When Terry retired from Caterpillar, he received a pension: Caterpillar would pay him $50,000 the first year he was retired, with the amount increasing by 5 percent each year thereafter. If inflation turned out to be 2 percent each year, what would happen to the real value of Terry's pension? A. It would decrease each year by 5 percent. B. It would increase each year by 3 percent. C. It would increase each year by 5 percent. D. It would decrease each year by 3 percent.

B. It would increase each year by 3 percent.

Explanation:

Given

Pension = $50,000 in first year

Increment = 5%

Inflation = 2%

Inflation doesn't only affect the value of an investment, it also influence the liabilities of a pension fund.

Consider a pension plan which gives a worker a benefit based on final average salary; A slight increase in the inflation would reduce the worker's real benefits in the years after retirement.

So, instead of Terry's pension to increase by 5% each year,

It'll increase by 3%

This is calculated by subtracting the inflation rate from the real increment rate.

5% - 2% = 3%

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