Estimate Your Pension

Use the following discussion of pension benefits to develop a more accurate estimate of your pension income in retirement. It is important to note that every pension plan is different, and those differences can have a significant impact on your actual benefits. Thus it is critical that you fully understand the rules associated with your pension plan before relying upon your estimate. However, the large majority of pension plans are based on a few simple principles - Service Credit, Final Average Salary, and the Benefit Multiplier.

Service Credit

Your service credit is the time you put in on the job. Some plans may use a different term for this, but it usually means the same thing - how many years of service you have accumulated. Usually you need to serve at least 5 years to be vested, which is the financial planning term for qualifying for benefits. If you are not vested you will not receive benefits. Some plans allow for partial vesting but most require at least 5 years of service before you qualify for any benefits.

In the traditional career where an individual starts early and works 20-40 years at the same job, service credit is a straightforward concept that can be taken for granted. However, it can get complicated in situations where you have changed jobs, temporarily stopped working only to return to the job later, or work part-time. Pension systems vary greatly on how they calculate the time that will be credited toward your final service credit. Check with your employer's benefit office to confirm the rules for your plan.

Final Average Salary or FAS

Again this can have many names including Average Final Compensation but the idea is to determine what salary to use to calculate your pension benefit. Typically, the higher the salary the higher the benefit so it is important to make sure your FAS is high. In most pension plans your FAS is calculated by averaging your last or highest three or five years of salary. So in a typical scenario your FAS will equal the average of your last three years salary. Suppose you are making $45,000 three years before retirement and you expect to receive pay raises equal to the cost of living adjustments or about 3% currently. Your last three years of salary would then be $45,000, $46,350, and $47,740.5. The average of these three numbers is therefore $46,363.5.

Benefit Multiplier

The benefit multiplier determines the size of your benefit. The national average is currently around 2% but it varies greatly from plan to plan. Using 2% as a guide, you can roughly estimate your benefit as a percentage of your salary (see the description of final average salary above) by doubling your years of service. So if you have been in for 10 years then your benefit will be close to 20% of your salary. If you are a public safety professional, your benefit multiplier is likely to be higher, 3% or more, so make sure you adjust your estimate accordingly.

So let's put this all together. Combining Service Credit, Final Average Salary and the Benefit Multiplier, a typical pension formula might look like the following:

Service Credit Years + Final Average Salary + Benefit Multiplier = Annual Retirement Benefit