Wednesday, April 18, 2007

How Much Do You Need to Retire - Part III

Today is the third post in the How Much Do You Need to Retire series. In Part I we calculated your yearly spending in retirement, while in Part II we covered government benefits. In Part III we are going to look at a company pension plans.

1) 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).

I switched jobs last year and was told I had accumulated about $10,500 in my previous defined benefit pension plan. My new pension plan is defined contribution. I pay in 5% of my salary and my employer matches another 5%.

To estimate how much I will get from my total pensions 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.

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

Starting Amount $11,000 (my total pension money saved in both plans to date)
Then I'm adding around: $533/month
At a 5.5% rate of return for 16 years (until I turn 45).

I end up with $189,978. I know that according to my plans I can't touch this money until I turn 55, but if I'm retired at 45 I won't be adding any more money to it. So using the same calculator as above I enter in:

Starting Amount $189,978
I'm now adding $0/month
At a 5.5% return for another 10 years (until I'm 55)

I end up with $328,866. If I take that money and use the safe withdraw rate of 4% I should be able to generate $13,154/year for my retirement starting at 55.


Therefore if I take that amount and add it to my government benefits I calculated yesterday I should get $13,154 + $20,100 = $33,254/year from age 65 onward. So I know now that I'll have enough money just from CCP, OAS and my pension to pay for my retirement from age 65 onwards since my target value was $26,950 from Part I.

I had planned on covering RRSP's today as well, but this post grew too big. So come back tomorrow and I'll cover those and taxable accounts. Then on Friday we will pull all this information together into how much do I need to retire at 45.

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