What It Measures
In the pensions world, accrual rate is the rate at which an individual’s entitlement to pension benefit builds up related to his or her salary, often in an employer’s pension scheme.
Why It Is Important
It enables an individual to receive a pension benefit that is predictable and fair, while also providing employers with a simple way to predict the potential liabilities of a pension scheme. If your organization’s pension is based on an accrual rate, employees earn (or “accrue”) a monthly pension amount each year they work. If the employee earns a full pension, they will receive the sum of all those annual accruals as the total pension amount. The higher the accrual, the higher the eventual pension pay-out.
How It Works in Practice
Accrual rates are usually expressed as a fraction of final pay. They vary between different countries and industry sectors, but are generally between 1/50 and 1/80. In the case of an accrual rate of 1/60, this means the employee receives 1/60th of their pensionable earnings for each year of eligible service. To calculate the pension of an employee who retires at the age of 58 after 30 years service on a final salary of $70,000, apply this formula including the accrual rate:
Pension liability = Accrual rate × Final salary × Years of service
So, in this case the pension liability is:
1 ÷ 60 × $70,000 × 30 = $35,000
The lower the denominator in an accrual rate, the higher the accrued benefits for each year of eligible service. So an accrual rate of 1/50 would create a different result:
1 ÷ 50 × $70,000 × 30 = $42,000
Tricks of the Trade
Accrual rate can be applied to an employee’s “final” salary, or may sometimes be applied to what is known as the “best five”—the average of the five highest salaries an employee earns over their entire eligible years of service.
An accrual rate can sometimes be expressed as a percentage, such as 1.25% (which is equivalent to 1/80).
Accrual rates can also be expressed as dollar amounts rather than percentages or fractions. These schemes tend to be less advantageous for employees, since the employer’s contribution is not tied to the employee’s salary and will not necessarily increase at the same pace.
Accrual rates can be applied to other employee benefits (commonly holiday and sick pay), but may also be used to refer to the interest added to certain sorts of mortgage loans.