Taking Canada Pension Plan at 65 versus 60 versus 70
In earlier years, the incentives to begin your Canada Pension Plan (CPP) payments at 60 made more sense. However, a few years ago, the Federal government created a compelling incentive to delay taking CPP. First, for each month before age 65 that you begin receiving your payments, there is a decrease by 0.6%. If you start at age 60, a full 5 years or 60 months earlier than the standard 65, you are receiving 36% less. Furthermore, for each month after age 65 that you delay beginning CPP you receive an additional 0.7%. If you delay to the maximum of age 70, your payments are an extra 42% larger than they would be otherwise. That can make a substantial difference over a long life.
In this post, I present a comparison of how these differences might work out.
Introducing Our Hypothetical Retired Couple, Michael and Mary Smith
Michael and Mary Smith were born in 1955. They got married in 1977 a few months after each of them graduated from university. They both had solid jobs and earned on average about 95% of the Year’s Maximum Pensionable Earnings (YMPE) each year that they worked. In 1983, and again in 1984, Mary gave birth to their two children, shortly after they bought their house. Mary chose to stay home with the children until the youngest was in elementary school, returning to fulltime work in the fall of 1990.
Although both Michael and Mary had solid middle-class careers, neither of their employers ever offered a pension plan. Saving for retirement was entirely up to them. They began contributing 10% of their income to their Registered Retirement Savings Plans from the month they began to work. During those working years, they averaged investment returns of 3% above inflation. They also felt a responsibility to set aside money for their children’s post-secondary education, which they did, but it also meant that they never managed to contribute the maximum 18% of qualifying earned permitted under RRSP rules.
In their mid-40s, two events with significant financial impacts occurred almost simultaneously. First, Michael and Mary paid off their mortgage. Second, their children went off to university, which marked the end of saving for their education. The children were told that any extra expenses beyond the money in their Registered Education Savings Plans was their responsibility. They could earn it through work, through academic scholarships, or through loans. It was time for Michael and Mary to start getting serious about saving for their retirement.
Michael and Mary kept up with contributing 10% of their earnings to their RRSPs, but they now expanded their savings by investing in a jointly owned non-registered investment account, gradually increasing the amount each year. In 2009, they shifted the bulk of those savings into Tax-Free Savings Accounts, maximizing their TFSA contributions each year. They viewed all three account types as sources for their retirement income.
Michael and Mary kept at this pace throughout their working careers. However, as they approached age 60, they began to wonder what would make the most sense for them in terms of starting their retirement. They were open to beginning their retirements anytime between ages 60 to 65. They also wondered what the impact might be of beginning to receive CPP payments at 60, 65 or 70. To get an idea, they sat down in front of their computers and began working out the options on a spreadsheet.
Estimating their Lifespan
Both Michael and Mary are healthy and based on their parents and other older relatives it seems likely that they will both live well into their 90s. They find an actuarial table online which confirms their expectations for longevity, so they decide that they need to spread out spending from their investments so that they last until their age 98.
Scenario 1: CPP and Retirement at age 65
Since 65 is the “standard” retirement age, Michael and Mary start there. In this scenario, they elect to take CPP and Old Age Security (OAS) at age 65. They convert the entirety of their RRSPs into RRIFs during the year that they turned 64 so that they can begin taking their Annual Minimum Payments in the year they turn 65. They also choose to spread out their TFSAs and Non-registered accounts over the entire period of their retirement. The balances of those accounts at the beginning of the year they turn 65 are as follows:
Looking across these various sources of income, including CPP and OAS, Michael and Mary earn income, before tax, as follows:
For tax purposes, CPP, OAS and RRIF payments are all fully taxable. The TFSA, as its name makes clear, is tax-free. The non-registered account could theoretically have interest income that is full taxable, as well as dividend income, which benefits from the dividend tax credit. For our purposes, the income will only be realized from selling a portion of the equity. Part of this would be the invested principal and the remainder would be capital gains. Since our current tax system provides for a 50% capital gains inclusion rate, only a portion of the income is taxable.
Scenario 2: CPP and Retirement at age 60
Many Canadians fear that they will not live the long years they need to get back all that they have paid into the Canada Pension Plan throughout their careers. There is also the simple allure of receiving payments from a government program. Michael and Mary wonder whether they can swing retirement at 60, speculating that those extra five years up front will make up for the lower amount they are going to receive for the rest of their lives.
At the end of the year before they turn 60, they convert their RRSPs to RRIFs. They also apply to begin receiving their CPP at age 60. Like before, they plan to withdraw from their TFSAs and non-registered account, drawing out the same amount of money each year until age 98. Their balances at the beginning of the year they turn 60 are as follows:
As one might expect, with five fewer years to save and invest, the balances on Michael’s and Mary’s accounts are considerably lower. This is a double-edged sword, and both edges are painful. With five fewer years to save and let their investments grow, they accumulate less money. In addition, they have to fund five more years in retirement, which spreads this lower amount even further.
From a tax perspective, there are pros and cons. The pro, if one can consider this a pro, is that with lower income, considerably less tax needs to be paid. The con is that RRIF income is not eligible for income splitting until age 65. To top it off, the same age requirement means that Michael and Mary cannot claim the $2,000 Pension Income Tax Credit. As a result, two potentially valuable tax saving opportunities are not available to them.
Scenario 3: CPP at 70 and Retirement at 65
In our third scenario, Michael and Mary choose to retire at age 65 but defer receiving CPP until age 70. Instead, they will spend more of their RRIFs first to make up for this initial lack of funds. Because they begin to draw on their own resources at 65, their beginning balances at 65 do not change:
However, delaying CPP makes a significant difference overall.
As you can tell by now, for Michael and Mary, the best outcome is when they choose to retire at age 65 but defer their CPP to age 70. That calls for spending a greater amount of their RRIF up front, which means that overall, their RRIFs provide them with less income, but that is more than made up for by the larger CPP payment.
In contrast, they take a huge hit for retiring at 60, both in terms of the reduction in overall CPP received and in the reduced RRIF they have to work with. The outcome of retiring at 60 is an annual income that might be difficult for Michael and Mary to manage.
Some Final Thoughts
In all three scenarios, Michael and Mary plan to spend all of their money. If they want to leave an inheritance for their children, however, they may choose the standard age 65 to begin their CPP rather than deferring it until age 70. For, regardless of the better overall income through deferring the start of CPP, the early depletion of their RRIFs means that less will be available to their heirs when they die.
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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.