The Canadian retirement system is designed with three pillars for building retirement income:
Old Age Security (OAS) – provides income to all Canadians regardless of employment, subject to residency and income tests.
Canada Pension Plan (CPP) – replaces up to 25% of pre-retirement income up to the CPP earnings ceiling.
Private savings – in the form of employment pension/savings plans as well as personal RRSPs and TFSAs.
For those who work in the public sector, all three pillars provide inflation-protected guaranteed income for life, replacing 70% of pre-retirement income, or more.
Most people in the private sector, however, do not have generous defined benefit pension plans. Rather, they accumulate a pot of money during their career and must figure out how to make it last through retirement, despite not knowing future investment returns or how long they will live.
It appears that many Canadians deal with this uncertainty, in part, by choosing excessively conservative spending rates. There is a more elegant solution to this income insecurity problem that goes overlooked by most Canadians.
You can start CPP anytime between age 60 and 70. Most people start at age 65 because that is the customary retirement age. Statistics show that fewer than 5% of Canadians delay CPP beyond age 65, and only about 1% of Canadians delay until age 70. These statistics are disappointing because many people would gain significant wealth and security by delaying CPP. To understand why, we must look to the adjustment factors applied when delaying CPP.
Before age 65, CPP pensions are reduced by 0.6% per month to reflect a longer payout period. After age 65, pensions are increased by 0.7% per month to reflect a shorter payment period. By delaying CPP to age 70, your monthly pension could be 42% larger, plus any wage-inflation adjustments during the deferral period.
The following table illustrates the total payments received based on the maximum CPP pension of $1,203.75 per month for 2021:
For instance, if you live until 90 you could receive an additional $133,000 in payments by deferring CPP to age 70 rather than beginning early at age 60.
The CPP deferral increases of 0.7% per month are overly generous, especially for healthy people. Given their longer life expectancies, women stand to gain the most from delaying CPP. The increases are also overly generous in a low interest environment because you cannot generate a safe real return by taking CPP early and investing the monthly payments.
By delaying CPP, you are essentially using these forfeited payments to purchase additional inflation-protected guaranteed pension at age 70. If the additional pension were priced in the retail insurance market, it would cost nearly twice as much (for a woman, given longer life expectancy) for an increase of only half that provided by the CPP.
However, the increase in wealth from delaying CPP is only half of the benefit. What likely goes underappreciated is the psychological security that comes with a much larger lifetime inflation-protected income guarantee.
Unfortunately, it seems that most people see delaying CPP as a gamble on living a long life, worrying that they might not extract enough value from the CPP if they die young. But this intuition is precisely the wrong way of thinking about risk. First, it’s worth stating what should be obvious but isn’t: if you die young, you will not be alive to regret delaying your CPP pension. Second, if you die young your spouse’s wealth will likely rise considerably, as the wealth accumulated to support two people is now available to support just one.
Canadians currently at age 60 have almost a 50% chance of living to age 90. The CPP deferral decision is more important than most realize, but the decisions Canadians make about CPP are alarmingly short-sighted. If you have the luxury of contemplating delaying CPP, it is worth a deep dive into the numbers.
A BALANCE BETWEEN ANNUITIES AND ASSETS
If you defer CPP (and/or OAS) to age 70, you will need to use your invested assets to bridge the income gap from age 65 to 70. Although, actuarially, it’s a smart decision for many people to defer CPP, one must also consider the value of spending flexibility. Before you decide to delay CPP you should ensure you will have enough invested capital at age 70 and beyond to fund any surprise expenditures that might arise during retirement.
But there is also a risk of having too much wealth in liquid financial assets. Elderly Canadians are easy targets for financial abuse and scams. By annuitizing an appropriate portion of your retirement assets, you are more protected against theft from organized criminals, and also (sadly) individuals close to you who may not have your best interests in mind.
OLD AGE SECURITY (OAS) CAN ALSO BE DELAYED
Pensions from the OAS can also be delayed from age 65 to age 70, but they cannot be started early. The increases are 0.6% per month compared to 0.7% for CPP. The same economic principles apply, with slightly smaller benefits to delaying OAS versus CPP.
EXPLORE YOUR SITUATION
There are other issues that could influence your decision, such as your CPP earnings history, and the complex interrelation of investment income, government benefits and income taxes. There are some scenarios in which delaying CPP is not a good idea.
QV can help you with your retirement plan, including how government benefits can best be used to create income security and wealth in retirement. Contact your Investment Counsellor to start the discussion.
The CPP Take-Up Decision – Risks and Opportunities
Get the Most from the Canada & Quebec Pension Plans by Delaying Benefits