308 Chapter 7 Retirement Plans
(c) Following the formula, we fi nd the monthly benefi t would be 40($80) $3,200 per
month, except that this is more than the maximum. So the benefi t would be the maximum
$2,000 per month.The benefit formula used in Example 7.1.1 does not take into account how much the retiree
was earning before retirement. Often benefit formulas take earnings into account as well.
The next example is illustrative of that type of formula.Example 7.1.2 The XYZ Corporation Pension Plan provides a lifetime income to its
employees on retirement at age 65. The formula provides 2% for each year of service
of the average of the employee’s earnings for the last 3 years on the job, up to a
maximum of 70%. Jelena retired at 65 with 28 years of service. Her earnings for her
last 3 years were $37,650, $39,525, and $40,187. What is her pension benefi t?Since she had 28 years of service, she is entitled to 28(2%) 56% of her fi nal 3-year average
income.Her 3-year average income is ($37,650 $39,525 $40,187)/3 $39,120.67.So her annual pension benefi t is (56%)($39,120.67) $21,907.53 per year.In both of these examples, the formula gave an income on the assumption that the employee
retired at age 65. Of course, some people may choose to take an early retirement or keep
working beyond age 65. Since a pension plan provides benefits for life, someone retiring
at 60 would be expected to receive benefits for longer than if he retired at 65. Similarly, if
someone keeps working past age 65, she would expect to receive benefits for fewer years.
Thus, plans often include formulas that allow someone to start receiving a reduced benefit
at an earlier date, or an enhanced benefit starting at a later date.Example 7.1.3 The XYZ Corportation (from Example 7.1.2) offers employees the
choice to retire as early as age 60 or as late as age 72. Those retiring before age 65
have their calculated benefi t reduced by 2.5% for each year they retire prior to age 65;
those retiring later have their benefi t increased by 1.9% for each year beyond age 65
that they work.(a) Brooke plans to retire this year at age 63. She has 19 years of service to the
company, and her last 3 years’ earnings were $48,000, $52,000, and $54,000.(b) Kurt plans to retire this year at age 69. He has 37 years of service, and his last
3 year’s earnings were $41,500, $43,750, and $46,300.Find each employee’s pension benefi t.(a) Brooke’s 19 years of service entitle her to 38%. Her fi nal 3-year average salary is
$51,333.33. If she were 65, her benefi t would be (38%)($51,333.33) $19,506.67.
Because she is retiring 2 years early, she will give up 2(2.5%) 5% of this benefi t, leaving
her with 95%. So she would receive (95%)($19,506.67) $18,531.34 per year.(b) Kurt’s 37 years of service would give him 74%, except that the maximum percent
is 70%. His fi nal 3-year average salary is $43,850. If he were 65, his benefi t would
be (70%)($43,850) $30,695. Retiring 4 years late means he will get an extra 4(1.9%)
7.6%, so he will get 107.6% of this, or (107.6%)($30,695) $33,027.82 per year.In each of these examples, the calculated benefits will be paid for the life of the retiree. This
is a very desirable feature; as long as you live, your pension income continues. However, if
you have a spouse or other dependent who relies on your income, this can be a problem.
If you pass away first, your dependent would be left without the pension payments that end
with your death.
Pension plans usually offer the option of a benefit that is guaranteed for the lives of both
people, sometimes with a reduction in the benefit paid when one person dies. The formulas
for these benefits, though, can be very complicated, depending on the age (and hence the
life expectancy) of the spouse. We won’t deal with these more complicated formulas in this
text, other than noting that since the benefits have the potential to be paid for a longer period