Replacement Rate

You work as a street magician. Your parents worry about your ability to make ends meet now, and really worry about whether you can save for retirement (they've given up bothering you about that law degree they paid $100,000 for you to get).

Luckily, you've got the retirement part figured out. You are part of the union. A portion of all the dollars that get thrown into your hat at the end of every show (the ones you don't make disappear as part of the act, that is) go into a pension fund.

Right now, you're earning $4,000 a month. If you stay in the union for 20 years, your benefits will vest and you will be entitled to a pension of $1,000 a month. That means your replacement rate is 25%.

The replacement rate measures the percentage of monthly income you keep in retirement. Divide the amount you earn each month in retirement by the amount of your monthly salary as an active worker. That equation provides the replacement rate. The figure is used to judge the effectiveness of a pension plan.