Your Ultimate Guide to The CPP: Part II – When Should You Start Benefits?
When is the best time to start your Canada Pension Plan benefits? This question is hotly debated and it’s a tough decision for Canadian retirees to make. Everyone seems to have their own strong opinion.
The typical age to start receiving CPP/QPP payments is 65. However, you can start receiving payments as early as age 60 at a reduced rate, or as late as age 70 at a higher rate. So, when you start your benefits makes a huge difference in your monthly payments.
It’s common knowledge among economists that even though people prefer bigger rewards over small ones, they have an even stronger preference for present rewards over future rewards – even when the future rewards are much bigger.
You know, a bird in the hand and all that.
How do you pick a start date?
The earliest you can take your CPP benefits is the month after your 60th birthday. However, your benefit will be reduced by 0.6% for each month before your turn 65, to as much as 36%.
If you wait, your payment will increase by 0.7% for each month after age 65, up to 42% by age 70. There is no advantage to waiting past age 70.
If you take CPP as early as possible (at age 60), you enjoy more total years of benefits, potentially allowing you to retire earlier. However, if you wait (up to age 70), you get more money each year.
Conventional thinking suggests you should draw as soon as possible, but it also seems foolhardy to pass up the larger payments you’d get if you wait until later.
Service Canada says that more than two-thirds of Canadian take it before age 65, but there is a growing trend to defer CPP payments. One reason is our increasing longevity, but it can also be because fewer people have indexed defined benefit pension plans.
So how do you pick a start date? It depends on several factors.
Reasons to take early CPP benefits
Is it wise to take a voluntary reduction in income by up to 36%? There are situations in which taking CPP early is beneficial and it’s not always about the numbers. Here are some things to consider before you make your decision.
- You need the cash flow. Perhaps you were laid off and it’s a struggle to find employment, or you retired early due to poor health. You might be working just part-time or have large debts to pay down. If you don’t have much in the way of personal savings or enough income to support yourself, you may have no other choice.
- Eligibility for GIS. You’re confident you’ll be eligible for the Guaranteed Income Supplement at age 65. Since CPP is taxable income, a lower benefit will increase your GIS payment.
- You have a reduced life expectancy. If you have reason to suspect a shortened life expectancy due to genetics or poor health, starting CPP payments early can make financial sense. It will allow you to maximize how much pension income you draw over your remaining lifetime. However, if you suffer from a “severe and prolonged” disability you should apply for CPP disability pension instead. If you’re approved, the CPP disability amount will always be higher than the retirement pension and will convert to a full pension at age 65.
- Few or low-income contribution years. When you take CPP at age 60 your benefits are based on your best 35 years of earnings. If you started working later in life or retired in your fifties those years of zero contributions will most definitely reduce your benefits if you wait until age 65.
- You want to preserve your savings. You may want to maintain your savings for a “rainy-day” fund to cover any sudden needs, or to maximize the amount of money in your estate.
- You want the enhanced cashflow. If you have other income sources like an employer pension you might want to be able to spend more to support a greater retirement lifestyle in the earlier years while you’re young and healthy enough to enjoy it.
Should you invest your early CPP benefits?
Some retirees believe they should take CPP as soon as possible and invest it. The idea being that the longer their investments can compound, the better off they would be versus delaying CPP to age 65 and beyond. But it doesn’t usually lead to a better outcome.
Remember, the CPP is taxable income so you won’t be able to invest the full amount. If you invest it into your RRSP you still have to pay taxes at a later date when you withdraw the funds – ending up with the same tax situation.
Investors are usually overconfident in their investing ability and over optimistic about their expected rate of return. Also, when you take investment fees into account, think about how much you will need to earn to beat the guaranteed 7.2% return that comes with delaying an inflation indexed CPP by a year?
Reasons to defer CPP benefits
What if you are among the two-thirds of Canadians who live past the age of 85? Also, at 85, average life expectancy is another eight years. Statistics Canada predicts a continued rise in life expectancy of roughly two years over the next 15 years.
For many of us, delaying CPP benefits is the safest approach to maintaining a secure income over the longer lives we may be in store for.
Consider these reasons to delay taking benefits:
- You expect a longer than average life expectancy. If you are in excellent health when you retire and have good genes on your side, you will receive more money during your lifetime.
- You plan to continue working and you earn a good income.
- You don’t need the money to live on now. Pensions and investment income are enough to cover your living expenses.
- You don’t have a fully indexed defined benefit pension. A larger CPP payment is vital to your inflation-protected financial well being.
- Your benefit amount is tiny, and you want to beef it up.
Lower your retirement income risk
It has always been assumed that spending and the cost of living will decrease during retirement. But future expenses are difficult to predict. You can lower your retirement income risk by delaying CPP payments.
Those who wait to take CPP will often need to take larger withdrawals from savings such as RRSPs, Tax-Free Savings Accounts (TFSAs) and other investments to bridge the gap. Some people object to this because they want their savings for liquidity or estate purposes.
On the other hand, if you draw down your RRSPs you might be in a lower tax bracket at age 70 and you would be getting safe, reliable income that isn’t affected by low interest rates or market fluctuations and risk. You would be converting your risky assets into a guaranteed income stream for life.
“Spend your risky dollars first because they may not be there for you in your 80s, depending on how your investments do. A bigger CPP cheque, however, will definitely be there for you.” – Fred Vettese, actuary and author
What is CPP integration?
All defined benefit pension plans in Canada are integrated with the CPP. This means the pension plan pays higher amounts to retirees who start their pensions before age 65 and then reduces it after age 65. This is called a bridge benefit.
It is based on the assumption that most pensioners will start receiving their CPP and OAS payments at 65 and will need more DB pension to supplement their income until then.
The bridge benefit has nothing to do with the timing of starting your CPP pension, nor does it change the CPP amount.
You can still choose to take CPP early while receiving the bridge benefit. It’s a way to have additional income prior to age 65.
Taking CPP benefits while still working
People who continue to work past age 60 now have the opportunity to also collect CPP without having to stop work. Before you had to stop working for two months in order to collect.
Plus, it used to be that if you were collecting CPP, you didn’t have to pay into it if you started working again. Now, all Canadians who work have to pay into CPP, up to age 65. After 65 you can continue paying or opt out.
All contributions go towards increasing future CPP income through a new top up plan called the Post-Retirement Benefit (PRB). This small amount (2020 maximum is $29.39) is added to your retirement pension each January, even if the maximum CPP benefit amount is already being received.
If you take CPP while you’re still earning employment income your taxable income will increase.
The bottom line
When should you begin taking Canada Pension Plan benefits? There are no right or wrong answers. There is a case to be made for taking CPP at age 60, deferring until 70, or taking it somewhere in between.
While many people feel that there is some benefit to enjoying CPP earlier in retirement, many others think that delaying CPP is like insurance for longevity.
Although there are many calculations around about the mathematical break-even points of taking your CPP benefits at various ages, the benefits are designed to be actuarially neutral for average life expectancy, which for Canadians is age 80 for men and 84 for women.
Many people get hung up on the concept of the break-even point when deciding when to start their CPP. They want to make sure that they get as much out of it as possible in the event they die young.
The choice should be based on your individual numbers and take into account not only your life expectancy, but also current and future tax brackets and your immediate and future income needs. Also consider the impact on any other benefits you’re receiving, or will be receiving, such as OAS and GIS.
In addition, it’s important to understand that if you start government pensions immediately upon retirement, you free up money in your nest egg to invest for later. Or conversely, if you defer government pensions, you generally need to draw more heavily from your portfolio during the deferral period.
One strategy doesn’t fit everyone. The best way to figure out what’s best for you is to seek the advice of a financial planner or other professional. It’s their job to look at the details of your financial life and help you reach the right conclusion.