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How Defined Benefit Pensions Work
Understanding the Pension Multiplier
Pension vs 401(k): Key Differences
Lump Sum vs Monthly Pension Payments
Frequently Asked Questions
Most defined benefit pensions use this formula: Annual Pension = Years of Service x Final Salary x Multiplier. For example, 25 years x $85,000 x 2% = $42,500 per year ($3,542/month). The multiplier varies by employer, typically between 1.5% and 2.5%.
The pension multiplier (also called the benefit accrual rate) is the percentage of salary earned per year of service. A 2% multiplier means you earn 2% of your final salary for each year worked. After 25 years, that is 50% of your final salary as an annual pension.
The monthly pension provides guaranteed lifetime income, which is valuable if you expect to live long. The lump sum offers flexibility and can be invested, but you bear the investment risk. Generally, the monthly pension is better for most retirees unless you have health concerns or other significant assets.
Yes, pension income is taxed as ordinary income at federal and most state levels. However, some states exempt pension income from state taxes. You can have taxes withheld from your pension checks to avoid a large tax bill at year end.