Monday, April 29, 2013

When Should You Start Collecting CPP?

The standard age to start collecting CPP benefits is 65, but you may get a reduced pension as early as age 60, or get a larger pension by starting as late as age 70. A factor affecting the decision of when to start collecting CPP that I hadn’t considered before is the penalty that comes with years when you make no CPP contributions.

Most descriptions of how to calculate your CPP benefits are too hand-wavy to be useful. However, Doug Runchey wrote a great post at the Retire Happy Blog on how to calculate your CPP retirement pension. I used this post to work out my own projected CPP benefits.

I worked out 3 scenarios: collecting at age 60, 65, and 70. When you take your CPP before age 65, your benefits are reduced, and if you postpose benefits until after age 65, your benefits increase. We’re working through a transition period right now, but by 2016 and beyond, the reduction before age 65 is 0.6% per month and the increase after age 65 is 0.7% per month.

This means that if payments start at age 60, the payment amount is reduced 36%, and if they start at age 70, they are increased 42%. It’s important to understand that any reduction or increase is permanent. If you take early CPP at age 60, you won’t get back to normal payments at age 65; the 36% reduction applies for the rest of your life.

In each of my scenarios, I assumed that I wouldn’t be working past age 60. The only variable was the start date of collecting CPP. This means that the longer I delay collecting CPP, the more years I will have without making any CPP contributions. Unfortunately, this reduces CPP benefits more and more the longer I delay CPP benefits.

A very simple analysis of CPP payments takes the 36% penalty for starting at 60 and the 42% bonus for starting at age 70 and declares the benefits at ages 60, 65, and 70 to be in the ratio 64:100:142. However, when I did the full calculations for my situation, which included the penalty for years without contributing, the ratio was 72:100:129.

Based on just these factors, I should take CPP at age 60 if I don’t expect to make it to age 78, should take CPP at 65 if I expect to live to between 78 and 88, and should wait until age 70 if I expect to live past 88. However, another important factor in the timing of starting CPP benefits is the return I expect to make on my savings.

If I expect to make a positive real return on my savings, then the age cut-off ages of 78 and 88 rise. The bottom line for me is that unless the CPP rules change or my working plans change, I’m likely to start collecting CPP benefits at age 60. Each person’s situation is different, though. Your mileage may vary.

1. All calculations assume one earns the Maximum Pensionable Earnings for each year of their working career. If you have been laid off, or take semi-retirement or early retirement, the bonus of waiting to 70 could easily be wiped out.

I'd like to see how the new increased pension will be calculated if one takes CPP at 60 and continues to work.

1. @Anonymous: I'm not sure where you got the idea that my calculations assumed maximum pensionable earnings every year. I followed the calculations in the Runchey post, and I definitely did not make maximum contributions each year because I worked as a consultant for quite a while.

2. I think another factor to consider should be whether or not you plan to purchase an immediate annuity in retirement as longevity insurance. The small percentage of retirees with very large portfolios relative to their lifestyle may not need this insurance, but it makes sense for many retirees.

One problem with annuities is that you're subject to the risk that the company you purchase the annuity from ceases operations, leaving you without an income stream you were depending on. CPP, however, is an annuity with almost probably the lowest such risk.

Therefore, after comparing the difference in monthly payment between collecting at two ages such as 60 and 70, it would be worthwhile to determine how much you would have received in CPP payments over that time period (10 years in this example). If you can instead pay for that out of your savings, you can exchange those savings for a larger annuity from the Canadian government in the form of CPP. You have essentially purchased an annuity of the additional CPP benefits by delaying collection of the benefits.

I haven't done the math for this yet, as I'm still quite a ways away from needing to make this decision. And I suspect whether it makes sense to do so will depend on the interest rate environment at the time, and therefore the cost of an annuity from an insurance company. It does subject you to some interest rate risk during the delayed CPP collection period (i.e. your assumptions at the point in time where you decided to delay collection of benefits may change before you do collect benefits). But I would be willing to pay a premium for the quality of the annuity from the Canadian government relative to that of an insurance company.

1. @Returns Reaper: I think that buying an annuity is an independent concern. Once you've crunched the numbers for your particular situation and decided when it's most beneficial to start collecting CPP, you can develop a plan around this for investing your savings.

2. My main point was that delaying collection of CPP can be considered to be purchasing an annuity, and this annuity can probably be considered to be lower risk than buying an annuity from an insurance company.

So I see the two decisions as dependant. If you decide to buy an annuity, it can factor into your decision about when to start collecting CPP. I'd rather have a larger CPP payment than a smaller CPP payment and an annuity from an insurance company to make up the difference.

Of course, an important factor in making the decision is what the larger CPP payment is costing you relative to the cost of an annuity.

3. The nature of survivor benefits also favour the take-it-at-60 argument. Chances are that both you and your partner, if you’ve had decent jobs, could each qualify for something close to the maximum pension at age 65 — which could be an issue once one of you dies. Even if both partners have contributed all their lives, the sum of the deceased person’s pension and the survivor's pension can’t be more than the maximum allowed. Better to stay further from that threshold by taking discount at age 60, particularly if one partner turns out to die prematurely.

1. @Anonymous: I didn't know about that cap. You make a very good point.

2. That cap is really dangerous to many people's plans. They may have planned for, say, \$800 a month CPP each for an annual payment of \$19200. Then one spouse dies and the other has only \$12144 a year to live on. That can make quite a nasty difference, especially if the spouse who died also had a DB pension that only pays 60% (or less) as a survivor benefit.

3. Anonymous - Taking your CPP early DOES NOT help you receive more survivor's benefit, as the maximum uses your "calculated" retirement pension amount, not your actual reduced retirement pension amount. Here is a link to an article that I wrote on this subject: http://retirehappy.ca/cpp-survivor-benefits/

4. Michael

In re-reading your above blog, I see that I misled you a bit when calculating an over-age-65 retirement benefit. I have posted a clarification on the Retire Happy blog, but I thought that I should contact you this way also.

In my article, I see that there was one further dropout that I should have mentioned, and that’s the “over-65 dropout.”

I left it out intentionally, trying to keep things a bit simpler and because it used to be that very few people waited beyond age 65 to take their CPP retirement pension.

Basically, if you’re working beyond age 65 at a high income level, you’re allowed to replace an equal number of lower earning months with these after-age-65 earnings. And if you’re not working or working only minimally, you can simply drop out those over-65 months so that it doesn’t reduce your calculated retirement pension.

My apology if this omission has misled you in calculating a breakeven date for waiting past age 65 to start your retirement pension.

1. @Doug: Thanks for the additional information. That provides a little more incentive to keep working past age 65.