Considering the Constellation of Concerns at Retirement
When I was a young boy living on the more rural outskirts of Chilliwack, BC, my brother and I would often go over to our cousin’s place just up the road and sleep outside overnight. This was in the summertime, of course. We would look up at the sky to try and identify the constellations or glimpse an occasional shooting star. Frankly, I seldom slept very well or at all during those outdoor sleepovers, but one of the things I remembered was looking up at the sky periodically over the hours and noticing that the constellations had rotated around the apparent centre of the sky, the North Star, or Polaris. It was fascinating to recognize that creative minds had been at work thousands of years ago to “construct” those patterns in the celestial sphere above us.
In the last couple of weeks, I have had multiple communications about retirement with friends and extended family members, all of whom are in their 60s and contemplating retirement this year. The reason I brought up constellations in the previous paragraph is that putting together a retirement plan often involves some creative imagination but, in this case, applied to the tying together of different sources of income: CPP, OAS, GIS, pensions, RRSPs, TFSAs, and non-registered accounts, to name those that easily come to mind.
What follows are some ideas on the order of withdrawals to contemplate if you are planning on retiring.
Which Sources of Income Should I Withdraw from First?
Should I start CPP early or delay?
This assumes you have some assets beyond the government-based benefits of the Canada Pension Plan (CPP), Old Age Security (OAS), and possibly the Guaranteed Income Supplement (GIS). Many Canadians begin receiving CPP as soon as they retire, or even as soon as they turn 60, even if they are still working. They fear that CPP will run out so they had better take it while it’s still available, or they fear that they will die before they have had a chance to benefit from what they’ve paid into for the entirety of their working life.
Let’s consider, however, that for each month before age 65 that you begin CPP, you lose 0.6% of what you would have otherwise been entitled to. That works out to 7.2% for one year or a 36% discount over five years. To see how that might work out, let’s imagine that you have an older sister, aged 65, who has maximized her pension contributions over her working career and is, therefore, eligible for the 2023 maximum at age 65 of $1,306.57 per month. Being a competitive sort, despite being five years younger than your sister, you decide to take CPP this year, too. You have also managed to maximize your CPP contributions, but because you are still a relatively youthful age 60, you have to absorb the 36% discount (0.6% per month x 12 months x 5 years) and therefore only receive $836.20 per month.
However, if instead of receiving CPP early, you decide to delay CPP past 65, you gain 0.7% per month or 8.4% annually. If you wait to age 70, you gain 42% on your pension (0.7% per month x 12 months x 5 years). Let’s imagine that there is a sister 10 years older than you who has also maximized her contributions over her working life. Let’s assume that she retired at age 65 but decided to delay receiving CPP until this year, when she turns 70. Because of this delay, she is going to receive $1,855.33 per month ($1,306.57 per month x (1 + 0.7% per month x 12 months x 5 years).
What about the fears of CPP running out or dying early and thus being “cheated out” of your contributions? On the former, the most recent report from the “Chief Actuary of Canada indicated that the CPP is sustainable over a 75-year projection period.”
Concerning the probability of an early death, if you have made it to age 60, then you have already made it past the causes of an earlier death and you now have even odds of making it to 89 (male), 91 (female), or 94 (last to die of a male/female couple). According to the IQPF and FP Canada Standards Council Projection Assumption Guidelines, CFP® professionals are encouraged to use a 25% probability of survival odds, which lifts those ages to 94, 96, and 98, respectively. Given that the crossover point, when delaying CPP catches up with those who took CPP early, is around 83 years old, this suggests that you will probably do better if you delay beginning CPP past age 65.
Consider the benefit of delaying CPP, if you can. With CPP, you get a guaranteed, inflation-adjusted source of income for the remainder of your life. With a private investment portfolio, you have to deal with assets that are not guaranteed, not tied to inflation, will not necessarily last for the remainder of your life, and that you have to either manage yourself or delegate to an investment advisor.
What if I have too many low-earning years?
How much you receive from CPP has partly to do with the age at which you begin receiving CPP, but it also has to do with the years you can drop out from the calculation of your CPP benefit. The CPP program will automatically drop out the 17% of your contributory period that are your lowest earning months. This period begins when you turn 18 and ends at 65 or earlier, depending on when you begin CPP. If you take CPP at 65, 17% works out to 8 years. If you begin CPP earlier, say at age 60, then 17% works out to 7.14 years. This situation can become a problem if you retire before age 65 but decide to delay CPP to age 65 or later. You may be adding more zero-earning years to your contributory period, gradually reducing the amount you will receive. However, if you delay receiving CPP past age 65, you start taking advantage of the 0.7% monthly increase. This factor may or may not influence your decision to take CPP right at retirement.
There are, however, at least two other provisions to drop out lower earning years. First, the primary caregiver of children up to age 7, most often the mother, can drop those caregiving years from consideration as well. For example, a mother with two or more children with the oldest and youngest born 6 years apart, can drop out about an additional 13 years from consideration under the childrearing provision.
In addition, if you have experienced a period of disability those months may also be eligible for being dropped out.
Where do I get income if I delay CPP?
Old Age Security
All this talk about delaying CPP is moot if you don’t have any other resources to draw on to fund your living expenses. That leaves just about any other source of income as the alternative. At age 65, you can begin receiving OAS, if you wish. There is also some benefit to delaying this source of funds up to age 70 as you will receive a 0.6% per month (7.2% per year) increase for delaying receipt of this income source. But let’s assume for now you take OAS at 65 to mitigate the impact of delaying CPP.
Guaranteed Income Supplement
Beyond OAS, you could theoretically limit yourself to withdrawing only from TFSA assets. This could entitle you to the GIS as well as withdrawals from a TFSA are not taxable income. That might restrict your lifestyle too much between ages 65 to 70, though. Some might also question the morality of drawing on a government program meant to support the poorest seniors in Canadian society when you may have more than sufficient assets to support yourself.
In addition to OAS, there is also the employer pension plan. Not everyone has one, of course, but it is a source of income. If it is a defined benefit (DB) plan, you can even receive a pension credit that can be shared with your spouse, reducing your taxes by $300 each. If it is a defined contribution (DC) plan, the same rule applies, but only if the assets have been converted into a life annuity. If, however, you had left your employer and converted the DC plan to a locked-in retirement account (LIRA) and later converted it into a Life Income Plan (LIF), while you would still withdraw from the LIF, you could not take advantage of the pension credit until reaching the age of 65.
Beyond OAS, and employer pensions, there are your personal savings in RRSPs and TFSAs. Many Canadians have the instinctive desire to delay converting their RRSPs to Registered Retirement Income Funds (RRIFs) until they are forced to do so at age 71 because they want to delay having to pay taxes. However, as indicated earlier, there is a potential advantage in spending riskier assets earlier in retirement in exchange for having a secure source of income in an increased CPP.
There are other reasons to spend your RRSP/RRIF assets earlier. In the case of a retired married couple who each have their own RRIFs, the last-to-die spouse can receive the rolled-over RRIF on a tax-free basis but will then have to take larger Annual Minimum Payments which will be taxed at higher levels since it will be taxed entirely in the survivor’s hands. Furthermore, upon the death of the surviving spouse, the RRIF will be fully taxable. If a large amount remains, a significant tax bill will be due, diminishing the assets to pass on to the heirs.
This situation argues, therefore, for leaving the TFSA as the last to be withdrawn. When you have excess income, which can happen if your required annual minimums from your RRIFs are more than you need, you have a tax-sheltered place to put the excess, and if you have a large expense in a given year, there is no impact on your taxes by withdrawing from your TFSA rather than taking out extra from your RRIF. When the first spouse dies, there are no tax implications for the surviving spouse and once the survivor spouse has died, the balance can be passed on to the heirs as beneficiaries with minimal tax consequences.
Few Canadians maximize their contributions to both their RRSPs and TFSAs, but if you find yourself in that situation, then the next account into which you can put away money for retirement is a non-registered account. You will pay taxes annually on any dividends and interest you receive, plus any net capital gains on securities sold, but you can delay those sales until you need to and only half of any gains are included in taxable income. Although not always the case, this tax advantage can make the non-registered account a better candidate for delaying withdrawals than the RRIF. The non-registered account also tends to be a better account type for passing on financial assets to your heirs, too, because only the gains are taxed at the last death, not the entire balance.
These varied considerations are not always at the forefront for near-retirees. If you are among those considering imminent retirement, I encourage you to take some time for careful deliberation and planning on how you are going to fund your retirement and in what order you are going to withdraw from your available accounts. And may retirement lead to new discoveries and joys in this next phase of your life.
This is the 179th blog post for Russ Writes, first published on 2023-01-09.
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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.