A question I am often asked is, “How much money do I need to retire?” That’s an excellent question but the answer is usually a moving target because our vision of retirement will likely be much different at 55 than 35. The more important question for most people is, “Where I am going to find the money to retire?”

Typically, less than 10% of the working population are covered solely by a defined benefit pension as more employers, to reduce costs, have gone to defined contribution plan and group RRSP’s. The biggest difference between the two is that now the risk has been transferred to you. In a defined benefit plan the employer guarantees you a certain wage based on your income and years of employment, so the longer you live the costlier it becomes to the plan. In a defined contribution plan and group RRSP, more often you have the option of making the investment decisions, and in the end you have a finite amount of money which you then must decide how to invest and turn into income. So the risk is that you may run out of money. On the positive side a defined benefit pension is only as good as your employer (who may go bankrupt), while in a defined contribution plan the money is yours and you’re responsible for investing it.

“Great. If I have a pension or Group RRSP, how much over and above that pension do I need to save?” There are various formulas or rules of thumb including 70% of your pre-retirement income or 20-25 times what you expect to spend in your first year of retirement minus other sources of income like CPP and Old Age Security. Remember that prior to retirement much of your income is eaten up by higher taxes, ongoing expenses like mortgages, debt retirement, savings and raising a family. For most of us, we are planning retirement when the house is paid off and the kids are out of school.

The problem with formulas is that they don’t take into account individual expectations at retirement, whether they are to travel or start some new leisure activities. An individual financial/retirement plan is needed to make sure your vision of retirement is a possibility. Then you need to save to make that vision a reality. The key, then, is starting earlier than later. As a guideline, starting at age 45 you will need to save twice the percentage of our income each year than if you started at 25.

The time to get started is now.

July 24, 2009