Can You Retire on CPP and OAS Alone?
A couple we’ll call David and Marie are on the verge of age 65. They managed to pay off their mortgage back in 2008, but they haven’t saved much of anything since. Neither had employers who provided pensions or group Registered Retirement Savings Plans (RRSPs). They didn’t open RRSPs or Tax-Free Savings Accounts (TFSAs) for themselves, either. However, they do have $20,000 set aside in a joint savings account that serves as an emergency fund.
The Illusion of Stability
David and Marie always felt pretty good about their financial situation because they had managed to pay off their mortgage by the time they reached age 50 and they had some money set aside for unexpected expenses. The truth of their situation though, was not nearly as secure as they thought. Without looking into the details of the Canada Pension Plan (CPP) and Old Age Security (OAS), they assumed that they would be well taken care of. However, they are beginning to recognize that they may be facing some financial challenges.
Thanks to the lucky timing of their age cohort, those born in the late 1950s, when David and Marie bought their house, the price was at a low ebb that took years to recover. It’s now worth about $700,000. They also feel fortunate that they’ve paid off the mortgage and do not have any other debts. For that reason, they feel they’ve done well financially. They also have one car worth about $15,000. They used to have two vehicles, but about 10 years ago, when the second of their two children finished her studies and moved away, they felt that Dave could take the bus to his place of work downtown. Including their emergency fund and an extra $3,500 they keep in a chequing account, as they enter retirement, they have a net worth of nearly three-quarters of a million dollars.
Income in Retirement
Realizing that they should be doing some planning, David and Marie start inquiring about what they can expect to receive in government retirement programs.* It appears that they will both be receiving what the average 65-year-old retiree gets when they start CPP, about $773 per month or $9,273 per year. For OAS, they estimate receiving about $696 per month or $8,355 a year each. Given their income levels, they discover that they also qualify for the Guaranteed Income Supplement (GIS) and can anticipate about $204 per month or $2,446 per year each. Tallied up, they feel they can look forward to an estimated $40,147 per year.
Although David and Marie feel that they can manage this since they have always managed to live within their means, and they remember making those bi-weekly payments on their mortgage and monthly payments to their kids’ Registered Education Savings Plan (RESP), it’s been a few years since they’ve had to cut back this far. They then learn that for GIS calculation purposes, they can omit the first $5,000 of employment or self-employment income, which gives them another $10,000 to live on. They feel they can manage those relatively few hours of work reasonably well. Although it will still be a modest life, they feel they can manage this much better.
Or at least they felt they could manage this better on the assumption they could keep going with their part-time work for as long as they wanted. While they expect to spend less as they get into their mid-70s, they realize that a $10,000 income “haircut” will have a meaningful impact on their lives, even with the bump in OAS once they reach 75. The probability that one of them could live to 100 makes them wonder why they didn’t plan for living in retirement.
Resolving the Issue
Invest in TFSAs from Age 65
Although no doubt a challenge, one option that David and Marie may wish to consider is to reduce their living expenses by $5,000 per year so that they could save $5,000 per year in TFSAs for the 10 years that they plan to keep working part-time. Instead of $50,147, they would only have $45,147 available. Assuming they could earn 4.60% per year from a 50/50 equity/fixed-income portfolio, over 10 years, they could build up about $63,000 in tax-free assets. In the same investment portfolio, they could generate an extra income of about $345 per month or about $4,140 per year for the rest of their lives. That means they could have $45,147 from ages 65 to 74 and then from 75 on, with the increased OAS and regular withdrawals from their TFSAs, they could have an income of $46,261, which would smooth out their annual income considerably.
What if David and Marie Had Prepared Earlier?
Earlier, it was noted that David and Marie had paid off their mortgage in 2008. They made no efforts to save thereafter. What would have happened if they had chosen to divert the money not spent on their mortgage on saving for retirement? For example, what if they had maxed out their TFSAs over the interviewing years from 2009 to 2022? It’s not unreasonable to expect that they would have accumulated about $225,000 or more in TFSA assets between the two of them.
They Could Delay CPP
One option David and Marie can consider to improve their overall income is to delay the start date of their CPP payments. Each month they delay CPP increases the amount received by 0.7%. That works out to 8.4% per year or 42% if they delay from age 65 to 70. If they each expect to receive the average CPP of $9,273 per year if they begin at 65, a 42% increase means $13,167 per year. Multiply that by two and $18,546 increases to $26,334, a difference of $7,788. The issue, of course, is, how they make up that gap during the five years that they are not receiving CPP.
Use Their TFSAs to Make Up the Gap
Let’s suppose that going into retirement, David and Marie had $225,000 in TFSAs between them. We will further assume that they will work from ages 65 to 74, each earning $5,000 per year. From age 70 to 74, they will be receiving both their CPP and employment income. Then, from age 75 on, they will receive a slightly enhanced OAS, but they will no longer have income from work. Their income pattern will look like this:
You will notice that the years from age 70 to 74 are their highest income years. They begin CPP, but GIS decreases considerably. The years from age 75 onward decrease because of the decision to quit working. At age 75, that is not an unreasonable choice to make, but it does mean a loss of income that the relatively minor increase in OAS cannot make up for.
If we make $54,096 the benchmark for David and Marie’s income, can $225,000 in TFSA assets make up for the income gaps before age 70 and after age 74?
For the first five years, David and Marie need to withdraw $12,117 from their TFSAs. Assuming the same 4.60% expected return as above, withdrawing that amount of money over five years will leave David and Marie with $212,259.
Let’s assume that they leave their TFSAs to grow for the next five years because they are content with their income of $54,096. Their $212,259 grows to $265,781. Is anything left after they withdraw $8,026 per year for the next 26 years? As it turns out, David and Marie wind up with a larger TFSA than they anticipated, with a total of $450,636 between them by the end of their lives. Clearly, a target of $54,096 per year is too modest.
Eventually, they adjust their target to $58,991 per year. This means they will draw $17,012 per year from their TFSAs from ages 65 to 69, $4,896 per year from ages 70 to 74, and $12,921 per year from ages 75 to 100.
Lessons to be Learned
There are Costs to Inaction
If David and Marie had used the freed-up cash from no longer having to pay their mortgage or contribute to their kids’ RESP, they could have built up some savings that would have added considerably to their retirement income.
Delaying CPP May be a Viable Option
The challenge with delaying CPP is that you need to have another source of income if you want to wait five additional years beyond the standard retirement age of 65. Often this means “melting down” your RRSP sooner than necessary to fill that income gap. Here, the choice was made to favour TFSAs because of the tax-free nature of withdrawals. Regardless of the source, the income needs to come from somewhere. But why make this choice? While the possibility of dying before collecting a delayed CPP is something to be aware of, the probability is that most of us will live well into our 80s and half of us will probably live into our 90s. The benefit of delaying CPP to obtain an increased, guaranteed, inflation-adjusted income addresses the risk of outliving our money. While you might do well by investing your assets, the markets do not owe you a positive return. The less you have, the more reasonable it is to spend down those risky assets in exchange for receiving a more reliable income.
CPP, OAS, and GIS are Great but Not Enough for Most
For those who have been low-income earners for most of their careers, these government-sponsored benefits may put you in a better position than you were in your working years. In fact, because of the way GIS is clawed back, taking CPP earlier is often the better option so that it has a lesser impact on your GIS income.
On the other hand, those who have been middle-income earners during their working years will find CPP and OAS inadequate and may not qualify for a significant level of GIS. In that case, you may need to generate your own savings for retirement.
Don’t Leave Retirement Planning to the Last Minute
If you have been diligent about saving and have eliminated your mortgage or other debts by the time you reach your planned-for retirement age, a retirement plan may mean little more than an effort to optimize withdrawals from your various sources of income. However, if you are within a year or two of retirement and haven’t given your retirement income much consideration, you may find yourself having to substantially reduce your living standards to make ends meet. This is perhaps less severe an issue in the case of someone with a good defined benefit pension plan, but those are becoming increasingly rare, putting more of the onus on you, the retiree.
Appendix: Real Life Data for those Age 65 and Over
One of the leading figures in low-income retirement planning in Canada is John Stapleton of Open Policy Ontario. In a presentation† developed in November 2023, he and R. Maaranen provided information on the income of Canadian seniors by decile. Among other things, you will note that in the lowest three deciles, OAS and GIS contribute over 50% to the income of Canada’s senior citizens. I will note as well that employment income is an insignificant factor for the lower-income half of the population measured.
*These are 2023 numbers and assume no inflation.
†Thanks to Alexandra Macqueen for making me aware of the Open Policy Ontario presentation just as I was putting this blog post together.
This is the 227th blog post for Russ Writes, first published on 2023-12-11
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.