WHAT IS 'Flat Benefit Formula'

Flat benefit formula is one method for calculating a pension payout from an employee's defined benefit plan. In a flat benefit formula, the employer multiplies an employee's months or years of service by a predetermined flat rate.

BREAKING DOWN 'Flat Benefit Formula'

Flat benefit formula is one of the three basic ways to calculate how much an employee will receive as a pension benefit from a defined benefit plan. The other two methods of calculation are typically referred to as unit benefit and variable benefit.

A defined benefit plan is also referred to as a pension. In a defined benefit plan, the employer contributes to a retirement fund, which offers a set payout upon retirement. In a defined benefit plan that uses a flat benefit formula, the benefit comes from multiplying the employee’s years or months of service by a flat predetermined dollar amount.

Flat Benefit Formula Compared to Unit Benefit and Variable Benefit

A flat benefit formula takes the employee’s tenure at a workplace as the key factor in the formula that determines how much an employer will pay toward an employee’s defined benefit plan. For example, a defined benefit plan may provide $400 for every year of service. For an employee with 35 years of service, the employer calculates the annual benefit as follows:

Years * flat compensation figure = annual retirement benefit

For the above example, the calculation yields: 35 * $1,000 = $35,000

Flat benefit formulas are more common among defined benefit plans for hourly workers, and typically result in a lower pension payment than other methods of calculating benefits.

A unit benefit formula takes into account both the length of employment as well as the employee’s salary. At the time of retirement, the employer will typically calculate the benefit by multiplying the months or years of service, their final average earnings over a set period of time, and a predetermined percentage. Another formula may make the calculation based on a percentage of wages earned throughout the employee’s career with the employer.

For example, consider an employer that offers a 2 percent unit benefit plan, and that calculates benefits based on the average earnings over the last five years of employment. If an employee with a final average salary of $120,000 and 35 years of service retires, their annual retirement benefit may be determined with the following calculation:

Years * average earnings * compensation percentage = annual retirement benefit

For the above example, the calculation yields: 35 * 120,000 *.02 = $84,000 

A variable benefit formula, as its name indicates, is tied to market performance. While typical defined benefit plans offer a set return every year, in this case the benefit will fluctuate due to fluctuations in the market.

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