CPP is a major cornerstone of retirement income for many Canadians. Yet the decision as to when to start payments is often debated.
I recently came across a new research report which shares that delaying CPP to age 70 can be a financially advantageous strategy.
Let’s take a look at how deferring CPP works. If you defer CPP beyond age 65, you are rewarded with a 0.7% increase to your monthly payout for each month that you defer. The maximum CPP monthly benefit in 2020 for a 65-year-old is $1,175.83. For every month that they defer, that amount increases by 0.7% or $98.77. By deferring to age 70, they would increase their monthly payment to $1,669.68. That’s $493.85 per month of additional income – a significant monthly increase and a guaranteed increase, especially since CPP is indexed to inflation. et’s explore these two scenarios in more detail.
65-year-old retires and decides to take CPP.
They would receive $1,175.83 per month indexed to inflation. Assuming inflation was 2%, this equates to receiving $73,428.80 of CPP payments from age 65-70. At age 70, this retiree would still only be receiving the equivalent of $1,175.83 per month in today’s dollars. This payment would remain as such until they die.
65-year-old retires and decides to delay CPP payments until age 70.
In order to make up for not receiving CPP payments between the age of 65-70, this individual would have to tap into their savings. We will assume for the purpose of this exercise, that this individual only has RRSP accounts, they would effectively have to take out $73,428.80 from their RSPs. The same amount that would otherwise have been paid out by CPP over those 5 years. At age 70, this retiree would start CPP payments and would be receiving the equivalent of $1,669.68 per month in today’s dollars.
Comparing the Two Scenarios
Advantage of Scenario 1:
By taking CPP early and reducing how much they take from their RSPs until age 70, this retiree was able to have tax-deferred growth in their RSP. Assuming a 5% growth rate, this would equate to having an additional $85,041.10 (when compared to retiree in scenario 2) in their RSP at age 70.
Disadvantage of Scenario 1:
By taking CPP early, they are not taking advantage of the guaranteed increases in payments with CPP. Because of this, their CPP payment will be lower than the retiree in scenario 2 by $493.85 per month (indexed to inflation).
Advantage of Scenario 2:
By deferring CPP, they are guaranteed a higher inflation indexed payment at age 70.
Disadvantage of Scenario 2:
They are taking more funds out of their RSP early and so will have a smaller portfolio at age 70.
While, at age 70, the individual in scenario 1 would have $85,041.10 more in their RSP, their CPP income would be lower than the individual in scenario 2 by $493.85 per month. In order to understand whether the trade-off of having the larger RSP at age 70 is better than having $493.85 per month more of lifelong inflation protected income (assumed mortality age 95), we decided to test this theory using our proprietary Retirement VIEW software.
Our Retirement VIEW software is built to attempt to simulate real life by testing multiple market return scenarios over different timeframes and determining whether someone has sufficient capital (investments) to sustain a certain level of income.
For example, would someone who had $85,041.10 in an RSP at age 70 run out of money if they were to take out $493.85 per month from their investments? Our software gives this scenario an extremely low score and a high likelihood of running out of money before age 95. In order to ensure that someone has a stronger probability of not running out of money (in our firm, defined as 95% or above), this same client should have closer to $160,000 of investments to provide the required $493.85 per month of income. This is a significantly larger amount of capital than the $85,041.10 that would be lost from the RSPs to bridge to age 70.
In other words, after running this scenario through 10,000 simulations of potential market outcomes, the answer came back that deferring CPP to age 70 to take advantage of the guaranteed income increase seems to be the better option.
However, there are many individual assumptions not taken into consideration in this analysis which leaves it incomplete. Someone who may not be in good health or who has a reduced life expectancy could still be motivated to take CPP early.
As well, someone who does not believe that CPP will be available for their lifetime in its current form, may choose to take CPP earlier. However, as Bonnie-Jeanne MacDonald says in her Globe and Mail article:
“Contrary to popular misconceptions, this program is actuarially sustainable for at least the next 75 years. In other words, your CPP pension is a safe bet.”
Many factors need to also be considered, such as the accessibility of other assets, the availability of private pensions, the ease of access to capital, and the importance of leaving assets to beneficiaries or charities.
While there may be a strong argument to defer CPP payments, every client is unique, and their decision should be based on their reality and goals.
At Tall Oak Private Wealth, we assist clients who are preparing for retirement by formalizing their individual Retirement VIEW. We plan alongside retirees for their different income sources and answer the most important question they face throughout retirement: “Am I OK?”
At Tall Oak Private Wealth, we look forward to continuing conversations with you as we help you in planning your retirement.