a big effect on your income when you retire. This is important to know when you compare different plans.