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 preretirement 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 preretirement 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?
ONLINE CALCULATORS
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 lifetimeprojected
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. WAITING TO RETIRE?
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 5year 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.
EARLY RETIREMENT
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.
WORKING PARTTIME
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 parttime, and still come out ahead.
If they make $20,000 from parttime work, they will make more total
income than teaching fulltime!
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.
