Pension (Defined Benefit Plan)
An employer-funded retirement income paid for life, calculated from service and salary rather than a balance.
A defined benefit plan pays a formula rather than a balance: years of service multiplied by an accrual rate multiplied by final average salary. The employer carries the investment and longevity risk, which is the reverse of a 401(k) and the reason the two are not comparable by balance.
Private-sector coverage has fallen sharply since the 1980s, and remaining plans are concentrated in government, military, education and some union employment. Where one exists it is often the largest asset a household holds, despite never appearing on a statement.
Two details matter when valuing one. Many public pensions are not fully indexed to inflation, so a fixed nominal payment loses real value across a long retirement. And the promise is only as good as the sponsor: private plans are backstopped by the PBGC up to statutory limits, while public plans generally are not.
Worked through
30 years at a 1.5% accrual rate
A defined benefit pension taken at 55, calculated on final average salary.
- Years of service
- 30
- Accrual rate
- 1.5%
- Final average salary
- $92,000
- Annual benefit
- $41,400
Replacing $41,400 of lifetime income from a portfolio at 4% would take about $1.04M. That is the figure the pension stands in for.
Related in Retirement Planning
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