What is a Vested Benefit Obligation?

A vested benefit obligation is the actuarial present value of benefits that have been earned by employees. They will receive this benefit even if they stop participating in their employer’s pension plan. This obligation is typically associated with multi-year cliff vesting requirements for employees, so a firm whose employees have a relatively high level of seniority will have a larger vested benefit obligation than a firm with newer employees.

Example of a Vested Benefit Obligation

A company has a defined benefit pension plan, in which an employee is required to work for at least five years to become vested. The pension benefit formula is:

2% x Years of service x Final salary

An employee has worked for the company for six years, and so is fully vested. Her current salary is $50,000, and she has earned six years of service credit. The related vested benefit is calculated as follows:

2% x 6 Years of service x $50,000 Salary = $6,000/year

Assuming the pension obligation is valued at the present value of these annual payments, the company uses a discount rate of 5% and assumes payments over the employee's expected retirement period (e.g., 20 years). Using a present value formula, the obligation would be:

$6,000 x Present value of annuity at 5% for 20 years = Vested benefit obligation

With an annuity factor of 12.46, the vested benefit obligation is:

$6,000 x 12.46 = $74,760

Thus, the Vested Benefit Obligation (VBO) for the employee is $74,760. This amount represents the present value of benefits earned and vested as of today.