Magazine article The CPA Journal

The Impact of Changing Jobs upon Pension Benefits

Magazine article The CPA Journal

The Impact of Changing Jobs upon Pension Benefits

Article excerpt

Your client has just received an attractive job offer from another company. He or she is reasonably satisfied with the position currently held. What advice should you give? The decision rests upon a multitude of variables: family factors, financial aspects, conditions required by the employment such as a move, nature of the work, advancement possibilities as well as professional and personal development plus many other considerations. This article examines the impact that changing jobs has on the annual pension at retire ment.

Determinants of Pension Amounts

Company retirement formats range greatly -- including defined benefit plans, defined contribution plans, and ESOPS. Additionally, given any one type such as a defined benefit plan, the computation of the benefit differs widely from company to company. For purposes of discussion, we will assume that all company retirement plans are the same: companies have defined benefit pension plans in which the benefits at retirement are calculated according to the following rules:

1. The plans have a five-year "cliff" (all or none) vesting;

2. The company pension is based on the salary earned in the last year of employment; and

3. The pension fraction is 2% per year worked.

Thus, if vested, an employee's retirement is calculated by taking the last year's salary and multiplying by 2% for each year of eligible service. In the case of a retiree who worked for Company A for a few years and for Company B for the remainder of his or her career, the retiree would receive two pensions. The first pension would be based on the number of years of service at Company A times 2% multiplied by the last year's salary earned at company A. The second pension would be computed exactly the same way except that it would be based on the years of service and the salary earned in the last year at Company B.

For example, if an employee left Company A when his salary was $40,000 after working 15 vears and after becoming fully vested, to take a job with Company B for 25 years and then retired when his salary was $80,000, the annual pension would be as follows:

Company A salary --$40,000 X .02 X 15 years = $12,000

Company B salary --$80,000 X .02 X 25 years = $40,000

Total annual pension = $52,000

Several points are worth noting. First is the fact that if this same employee worked for either Company A or for Company B for all 40 years and retired at the same $80,000 salary, the total annual pension would be $64,000 ($80,000 x .02 x 40) or $12,000 more per year. Thus, the $12,000 annual loss of an amount of pension represents the cost of switching jobs.

The second point worth noting is that in the case of the employee above the "lock-in" of pension at an early (lower) salary created the $12,000 difference in pension. This freeze of the salary variable of the pension formula at an earlier, lower salary amount means that the employee loses some of the benefit of a higher ending salary (for the years worked on the first job). If there had been no salary increases over the years since leaving the first job, then the salary "lock-in" would have no impact on the pension. It is the increase in salary over the career that causes the loss of pension from changing jobs. Because workers' salaries tend to rise over their careers, whether from inflation or from merit, job switching causes pension losses. The loss of pension must be balanced against possible higher salary from changing jobs.

Last, it should be noted that switching jobs without vesting is extremely costly, particularly at the time just prior to vesting. Because most companies have "qualified" plans (qualified for favorable tax treatment), full vesting for these qualified plans must be no shorter than five years. This is known as "cliff" or "all or none" vesting. An employer can also qualify its pension with other vesting schedules that include partial vesting (the employee is credited for less than the full 2% if the employee works for a period shorter than the full vesting period). …

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