10.

3 Pensions (HW #3, 5, 9) Name: _____________________

10.3 Pensions
Vocabulary
Deferred compensation Money that is given or received at a later date usually in return for services
that have been given or received at the present time.

pension A type of retirement plan where an employee receives compensation from an

employer after retirement.

Defined benefit plan An employee pension benefit that is calculated based on a formula that may
involve the average salary before retirement, the age of the employee at
retirement, the length of employment, and some predetermined percentage
multiplier; the employer makes all decisions on the investment options for the
money in the plan.

vested The number of years an employee must participate in the plan before having
the right to the investment or part of the investment.

Single life annuity Offers the retired employee a fixed monthly amount until death, when all
benefits stop.

Qualified joint and A type of retirement account that offers the retiree a smaller monthly
survivor annuity payment; upon death, the spouse will continue to receive reduced payments
until his or her death.

Lump-sum payment Where all of the money owed to a retiree is given in a single payment and no
further payments are made to either the retiree or the beneficiary.

Pension Benefit A federal government agency that insures most defined benefit pension
Guaranty Corporation plans.
(PBGC)

Employee Retirement The federal act that established protection of pension plans and the PBGC.
Income Security Act
(ERISA)

Pension Protection Act The act that amended ERISA and offered legislation to strengthen and
protect many types of pensions.

Cost of living A small increase in a retiree’s benefits based on the Consumer Price Index
adjustment (COLA) (CPI) or cost of living index.

Consumer Price Index An indicator of inflation that measures the change in the total cost of a
(CPI) specific list of services and products.

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10.3 Pensions (HW #3, 5, 9) Name: _____________________

There are different formulas that are used to calculate a pension:

● Flat-benefit formula - pays a flat monthly pension based solely on the years that
the retiree has worked for the employer.
● Career-average formula - pays a pension that is based on a fixed percentage of
the average earnings of all of the years the retiree has worked for the employer.
● Final-average formula - pays a pension that is based on a fixed percentage of
the average earnings of the last several years (often 3-5) of work with the
employer.

Determining monthly pension with flat benefit formula

1. Determine $ amount awarded for each year of service
2. Multiply this amount by the number of years of service

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10.3 Pensions (HW #3, 5, 9) Name: _____________________

Determining monthly pension with cost of living adjustment (COLA)

1. Determine starting $ amount for monthly pension
2. Multiply monthly pension benefit by the first cost of living adjustment (100% +
COLA) to determine new benefit.
3. To calculate latest monthly benefit, multiply current benefit by second cost of
living adjust (100% + COLA)

Suppose we have already calculated Alex’s average career salary to: $70,986.68 and
Alex had 25 years of service.

Determining monthly pension with career-average formula

1. Determine career average salary
2. Determine number of years of service
3. Determine multiplier
4. Multiply values from 1-3 to determine annual pension benefit

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10.3 Pensions (HW #3, 5, 9) Name: _____________________

Brian and Marina are married and each is planning on retiring after 30 years of
employment.
● Marina worked the entire 30 years for Lincoln Central Corporation. For the last 3
years she has been making $110,000 per year.
● Brian has been making $110,000 for the last 3 years at Lincoln Central, but has
only been working there for 15 years. Prior to his current job, he worked for 15
years at a competitor and had a final average salary of $60,000.

Both employers offered a defined benefit plan that calculated the annual pension as the
product of the final 3-year average salary, the number of years of service, and a 2%
multiplier. Calculate and compare Marina and Brian’s annual pension upon retirement
from Lincoln Central.

Determining monthly pension with final-average formula

1. Determine three year average salary
2. Determine years of service
3. Identify percentage multiplier
4. Multiply 1-3 together to get annual pension benefit

Marina: (3-year average salary) x (years of service) x (percentage multiplier)

Brian:
● Annual benefit from job 1:

● Annual benefit from job 2:

● Total annual pension benefit:

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10.3 Pensions (HW #3, 5, 9) Name: _____________________

Determining monthly pension with 6-year vesting formula

1. Determine average salary
2. Determine years of service
3. Identify percentage multiplier
4. Multiply 1-3 together to get annual pension benefit
5. Multiply result from 4 by vesting percentage based on years of service

Full benefit: (3-year average salary) x (years of service) x (percentage multiplier)

Vesting percentage based on 5 years of service:

Annual pension: ______________________________

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10.3 Pensions (HW #3, 5, 9) Name: _____________________