What does the percentage of earnings per year of service formula calculate?

The formula that uses a percentage of earnings per year of service is designed to calculate a certain percentage of an employee's pay that accumulates for each year they work for the organization. This method is often utilized in defined benefit pension plans, where the retirement benefit is determined by a formula based on the employee’s salary and the duration of their service.

Specifically, the percentage reflects how much of the employee's final or average salary they will receive as a benefit for each year of service. For instance, if the formula states that employees earn 2% of their average pay for every year worked, and an individual has worked for 30 years, they would multiply their average salary by 60% (2% x 30 years) to determine their total pension benefit. This approach rewards longevity and creates an incentive for employees to remain with the company longer.

Understanding this allows one to grasp the foundational principles behind pension plans and how employees accumulate benefits, rather than simply receiving a static amount based on the final salary, a fixed payout, or any benefits tied directly to company profits.