How Most Retirement Pensions Work
Before deciding the best time for you to retire, it’s really helpful to understand how pensions work. All pensions are designed using a math formula. Don't quit reading if you aren't a math teacher, this formula is easy to understand. Let's use Tennessee, my home state, as an example. The formula for teachers here is 1.5% x years of service x 5 highest years' average salary (found in the retirement guide published by the state). So if a teacher works 30 years and averaged $40,000 per year her last 5 years the formula would be 0.015 x 30 x 40,000 = $18,000 per year in retirement.

You probably noticed that $18,000 was almost 1/2 of the $40,000 5yr average. Tennessee's pension is designed to provide about half of the pre-retirement salary at 30 years of service, much like the very first pensions. Note: Some pension plans allow or force you to opt out of Social Security, but usually pay a higher percentage of the pre-retirement salary. Here's the first hint to really simplify the formula no matter where you live. Multiply the factor for your state (ex: 1.5%) by your years of service (ex: 30) for your retirement. In our example, the answer is .45, or 45%. Now you can simply plug in your factor for your state. For example if your state's factor is 2% you would get 60% of your salary at retirement with 30 years service (.02 x 30 = .60). See how easy this is?

Ok, if you still want an easier way to do this, most state pension websites have an online calculator where you can enter your information and see a projection of your retirement benefits. Below is an example of Tennessee’s retirement projection for a teacher retiring with 30 years of service. You will see the monthly amount you would receive depending on the survivor option you choose, which we’ll explain in detail in a later chapter. It also shows a lifetime-projected payout, which is the amount you will receive if you live the average lifespan.

While this projection is helpful, I really like knowing the shortcut formula so I can look at different retirement dates in a short amount of time, and for teachers whose states don’t have an online retirement calculator.

Now what if you were considering working 35 years instead? Simply multiply the factor (1.5%) by 35 years, which gives you .525 or 53%. Now simply multiply that by your 5-year salary (ex: $40,000) to get $21,200. Who says we need lawyers explaining this stuff to us. It's a whole lot easier when a teacher explains it.

What if you were considering retiring after 25 years? This is often called early retirement regardless of age, and most states have a minimum age of 55 to begin receiving monthly benefits. The formula works the same as before, except most states penalize you for retiring with less than 30 years of service. In Tennessee you are penalized 4.8% for every year you for each year you retire prior to 30 years of service, so in our example you would multiply 5 years by 4.8% to get a 24% penalty. That means you will only get 76% of your $40,000 income, or $30,400, in our example. OUCH! The formulas work very similarly in other states; simply plug in your retirement percentage and run the numbers. Most teachers choose to put up with class for five more years, rather than give up almost $7,000 per year in retirement.

Most teachers will not retire at 25 years and give up almost $7,000 per year in retirement income, but many of the teachers I work with decide it's not worth five additional years of service to retire with 35 years and only $3,000 more in income per year in this example. Most teachers can retire, work part-time, and still come out ahead. If they make $20,000 from part-time work, they will make more total income than teaching full-time!

As you can see this is not as complicated as the lawyers make it seem, but you do need to consider your options carefully before you decide on the year you will retire. You are almost ready to set a target date for your retirement.

The next step is learning three key things before making your decision.