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?
Winnie’s plan:
- 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.
Winston’s plan:
- 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:
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.
Lesson learned:
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.
Note: These examples are for simple illustration only. They do not reflect any tax savings or the impact of inflation and salary increases.