My employer offers a pension plan. According to the plan documents:

Effective November 1, 2009 you accrue benefits on a monthly basis
under the 2009 Benefit Formula, the sum of which determines a lump sum
payable at age 65 (or later if you retire after age 65). The 2009
Benefit Formula is as follows: 11% x monthly base/target pay rate Plus
5% x (monthly base/target pay rate – 50% monthly Social Security Wage
Base)

However the lump sum increases that I observe on the first of each month are much lower than what I calculate from this formula--e.g. about 4.7x lower for the August to September increase. I couldn't get a satisfactory answer on this from HR or Fidelity, which administers the plan.

The only thing I can guess is they are actually contributing some smaller amount that will compound to the quoted amount after 35 years when I retire at 65. Is this how pensions typically work? I see the following interest rates when I estimate my benefit that may be relevant:

PPA Interest Rate - 1st Tier: 1.130%
PPA Interest Rate - 2nd Tier: 3.710%
PPA Interest Rate - 3rd Tier: 4.520%
These interest rates are used to calculate the lump sum values shown on your results page.
  • Just to clarify, this plan will pay out in one lump sum @ your age 65? If so, it seems like there is a piece missing for us to answer your question. We have something for your ''in'' with the formula you gave us. We can assume a base pay of like 50,000. We have the ''out'' which is (I'm guessing) a dump of whatever's in the acct. Do you have specifics on if there is a target for the size of that lump sum? OR do you have anything about growth/interest on your deposits? – THEAO Sep 4 '13 at 20:01
  • It can be paid out as a life annuity or lump sum. The only thing the plan documents refer to is the "Pension Protection Act of 2006 (PPA) interest rate", but it's unclear to me how it is used (and what the three tiers mean). I was hoping most pensions operate similarly so somebody would be able to answer this even without the specifics of my particular plan. – Craig W Sep 4 '13 at 21:09
  • without numbers it is hard to know where the problem is: assume 5K per month income; I calculate $550 from part 1 and $13.13 from part 2 of the formula. I used the 2013 social security wage base of 113,700 per year. – mhoran_psprep Sep 6 '13 at 12:31
  • My salary is higher than that yet for September I only had ~$230 added to my lump sum value. My overall question: is this how pensions typically work? The employer contributes an amount that will compound to the promised amount by age 65? I am still trying to wrap my head around defined benefit versus defined contribution plans. – Craig W Sep 6 '13 at 15:53

I have had pension programs with two companies.

The first told you what your benefit would be if you retired at age X with Y years of service. Each year of service got you a percentage of your final years salary. There was a different formula for early retirement, and there was an offset for social security. They were responsible for putting enough money away each year to meet their obligations. Just before I left they did add a new feature. You could get the funds in the account in a lump sum when you left. If you left early you got the money in the account. If you left at retirement age you got the money that was needed to produce the benefit you were promised. Which was based on current interest rates.

The second company had a plan where they published the funding formula. You knew with every quarterly statement how much was in your account, and what interest it had earned, and what benefit they estimated you would receive if you stayed until retirement age. This fund felt almost like a defined contribution, because the formula was published. If most people took the lump sum that was the only part that mattered.

Both pension plans had a different set of formulas based on marriage status and survivor rules.

The interest rates are important because they are used to determine how much money is needed to produce the promised monthly benefit. They are also used to determine how much they need to allocate each year to cover their obligations.

If you can't make the math work you need to keep contacting HR. You need to understand how much should be flowing into the account each month.

First let's define some terms.

Your accrued benefit is a monthly benefit payable at your normal retirement age (usually 65). It is usually a life-only benefit but may have a number of years guaranteed or may have a survivor piece. It is defined by a plan formula (ie, it is a defined benefit).

A lump sum is how much that accrued benefit is worth right now. Lump sums are based on applicable interest rates and mortality tables specified by the IRS (interest rates are released monthly, mortality annually). Your plan can either use the same interest rates for a whole year, or they can use new ones each month.

Affecting your lump sum is whether your accrued benefit is payable now (immediately, you are age 65), or later (deferred, you are now age 30).

For example, instead of being paid an annuity assume you are paid just one payment of $1,000 on your 65th birthday. The lump sum of that for a 65 year old would be $1,000 since there would be no interest discount, and no chance of dying before payment. For a 30 year old, at 4% interest the lump sum would be about $237 (including mortality discount). At age 36 the lump sum is $246. So the lump sum will get bigger just because you get older.

Very important is the interest discount. At age 30 in the example, 2% interest would produce a $467 lump sum. And at 6% $122. The bigger the rate, the smaller the lump sum because interest helps an amount now grow bigger in the future.

To complicate things, since 2008 the IRS bases lump sums on 3 different interest rates. The monthy annuity payments made within 5 years of the lump sum date use the 1st rate, past 5 and within 20 years use the 2nd rate, and past that use the 3rd rate.

Since you are age 30, all of your monthly annuity payments would be made after 20 years, so that makes it simple since we'll only have to look at the 3rd rate. When you reach age 45 the 2nd rate will kick in.

Here is the table of interest rates published by the IRS:

http://www.irs.gov/Retirement-Plans/Minimum-Present-Value-Segment-Rates

You'll find your rates above on the 2013 line for Aug-12. That means your lump sum is being made in 2013 and it is being based on the month August 2012. Most likely your plan will use the same rates for its entire plan year. But what is your plan year? If it is the calendar year, then you would have a 5 month lookback for the rates. But if is a September to August plan year with a 1 month lookback, the rates would have changed between August and September. Your August lump sum would be based on 4.52%, your September on would be based on 5.58% (see the All line for Aug-13).

For comparison, a 30 year old with a $100 annuity payable at age 65 would have a lump sum value of $3,011 at 4.52%, but a lump sum value of $1,931 at 5.58%.

The change in your accrued benefit by month will obviously have some impact on the lump sum value, but not as much as the change in interest rates if there is one.

The amount they actually contribute to the plan has nothing to do with the value of the lump sum though.

protected by Chris W. Rea Aug 10 at 16:58

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