How to Calculate a Final Salary Pension
During the 2007-2009 recession, the prolonged period of extremely low interest rates made funding final salary pension schemes much more expensive, as the rates of return on investments held in those schemes fell.
At this time many companies, such as IBM, closed final salary pension schemes, or prevented new members from joining existing schemes. Many such schemes ran up huge deficits by being forced to pay set pension levels regardless of the scheme's income. If you have a final salary scheme it is very important to make sure you understand exactly what benefits you are entitled to, as there are variations in how different schemes have been structured.
Read through the full details of your pension scheme very carefully, making notes of important points and anything you need to check with the scheme's trustees or a financial adviser.
Re-read the scheme, writing down the details you need to calculate your final salary based pension.
Look for details of what constitutes your pensionable salary. This may be just your basic salary or include overtime, annual bonuses, an allowance for benefits etc. There may also be a maximum figure that can be used in any one year.
Check how the final pensionable salary is defined in the document. There are several common variations used in such schemes: It may be your pensionable salary for the last year of your employment, an average from a certain number of years (often the last three years are used), or the best three of the last ten years.
Calculate the correct salary that will be used to calculate your pension from the above data by checking your annual income from the appropriate period, as stated on tax documents, reviews from your company or similar sources.
Find the accrual rate for your scheme. This will be a fraction or percentage of your salary applicable per year of service. Multiply this rate by the number of years of qualifying service you have.
Multiply the result by the final pensionable salary and that will give you the amount of your pension.
- The above calculations can be expressed by a formula. Each variation of final salary scheme will have it's own formula, but this is a good generic example.
- pension = ( length of pensionable service x %age accrual rate/100) x final pensionable salary
- A final salary pension scheme is known as a defined benefit scheme and must not be confused with defined contribution schemes, where payouts depend on the income and investment values of the scheme.
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