Wednesday, March 15, 2017

The Case for Delaying CPP and OAS to Age 70

There are good reasons why some people start collecting CPP and OAS benefits as early as possible. However, many people start collecting CPP and OAS early for emotional reasons that don’t hold up under scrutiny. The main reason to delay benefits until age 70 is simple enough: most of us need to plan for the possibility of a long life.

Let’s start with some basics about CPP and OAS payments. Old Age Security (OAS) can start anywhere from age 65 to 70. Most Canadians at age 65 are eligible for the maximum pension (currently $578.53/month and rising with inflation). However, waiting until age 70 gives the payments a 36% boost (0.6% for each month of delay). A 70-year old just starting OAS today would get $786.80/month.

Canada Pension Plan (CPP) benefits are more complex to calculate. Doug Runchey has a great description of how to calculate your CPP pension. The biggest CPP retirement pension a 65-year old can collect today is $1114.17/month, rising with inflation. However, the average is $644.35/month. Whatever amount you’re entitled to, you’re allowed to start payments as early as age 60 or as late as age 70. The penalty for starting at age 60 is a 36% reduction, and the benefit for waiting from 65 to 70 is a 42% boost. So, the maximum payment at age 60 is $713.07/month, and the maximum starting at age 70 is $1582.12/month. That’s quite a big difference.

One technicality about CPP is that delaying benefits from age 60 to 65 can reduce your calculated pension a little if you’re not working past age 60 because you’ll have more years with no CPP contributions. (There is a special “dropout” that allows you to not count the years from 65 to 70.) So, depending on your exact circumstances, the dramatic difference between CPP at age 60 and at age 70 can be a little smaller than I showed, but it doesn’t affect the rest of the discussion much.

There are some good reasons to start collecting CPP and OAS as soon as possible. If you have much lower than normal life expectancy for any reason, it makes sense to collect some money while you’re still alive. If you have no savings and you plan to live only on just the total of your pensions (including the lower CPP and OAS payments that come from taking them early), then it makes no sense to delay CPP and OAS.

Suppose you have a normal life expectancy and have at least enough savings to be able to make it to age 70 without collecting CPP or OAS. This means that if you calculate the boosted payments you’ll get from CPP and OAS at age 70, your savings will cover withdrawals of at least this amount for the years from when you retire until you’re 70. So, you have a real choice: take CPP and OAS sooner or later?

There are some strong emotional reasons to take CPP and OAS sooner. One is that we discount the future too much. Another is that we sometimes use the fact that CPP is available at age 60 to justify retiring at 60, whether we have enough savings or not. Yet another is that it’s psychologically hard to spend down one’s savings, and as Frederick Vettese explained, you’ll have to do that faster if you delay CPP and OAS.

I’ve heard people try to justify taking CPP at age 60 saying that they want to have some money to spend while they’re still young enough to enjoy it. However, they could just spend more from their savings to achieve this. If delaying CPP and OAS to age 70 has a net benefit, then doing so will allow you to spend a little more during your early years of retirement than if you took CPP and OAS as early as possible.

We only need to consider one dominant fact to see that delaying CPP and OAS is a big win: you might live a long life. The scenario that puts the most strain on your finances is living a long time. If your financial plan works for a long life, then you won’t have financial trouble if you don’t live so long.

If you do live a long time, you’ll get the most value from CPP and OAS if you wait until age 70 to get larger payments. Knowing that you’ll be better covered after age 85 with big CPP and OAS payments makes it possible to spend more early on. The problem with longevity risk is that we are forced to plan for living to 95 even if we expect to only live to 85. The great thing about large CPP and OAS payments is that they keep growing with inflation as long as you live. This eliminates part of your longevity risk.

If you live a long life, the math overwhelmingly supports taking CPP and OAS at age 70. Doing so makes it possible to spend more in your 60s than you could do safely if you take CPP and OAS early. But what if you don’t live long? You’re still better off delaying CPP and OAS. You don’t know in advance that you won’t live long, so you’re still forced to plan for the possibility of a long life.

You may see some analyses with detailed calculations to decide when to take CPP and OAS. These often use normal life expectancy to make the choice. These analyses just aren’t relevant to most of us because we have to plan for the possibility of a long life. An exception is if you’re wealthy enough that you plan to under-spend your assets and longevity risk matters little.

In many financial decisions, the truth is in the numbers, but only when you get all the facts right. If you get a fact wrong, such as not planning for the possibility of a long life, the math gives you an answer that is exactly wrong. It pays to think clearly about the gift of high CPP and OAS payments you can get by waiting until you’re 70 to collect.

24 comments:

  1. I've thought about this subject before. I consider delaying CPP to be nearly equivalent to purchasing an immediate annuity with a couple of key differences:
    1. The CPP annuity is backed by the Canadian government rather than an insurance company, so I perceive it to be safer.
    2. The CPP annuity is indexed to inflation, which is better than most annuities offered by insurance companies.

    The last time I checked a few years ago, nearly all immediate annuities had a constant payout, which means the value of the payouts are eroded by inflation. There were a few products that increased at a fixed rate of 2% per year, but I didn't find any that were indexed to the CPI (but I feel there must be something out there somewhere...?)

    If I had to choose between $700/month at age 60 or $1500/month at age 70, I'd consider it to be the same as making $700 monthly payments for 10 years to purchase an $800/month annuity with indexed payouts.

    If I assume a 5% cost of capital, the $700 monthly payments would cost me about $110,000 over the 10 year period. Based on data from lifeannuities.com, I'd expect to be able to purchase an annuity with no more than a $700/month payout at age 70. This is a flat rate, not indexed to inflation. So based on this very quick (rough) math, if you see a need for the guaranteed income CPP or an annuity provides, I'd see no reason not to "buy" the government's CPP annuity.

    I know I ignored inflation during the 10 year payment period, but I suspect it isn't going to change the picture dramatically. The outcome would have to be _very_ different before I'd decide an insurance company's annuity would be a better deal.

    Having said that, annuities are longevity insurance. Generally speaking, if you don't need insurance, you shouldn't buy it. So making sure you have income for as long as you might live is important, but making sure you have more than you need probably isn't a good deal for you.

    ReplyDelete
    Replies
    1. @Returns Reaper: You're right that you can consider delaying CPP from age 60 to 70 to be 10 years of investment to get a lifetime of payments from age 70. If you take into account inflation in all aspects of the calculation, the case is even more compelling than it looks when considering constant payout annuities.

      If you live to 95, the IRR of this investment is a real return of 7.2%. If you live to 85, the IRR is a real return of 5.05%. These returns are hard to beat.

      As for CPI-indexed annuities, Standard Life Canada used to offer them, but I'm not sure if anyone does any more in Canada.

      Delete
  2. Your analysis assumes that you spend your CPP. Would your conclusion be different if you took CCP at 60 and invested the money instead of sending it? Ten years of investment might make up for the increased CPP receipt at 70?

    ReplyDelete
    Replies
    1. @J.K. Reid: The IRR of the investment would have to be 7.2%/year to match increased CPP to age 95. So, delaying CPP wins if you live long. Wealthy people who have no plans to spend all their money might not worry about living a long life, but in this case, the headwind of taxes in a non-registered account makes delayed CPP look good as well.

      Delete
    2. @J.K. Reid: I should have said the IRR has to be a _real_ return of 7.2%/year (i.e., above inflation).

      Delete
  3. Hi Michael,

    I recently spent a couple days researching this. I found that how you invest and your tax bracket working vs retired are the main factors. It is often beneficial to delay OAS to 70, as well: https://edrempel.com/delay-cpp-oas-age-70-complete-answer-real-life-examples/


    Ed

    ReplyDelete
    Replies
    1. @Ed: It was hard to tell too much from your examples because you didn't list assumptions like expected returns. I suspect I would come to different conclusions in some of your examples.

      Delete
  4. Is there any risk somewhere down the road of adjustment by the government to the plan? If there is, it likely would be a negative one. Not suggesting it is a big factor in the decision to delay, but lots of things can happen in ten years.

    ReplyDelete
    Replies
    1. @Kaunha: That's definitely a possibility. It's hard to predict the future. If anything truly big were to happen that impaired the government's ability to fulfill its commitments, stock markets and the rest of the economy would likely suffer too.

      Some financial advisors like to try to scare potential clients by claiming that there won't be any CPP or OAS for us when it's our turn. This would certainly be enough to get some people to grab CPP and OAS while they can. But I'm not concerned about this.

      Delete
  5. My wife and I took CPP when we reached 60. We just turned 65 and took OAS right away. Why? We think we are in better physical shape now than when we'll reach 85. We have more money to spend and enjoy right now. We were able to enjoy 5 years of "extra spending" than having to wait 70. We calculated that the break-even point is around 78, so why wait?!

    My father passed away at 82, my mother is 90... and counting. My wife's mother passed at 83, her father at 78. What are the odds for us of getting to 95? Pretty slim! And looking at our folks when they were 75 - 80... barely able to walk, couldn't drive anymore, lots of pills... not for me (at least now) So, I'm glad I had 5 more years to spend "my" government money. Being DINKS (Double Income No Kids), with a bit more than $1.2M (not including CPP/OAS) we have enough to "endure" the hardships of the market. We want to leave just enough for inheritance to buy a spot in the crematorium... then "back home" on the other side! (Yeap, we know there is life after earth-life!)

    JF

    ReplyDelete
    Replies
    1. @JackF: Unless you're planning to leave yourself with no money at all after some point, your reasoning doesn't hold up. You would actually have more to safely spend from 60 to 70 if you delay taking CPP and OAS to age 70. Whatever amount of savings you choose to hold back for old age, you wouldn't have to hold back as much if CPP and OAS payments are larger. This leaves more money to spend in your 60s.

      Delete
  6. This comment has been removed by the author.

    ReplyDelete
    Replies
    1. Just to add to my point, check out the following chart:
      https://edrempel.com/delay-cpp-oas-age-70-complete-answer-real-life-examples/

      I'm more in the camp of Erin, with a breakeven age for CPP at 86 and OAS at 92.

      What would I do with all this money at those ages if I wait? :D

      Note: Asking the question is answering it (for me!)

      JF

      Delete
    2. @JF: To start with, as I said in a reply above, Rempel doesn't show the assumptions he put into those calculations and I don't believe the results.

      There is no reason why delaying CPP and OAS to age 70 has to mean that you spend more when you're old than when you're young. Knowing you'll have larger payments coming during old age makes it far safer to spend your savings in your 60s.

      Delete
  7. @James: You are probably correct about Rempel. I didn't dig deep enough in its assumptions. However, being frugal spenders, my wife and I figured that we have enough in our portfolios to last. Awhile back, I did some spreadsheet calculations assuming the government would stop funding OAS (and even CPP), meaning that we would have to live without them, and we are good "until the end." Naturally, you have to take into accounts that we don't have any inheritance to give away. And if we pass away early, then our charitable organizations will be very happy. Conversely, if we stick around in our late 90's then they won't be as much happy.

    JF

    ReplyDelete
  8. Well done article Michael! Always amazes me how resistant many are to believing that you may actually be able to safely spend more by delaying benefits... Very few financial advisers preach this gospel because of perverse incentives.

    ReplyDelete
    Replies
    1. @Garth: It's true that advisors have a financial incentive to have their clients not sell assets through their 60s. However, I think the more powerful incentive is to tell clients what they want to hear -- that it's OK to take the money as soon as possible.

      Delete
  9. I like the cheeky comment by Jonathan Clements on this topic...

    "If you fully intend to die early in retirement, then yes, take your benefits as early as possible." ;)

    ReplyDelete
    Replies
    1. @Garth: There's so much emotion tied up in these decisions that maybe a great line like this is more persuasive than anything I can write in a post.

      Delete
  10. What I am always frustrated by is that if your spouse dies, you only get their CPP to the maximum for one person. I've never crunched the numbers to see what the actual numbers are but anecdotal evidence from my parents shows that they would go from a combined amount of $1700 per month to the max of $1100 if one dies. That is because they both worked all their lives. They are then in worse financial shape because the expenses don't go down much eg rent utilities etc. I believe this unfairly penalizes couples who have both contributed throughout their lives vs the antiquated model of stay at home moms and part time low income earning wives that the CPP cap uses.

    ReplyDelete
    Replies
    1. @Susan Tom: I agree that this is a problem. But I'm not sure there's much hope in changing it. Governments are very sensitive to criticism of paying a lot of money to rich people. Paying 1.5 times the CPP maximum to a man who has huge savings from the high-paying jobs he and his late wife had just looks bad.

      This goes back to the days when the NDP used to criticize the government in power about the number of millionaires who paid no income tax. This was a big driver for the alternative minimum tax.

      Delete
  11. I did taxes for many years and I find the lack of clawback on OAS for high net worth individuals vs high income frustrating. TFSAs, while great for many reasons, will only add to the problem. I am of the opinion that individuals with million dollar homes should have to include that when determining OAS eligibility as well as prescription subsidies.

    ReplyDelete
    Replies
    1. @Susan Tom: The optics of forcing elderly Canadians out of their homes makes this difficult politically.

      Something else to consider is that a million dollars isn't what it used to be. If you count homes and future pension payments, it's amazing how many retired Canadians are millionaires.

      Delete
  12. Good article Michael. Thanks.

    In response to people that say you should take CPP early because it is a bird in the hand, I tell them I prefer to ensure that my nest has enough eggs if I am fortunate enough to live a long life. Delaying CPP or OAS does that.

    ReplyDelete