Wednesday, August 19, 2015

What Happens to My CPP If I Die Early?

Many complain that they pay into the Canada Pension Plan (CPP) most of their lives but get little or nothing if they die early. They think their estates should get a lump sum as compensation. This thinking is misguided.

Here’s a recent example of this complaint about CPP and the new ORPP by Gail Vaz-Oxlade:
If you imagine an account in the CPP system with your name on it holding all the money you paid in, then it seems logical that your estate should get what’s left of that money when you die.

But what happens if you live unusually long? Your account will be empty. But CPP keeps paying. CPP is taking part of your longevity risk. CPP makes money if you die early and loses money if you live long. This is a fair trade, and you get the security of knowing that the CPP payments will continue for your whole life ticking up by inflation each year.

One of the biggest challenges of handling a portfolio in retirement is longevity risk. If you knew exactly how long you will live, you could plan to spend every penny. But you don’t know. To be safe you have to plan to spend much less to make the money last. With CPP, they take care of all this worry for you.

What would happen if the value of everyone’s CPP benefits were guaranteed to say age 90? By this, I mean that if you live past 90, you keep getting payments, and if you die earlier, your estate gets a lump sum of the remaining payments to age 90. The simple answer is that either CPP benefits would drop a lot or CPP premiums would rise a lot.

So, when someone complains that CPP doesn’t pay out to your estate when you die early, what they are really calling for is a big drop in CPP payments or a big increase in CPP premiums. Don’t fall for this. Whatever problems we may have with our CPP system, having payments stop when you die is not one of those problems.

22 comments:

  1. What do I care, I am dead! I am going for the Preet methodology of the last cheque I write will bounce, and there will be no money left for anybody.

    It is too bad the CPP doesn't have a "cash out" option, if you think you aren't going to live a long life in retirement, then you could "blow it all in Vegas!".

    ReplyDelete
    Replies
    1. @Big Cajun Man: I think you just explained why a CPP cash out option would be a disaster :-)

      Delete
  2. where would we be able to find stats as to how often the gov pays CPP past the average life expectancy? what is the expected flatline horizon? How can we determine the point where CPP is making yearly net profits vs breaking even or becoming a burden for our government? More so what are the correct question we should be asking to find the best solution?

    ReplyDelete
    Replies
    1. @Joaquin: You ask a number of good questions that CPP administrators could answer, but I don't know the answers.

      Delete
  3. Great post! Gail should know better.

    It always has me scratching my head when smart people push for something that is, with a little bit of thought, clearly a bad idea.

    ReplyDelete
    Replies
    1. @John: Glad you liked it. In this age of texting and tweeting, "with a little thought" doesn't happen often enough.

      Delete
  4. I suppose they should call it a delayed annuity instead of a pension?

    ReplyDelete
    Replies
    1. @Gene: I'm not sure this will help. Most pension systems I'm aware of stop payments at death (except for a possibly reduced spousal benefit that continues). Not all annuities stop at death. There are term-certain varieties that provide a lump sum if you die early.

      Delete
  5. Under certain conditions the estate, as well as a surviving spouse or children (who are usually beneficiaries to the estate) can receive CPP benefits after death:

    http://www.servicecanada.gc.ca/eng/services/pensions/after-death.shtml

    So it's not quite true that nothing's paid out if you die early.

    ReplyDelete
    Replies
    1. @Anonymous: It's true that I simplified the discussion. There are death benefits in some circumstances. However, if you die young, these death benefits do not fully compensate for the benefits you would have received if you had lived to the expected age at death. So, we are still left with the same debate.

      Delete
  6. Why are we looking at one side of the coin, i.e. CPP not compensating you enough if you die early. We should be considering in tandem the benefits of living longer than the expected age of death. Not to mention the added bonus of having longevity insurance, inflation protection and the investment risk mostly removed. If we supposedly die "early" we are short changed on time, so who cares about CPP.

    ReplyDelete
    Replies
    1. @Anonymous: You're right that we need to consider positives and negatives. Looking at only one side is like expecting to get your insurance premium back if you never make a claim.

      Delete
  7. Are we expecting to get something for nothing?

    ReplyDelete
    Replies
    1. @Anonymous: I suspect its more a case of not thinking everything through.

      Delete
  8. This is why I plan on tapping into my contributions as early as I can. Age 60 for me which is next year. Because we don't know and neither do the plan administrators so take your money at the earliest possible date. This is the same useless complaint I hear all the time about EI contributions. What you receive over the course of time FAR FAR FAR exceeds your contributions. It's not even close. You collect more in 1 year of CPP or EI than you would contribute in 10 years.

    It's a great deal no matter how you slice it. It's all indexed to the CPI so another great benefit attached to it. So you die early, (what is that date)
    nobody knows. It's a personal pension plan this CPP, based on your earnings. It's not an estate planning tool, when you're gone so is your CPP - TAKE IT EARLY! YOU MIGHT DIE WAITING!

    ReplyDelete
    Replies
    1. @Peter Wolf: Because of the reduction in CPP benefits from taking them early, it can sometimes make sense to wait to start collecting, but in most of the cases I've looked at, it does makes sense to take CPP as soon as you stop working (or age 60, whichever is later).

      Delete
    2. You understand that CPP is a bargain (no other way for most people to get that low MER and diversification!), so I'll trust your advice more than many investment columnists. But I'm interested that you'd say it's often better to take CPP early - with the new regulations brought in a few years ago, I had thought the actuarial adjustment was such that unless you have a health problem or lose your job pre-65, it's unlikely that taking early CPP would be to your advantage.

      Delete
    3. @Jean: In the cases I've looked at where you try to maximize after-tax retirement income when drawing CPP, OAS, RRSP/RRIF income, etc., the best results came from drawing CPP early (assuming you retire early). The actuarial changes make it a closer call, but didn't change my results. I don't think early CPP being better is a universal truth, though. Each person's situation is different.

      Delete
  9. Take it early, NO exceptions! NONE

    ReplyDelete
  10. @Peter... So if you take the CPP early, you win big if you die young. If you defer taking CPP, you win big if you live longer than normal.

    So to recap...Take it early, your possible results are (1) Right strategy, but you are dead. Or (2) Wrong strategy and you are still alive and perhaps running short...

    By taking it as late your possible results are (1) Wrong strategy but that's OK because you are dead. Or (2) Right strategy and you are still alive to enjoy it!

    I know what I am choosing...

    ReplyDelete
  11. Why shouldn't one view CPP as a bank account? When you die, does the bank steal all of the money left in your account? Of course not; that would be theft. So why is the government allowed to steal your contributions??? To my mind, if you die before you begin to collect (or even after, for that matter), the government owes all of the money in your account (plus interest) to your estate. The government is getting away with a(nother) massive and unfair grab here, folks. :-(

    ReplyDelete
    Replies
    1. @Unknown: No, that's not true. If you want CPP to be a bank account, then you'd have to accept that your benefits would stop as soon as you reach your life expectancy. If you happen to live longer, tough -- the account has been drained. The promise to keep giving you benefits if you live long comes at a reasonable price -- the end of benefits if you die young.

      Delete