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Tuesday, March 28, 2017

How much do you need to Retire – Version 3 – Part III

Posted by Tim Stobbs on March 26, 2008

Welcome to Part III where we are going to look at pension plans. For your reference in Part I we calculated your yearly spending in retirement, while in Part II we covered government benefits.

Company Pension Plans

Each pension plan is unique to some degree, so it is impossible for me to cover every detail of every pension plan. So if you don’t know the details of your plan get on the phone with your HR department and request the information otherwise it is hard to determine what you are going to get.

Pension plans come in two basic types: defined benefit or defined contribution. Defined benefit used to be the standard of most companies for a number of years. You contributed to the plan during your working life and then once you retired you got a set amount from the plan based on some type of formula. These plans could be very generous. I know one lady who is closing in on retirement that is expecting 70% of her current income (averaged over the last 10 years) in retirement from her plan. The problem with these plans is they are costly to run, so many companies have been shifting over to defined contribution. In a defined contribution plan the company will match a set amount of money you add to the plan. Once you retire you will get a lump some of money that you can buy an annuity with or transfer to a Registered Income Fund (RIF) which is similar to an RRSP, but you have to take out a minimum amount each year based on your age (your options may vary depending on your plan).

Well with my changing jobs over the last few years I’ve been in many different pension plans. First off when I was living in BC I had a defined benefit plan, I’ve cashed that out and transfered that to my LIRA (Lock In Registered Account). Then more recently my employer was bought out last Nov and I got my statement saying my pension amount is small enough I can transfer it to my regular RRSP rather than my LIRA account. Now my new employer pension plan is actually a group RRSP rather than a traditional pension plan which effectively puts my original retirement plans on their head.

Why? Because under my old calculations I was stuck with a large sum of cash I couldn’t use until age 55 because of my employer’s pension plan.  Now with the buyout and changing over to a group RRSP I can use some of those funds in my early retirement period (45 to 55). Effectively one of my biggest obstacles to my early retirement has been removed.

So all I have left to estimate is how much my LIRA will grow. To estimate this I’m going to assume a 7% rate of return and reduce that by 1.5% to reflect inflation so I get a number in today’s dollars (if your wondering why I’m using such a low inflation number check out these two posts: #1, #2). Therefore I will use a 5.5% rate of return. I should point out that I’ve been averaging over 8% on these investments, but I’m using a 1% buffer on my calculations to cover years of low performance and general estimating errors.

So if I start off with this calculator and plug in the following values:

Starting Amount $11,300
Then I’m adding around: $0/month (I’m not adding anything to this account)
At a 5.5% rate of return for 30 years (until I turn 60).

I end up with $58,617. I know that is hardly an earth shattering amount, but it will be useful to top up my income during my more normal retirement years.  If I assume I want this money to last a while I’ll only be taking out 4% per year or $2344/year

Summary

Therefore if I take that amount and add it to my government benefits I calculated yesterday I should get $2344 + $18,714 = $21,058/year from age 65 onward. So I’m still short of my goal of $26,618/year goal, but I’ve now moved the largest portion of my cash to my RRSP which I’ll cover tomorrow.

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