Key Pension Issues

That's because the monthly stipend you get is determined by a variety of factors, including how long you were with the company, how much you earned and how the company's pension rules are drafted. The age when you can claim your benefits can vary. Whether or not you can elect to receive a lump-sum payment in lieu of monthly benefits also varies. Some pensions are reduced by a portion of your Social Security benefits, some are not.

Because there are so many variables, consumers can shortchange themselves by making simple mistakes--retiring a day or two too early or a few years too late, for instance. These mistakes can cost beneficiaries tens of thousands of dollars, robbing them of often vital retirement income.

On the bright side, you can avoid the traps by learning about your plan. How? Read your "summary plan description," a long, boring and complicated legal document your company will send you, if you ask.

Here are a few of the key questions to answer while you're reading through the document. Keeping these questions in mind may help you wade through the legalese.

• When do you "vest"?

Vesting, in pension-speak, is when you qualify for pension benefits. If you leave a company before the vesting period is up, you generally lose your right to claim any defined benefit pension payments.

Typically, you must be with a particular employer for at least five years to be vested. During that time, you typically must have worked at least 1,000 hours a year.

If you leave your employer before the end of the vesting period but return to work for the same employer within five years, you generally get to add up both periods of work for purposes of pension vesting, notes Ethan Kra, chief actuary in the retirement department at William M. Mercer Inc., a New York-based employee benefit consulting firm. Stay away for more than five years, though, and you'll usually lose the right to claim the previous period for vesting purposes.

• What wages are counted to determine your monthly pension benefits?

Normally, your monthly pension payment will be determined by a formula based on the number of years you worked with the firm and your average salary over a specific period. For instance, a company may pay a pension that amounts to 1% of your pay for every year you work with the company. So, a person who worked for the company for 20 years would have 20% of his or her pay replaced by the pension.

However, it is crucial to know which year's pay--and what type of pay--is used in the formula. Some companies calculate the pension based on base salary alone, while others include base salary, bonuses and overtime. Also, some companies use your highest-wage years for the formula, while others use your final years' wages.

This distinction is important for people who continue to work for their companies part time after normal retirement age--a growing trend, according to Joseph Quinn, an economics professor at Boston College. In such instances, working those additional years can reduce your pension benefit--if you remain an official employee. However, you may be able to sidestep the problem by leaving the staff and becoming an independent contractor.

• How many years are used in the pension formula?

Some companies will allow you to build up a (theoretically) limitless number of "years of service" in calculating your pension. Others will cap your ability to earn additional pension credits after a set number of years. For instance, some companies may cap the number of years of service at 30, so in the previous example, the pension would replace a maximum of 30% of a retiree's income.

• Does your company impose a "Social Security offset"?

These adjustments, common in traditional defined benefit plans, will reduce your monthly pension by a portion of the Social Security benefits that you claim. The portion depends on the company's offset formula and how long you work for the firm. Someone who has been with a single company for his or her whole career could have an offset that amounts to half of his or her Social Security benefits.

The reason: Your employer pays half of the cost of Social Security. You pay 6.2% of your wages (along with an additional 1.45% for Medicare), and so does your employer. Social Security offsets allow your employer to get some of those contributions back, says Mike Johnston, an actuary with Hewitt Associates, a Lincolnshire, Ill.-based benefit consulting firm.

If you have been with a company for less than a full career, the Social Security offset should be prorated, Johnston adds, since other companies have probably contributed to the fund. That means your pension would be reduced by less than 50% of your Social Security benefit.