Wednesday, May 25, 2022

Why Do So Many Financial Advisors Recommend Taking CPP Early?

No doubt there are many financial advisors out there who do a good job of advising their clients on when to start their CPP benefits.  However, I frequently encounter advisors who declare that they always advise their clients to take CPP at 60.  Given the significant benefits of delaying the start of CPP benefits for those with sufficient assets or income to wait, why are some advisors so adamantly against it?  Here I offer some possible reasons.

According to Owen Winkelmolen, in 2018, 38% of Canadians took CPP at 60, only 7% waited until after they were 65, and only 2% waited until they were 70.  This certainly doesn’t suggest that many financial advisors advise their clients to delay CPP.

So, here are some possible reasons why so many financial advisors recommend taking CPP early.

Higher Assets Under Management (AUM)

When clients take CPP early, they spend less from their savings, and this increases the advisor’s AUM.  This is true, but the effect isn’t big, and it’s hard to imagine that many advisors are scheming to get a small bump in AUM.  For those advisors who are effectively salespeople, it’s possible that this is a motive for the organizations they work within.

Advisors are simply repeating what they were taught

It’s possible that advisors were taught that starting CPP early is best, and they’re simply repeating what they were taught.  This seems plausible for those advisors who work essentially as salespeople and whose training came primarily from their sales organization.  This seems less plausible for advisors who have more substantial training.

Some advisors have the same emotional need to take CPP early as their clients

Canadians have a strong bias toward taking CPP early for a variety of emotional reasons.  Perhaps some advisors have the same emotional reaction.  They intend to take their own CPP early, and they advise their clients to do the same.

Maintaining the illusion that they will bring client big returns

Less scrupulous advisors sell their services to potential customers (clients) by claiming they can generate high investment returns.  Perhaps claiming to be able to outperform the CPP increases that come from delaying the start of benefits is simply a matter of being consistent with the claimed ability to crush the market.

Haven’t kept up with CPP changes

Before 2011, starting CPP benefits before age 65 cost 0.5% per month.  This is now 0.6%.  Before 2011, starting CPP benefits after age 65 increased benefits by 0.5% per month.  This is now 0.7%.  A dozen years ago, the case for delaying CPP was much weaker than it is today.  Perhaps some advisors haven’t kept up with these changes.

Don’t understand how inflation indexing of CPP benefits affects this decision

I’ve seen detailed examples advisors provide where they conclude that you’re better off to take CPP early and invest the money.  However, these analyses ignored inflation.  CPP benefits are indexed to wage inflation before you start CPP, and they’re indexed to the consumer price index after you start CPP.  A flawed analysis might conclude that earning x% on your investments justifies taking CPP at 60.  A proper analysis would say that your portfolio has to beat inflation by x%.  See Taking CPP and OAS Early to Invest for a full explanation.

It’s too hard to bother fighting with clients who wants to take CPP early


Clients have strong emotional reasons why they want to take CPP early.  The amount of money at stake may not seem very much from the advisor’s point of view, and it’s just easier to tell clients what they want to hear rather than fighting them.  Many lists I see with reasons to take CPP at 60 include some version of “you (or the client) want to start CPP early.”  All decisions are ultimately up to the client, and advisors have to be selective about when to push back if they don’t want to lose the client.

After advising early CPP for years, to change now is to admit past mistakes

Nobody likes to admit they’re wrong, to themselves or anyone else.  If you’ve spent a career advising your clients to take CPP early, the only way to protect yourself from finding out you’ve been giving bad advice is to ignore evidence and keep advising clients to take CPP early.


In recent years, several sensible analyses of the benefits of delaying CPP have appeared.  But, many advisors are undeterred.  I’d be interested to hear expert insight into the dominant reasons for this lack of reaction from many advisors.

Monday, May 23, 2022

Taking CPP and OAS Early to Invest

A strategy some retirees use when it comes to the Canada Pension Plan (CPP) is to take it at age 60 and invest the money.  They hope to outperform the CPP increases they would get if they delayed starting their CPP benefits.  Here I take a close look at how well their investments would have to perform for this strategy to win.  I also repeat this analysis for the choice of whether to delay the start of Old Age Security (OAS).

This analysis is only relevant for those who have enough other income or savings to live on if they delay CPP and OAS.  Others with no significant savings and insufficient other income have little choice but to take CPP and OAS as soon as possible after they retire.

How CPP Benefits Change When You Delay Their Start


You can start your CPP benefits anywhere from age 60 to 70, with 65 considered to be the normal starting age.  For each month that you start CPP benefits before you turn 65, your benefits are reduced 0.6%.  So, suppose you’d be entitled to $1000 per month if you were 65 today.  If instead you were 60 today, you’d only get $640 per month starting CPP now.

For each month that you start CPP benefits after you turn 65, your benefits are increased 0.7%.  If you were 70 today, you’d get $1420 per month starting CPP now.

Inflation

The previous examples glossed over the effects of inflation.  In reality, if you were 60 today, you’d have to wait 5 or 10 years if you choose to take CPP at 65 or 70.  During that time, inflation adjustments would affect your CPP benefits.

Continuing the earlier example, if you take CPP now, you’d get $640 per month.  These benefits would rise over time with the Consumer Price Index (CPI) at the rate of price inflation.  However, if you wait until 65 to start CPP, you’d get a lot more than $1000 per month.  This $1000 per month would rise with 5 years of wage inflation.  That’s because CPP benefits increase with price inflation after they begin, but before they begin, they increase with wage inflation.

So, if you started CPP at 65, you’d get $1000 per month plus 5 years of wage inflation.  Wages usually rise faster than prices, so the delayed $1000 per month would rise by more than the non-delayed $640 per month.  In my analyses here, I assume that wages rise 0.75% per year faster than prices.  Assuming price inflation of 3% per year, by the time you reach 65, the CPP benefits you started 5 years earlier would be $742 per month, and your delayed benefits would be $1203 per month.

If you started CPP at 70, your benefits would be $1420 plus ten years of wage inflation.  If we turn you into triplets with identical CPP entitlements who take CPP at different ages (60, 65, and 70), their monthly payments at age 70 would be $860, $1395, and $2056, respectively.

A Dropout Penalty

There are some technicalities that I’ve glossed over so far.  My analyses here don’t take into account cases where people keep working after they start CPP to get additional CPP benefits.  I also don’t take into account CPP disability benefits.  One technicality that I do examine is the effect of not fully contributing to CPP from age 60 to 65.

Your CPP benefits are based on your average contributions paid into CPP.  However, you get to drop out 17% of your contribution months with the lowest contributions.  This increases your average contribution per month and gives you higher CPP benefits.  People who look after children under 7 and those with disabilities get additional dropouts.  If you take CPP at 60, you drop out your lowest contributing months between age 18 and 60.  If you take CPP at 65, you drop out your lowest contributing months from age 18 to 65.

So, if you don’t contribute to CPP after age 60, but you wait until you’re 65 to start CPP, you’ll need to use many of your dropout months for those 5 years.  This means you won’t be able to drop out as many other low contribution months.  The result is that your average CPP contribution amount could be lowered if you delay taking CPP until you’re 65.  This “penalty” ranges from nothing to an upper limit, depending on your work history.  In my analyses here, I do calculations for both a penalty of zero and the maximum penalty.  This allows the reader to see the full range of possibilities.

If you delay CPP until you’re 70, there is an additional dropout provision that lets you not count the months from age 65 to 70.  So, the dropout penalty doesn’t grow any further as you delay CPP past 65.

Constant Dollars

For the remainder of this article, I will be using constant dollars, which means all dollar amounts are adjusted for price inflation.  So, if you’re 60, and start CPP now, you’d get $640 per month in constant dollars for the rest of your life (based on the earlier example).  

Delaying to 65, assuming you have no dropout penalty, would get you $1000 per month plus 5 years of the gap between price inflation and wage inflation, which works out to $1038 in constant dollars.  Delaying to 70, again assuming you have no dropout penalty, would get you $1420 per month plus 10 years of the gap between price inflation and wage inflation, which works out to $1530 in constant dollars.

A side effect of working with constant dollars is that when we calculate the return from delaying CPP, this is a “real return,” which means the return over and above inflation.  An investment that earns a 5% real return when inflation is 3% has a nominal return of (1.05)(1.03)-1=8.15%.

Discrete versus Continuous


There are a number of ways that your CPP benefits change over time in discrete jumps rather than changing smoothly.  CPP benefits are adjusted for price inflation once each January, and the average industrial wage that is used to calculate your starting CPP level changes once per year.  As you delay CPP longer, the number of contribution months you can drop out grows, but it’s always a whole number.  In the case of OAS, payments rise with price inflation each quarter.

I’ve smoothed out all these calculations for the purposes of the analyses here.  These discrete jumps make little difference and serve mainly as a distraction.  So, if you calculate the perfect month to start CPP based on these smoothed calculations, you might be slightly better off a few months earlier or later.

A One-Month Delay Example


Suppose you’re deciding whether to take CPP at age 60 or wait one more month.  You’d be choosing between taking $640 per month now, or waiting a month to get more.  For the one month delay, the CPP rules say you’d get an additional 0.6%.  But this is 0.6% of the amount for CPP at 65, or $1000.  So, you’d get $6 more.

You’d also get more because of the excess wage inflation over price inflation.  Your CPP benefit (in constant dollars) for delaying one month works out to $646.40.

In deciding between $640 per month now or a delayed $646.40, the difference is one payment of $640 now versus an extra $6.40 per month for the rest of your life.  Note that this is a full 1% increase instead of the apparent 0.6% increase laid out in the CPP rules.  This effect makes delaying CPP more valuable in your early 60s than it is later on, even though the percentage increase in the CPP rules goes up to 0.7% per month after age 65.

Planning Age


How valuable this 1% increase in CPP is depends on how long you’ll live.  You might be tempted to guess your likely longevity, but this isn’t the same as choosing a sensible planning age.  According to the 2022 FP Standards Council’s Projection Assumption Guidelines, because I’ve already made it to my current age, there is a 50% chance I’ll make it to 89.  However, I don’t want to use a planning age of only 89 because I might live longer.  I don’t want to spend down all my assets by my 89th birthday because I might find myself still breathing after I blow out the candles.  So, I use 100 as my planning age.

As I get into more detailed analysis, I’ll start with a planning age of 100.  Later on I’ll give data on planning ages of 90 and 80.  For now, with a planning age of 100, delaying CPP by one month from age 60 works out to an annual real return of 12.6%.  This is an impressive return that is even better when we consider that it is a real return in excess of inflation.

All the One-Month Delays


We can think of the decision of when to start CPP as a sequence of up to 120 decisions of whether to delay just one more month.  The following chart shows the real return of each of these choices.  For the years from age 60 to 65, it shows this return for both the cases where you have no dropout penalty and where you have the maximum dropout penalty.  Individual results will be between these two values.


We see that this real return from delaying CPP by one month starts high and declines.  There is a bump up at age 65 when the CPP increase changes from 0.6% to 0.7% per month, but it declines again after that.

An investor hoping to earn 6% real returns and who has the maximum dropout penalty might be tempted to take CPP at 63 and a half.  However, this investor would then lose out on the great years from 65 to 69.  In fact, the average real return from age 62.5 to 67.5 is about 7%.  Unfortunately, we can’t take CPP at age 63.5 and then stop again at age 65.  We only get to pull the trigger once.

So, this chart doesn’t tell a complete story.  It gives the return from each one month delay, but sometimes, committing to a longer delay, such as from 62.5 to 67.5, gives better results.

The Best Delay


Instead of looking only at one-month delays, it’s better to consider all possible lengths of future delays and pick the best one.  So, for each month, I calculated the return for every possible future delay and chose the best one.  This gives the following chart, once again with a planning age of 100.


We see now that even for those with the maximum dropout penalty, there is always a delay with a real return of at least 7% all the way to almost age 68.  Anyone who thinks they can do better on their portfolios than a 7% real return has little reason to worry about amounts as small as CPP benefits.  

The 2022 FP Standards Council’s Projection Assumption Guidelines for a balanced portfolio are for about a 3% real return, and that is before deducting investment fees.  The worst case real return in the chart is 5.5% in the last month before age 70.  It’s clear that it’s not reasonable to count on a higher investment return than you can get by delaying CPP to age 70 if your retirement planning age is 100.

Planning to 90


Those with slightly weaker than normal health or who are wealthy enough that they’ll never spend all their money might choose a retirement planning age of 90.  The next chart is the same as the previous one except for the changed planning age.


We see that the real returns from delaying CPP remain very high in your early 60s.  Those who plan to make a 5% return on their investments might choose to take CPP at 68, but it’s difficult to give up a certain return in the 3% to 5% range in the hope of a better return that might not happen.

Planning to 80

Now we’re getting into the range for people with significantly compromised health.  You may have heard of an average life expectancy of around 80, but that tends to be old information, and it’s life expectancy from birth.  If you’ve already made it to age 60 today, you’re likely to make it to close to 90.

Unfortunately, some people have poor health and they’re so sure they won’t make it to 80 that they’re willing to spend down all their assets before they reach 80.  Here’s a chart for a retirement planning age of 80.


For someone expecting real returns on their investments in the 3% range, it makes sense to take CPP somewhere between age 62.5 and 65.5, depending on how much of a dropout penalty they have.  Delaying past age 67 makes no sense.

For those whose retirement planning age is well below 80 because of very poor health, it makes sense to take CPP at 60.

Delaying OAS


Unlike CPP, the earliest you can start collecting OAS is age 65.  You can delay OAS by up to 5 years for an increase of 0.6% for each month of delay.  So, the maximum increase is 36% if you take OAS at 70.

OAS payments are indexed to price inflation, and the increases before you start collecting are also indexed to price inflation.  So, OAS doesn’t have the wage inflation complications we saw with CPP.

In many ways, the OAS rules are much simpler than they are for CPP, but one thing is more complex: the OAS clawback.  For those retirees fortunate enough to have high incomes, OAS is clawed back at the rate of 15% of income over a certain threshold.  This complicates the decision of when to take OAS, and is outside the scope of my analysis here.

The following chart shows the real return of delaying OAS each month for a range of retirement planning ages, based on the assumption that the OAS clawback doesn’t apply.


We see that the case for delaying OAS isn’t nearly as compelling as it is for delaying CPP.  However, those with a retirement planning age of 100 get real returns above 3.4% for delaying all the way to age 70.  I plan to wait until I’m 70 to take OAS.

For a retirement planning age of 90, delaying OAS to 67 or 68 makes sense.  However, those whose health is poor enough that they plan to age 80 or less should just take OAS at 65.

Conclusion

Those who advocate taking CPP at 60 to invest and beat the returns from delaying CPP are at best misguided.  The returns from the first couple of years of CPP delay are eye-popping.  Depending on your retirement planning age and your expected investment returns, you may not choose to delay CPP all the way to age 70, but there is a strong case for doing so if your health is at least average.  The case for delaying OAS is weaker than it is for CPP, but it’s still strong enough that I’ll delay OAS until I’m 70.

Friday, May 20, 2022

Short Takes: Sustainable Investing, Mental Scripts to Calm Investors, and more

The list of needed repairs around my house that are beyond my skill to do myself keeps getting longer.  However, I’ve been promised that a contractor will be coming to complete one of them next week, and I managed to do a very poor concrete repair myself that might hold for a year.  I’m still riding high on last fall’s pool repair that I waited 3 years for.  So, it’s not all bad.  I’ll be happier when talented tradespeople aren’t all pulled into the vortex of building new houses.

Here are my posts for the past two weeks:


Money Like You Mean It

Trillions

Rich Girl, Broke Girl

Interest on a Car Lease

Here are some short takes and some weekend reading:

Christiaan Hetzner reports that Standard & Poor’s sustainability index now includes Exxonmobil and excludes Tesla.  I know Tesla’s price is sky-high and Elon Musk is a weird guy who sometimes writes dumb stuff on Twitter, but how is this relevant?  This is a huge black eye for sustainable investing.  The criteria they use are clearly nonsensical.  If I ever decide to embrace sustainable investing, I’ll have to build my own index of sustainable companies.

Preet Banerjee offers some mental scripts to help control your emotions when investing.

Justin Bender says the passive versus active investing debate is dead.  When it comes to stocks this debate should be dead.

Thursday, May 19, 2022

Interest on a Car Lease

I’ve written before on how to calculate payments on a car lease.  However, when I began reading Jorge Diaz’s book Car Leasing Done Right, I saw that he believes the interest calculation is different from what I’ve seen everywhere else.

Update 2022-05-19: Jorge Diaz confirmed that his interest calculation was wrong and that he intends to fix it in the next version of his book.

Diaz gives the following example:

MSRP $27,799 + PDI $1825 = Vehicle cost of $29,624
Term: 48 months
Residual Value: $14,561
Interest Rate: 3.99%
HST: 13%

Diaz calculates the total interest paid over the 4-year lease to be $1217.01.  This figure is consistent with taking the difference between vehicle cost and the residual value and calculating interest on this as it declines to zero.  We can estimate this by starting with cost minus residual ($29,624 - $14,561 = $15,603).  The average balance owing will be about half of this.  Then we multiply by 4 years and 3.99% to get $1202.  This is just an estimate, but it comes fairly close to Diaz’s figure.

However, everywhere else I’ve looked says the interest owing on a lease is calculated on the full vehicle cost as it declines down to the residual value.  Estimating once again, the average amount owing would be ($29,624 + $14,561)/2.  After multiplying this by 4 years and 3.99% interest, we get $3526.

Diaz says he got his figure from the “Hyundai Canada Build Tool.”  However, when I looked at this tool, it didn’t give the residual value or the total interest paid, so I couldn’t learn much from it.  But I went to the Canadian Automobile Protection Association (APA) to use their lease calculator.  The result was that the pre-tax interest was $3521.16, which is close to my estimate and way off Diaz’s figure.  Further, the APA lease calculator gave after-tax lease monthly payments of $437.50, but Diaz says it is $377.84.

My conclusion is that lease interest is calculated on the entire vehicle cost as it declines down to the residual value, rather than on just the difference between vehicle cost and residual value as this figure declines to zero.

Monday, May 16, 2022

Rich Girl, Broke Girl

Kelley Keehn’s recent book Rich Girl, Broke Girl uses interesting fictional stories about women to teach personal financial lessons.  Keehn understands the circumstances, pressures, and emotions that drive women to make poor financial choices.  The advice in this book is packaged in a way that makes it an easier read for those who’d rather focus on life than money.

Keehn uses the stories of ten women to illustrate different types of financial mistakes and how to fix them.  Each chapter begins with the history of a woman whose financial life isn’t going well.  It then moves on to what she did wrong, some financial lessons, and how she can fix her troubles.  The chapters end with an update on how the woman is doing now that she has made some positive changes.  The anticipation of getting back to the story made it much easier to read the ‘lesson’ part of each chapter.

The most interesting lesson to me was about the woman who let a casual partner move in and stay longer than she wanted.  Although she never intended for this to be a long-term relationship, they lived together long enough to be considered common-law partners.  She ended up losing half of her assets.  

More interesting advice for those who have trouble controlling their spending is to find some frugal friends.  It’s better to have peer pressure pushing you in the right direction rather than the wrong direction.

In a chapter discussing investing, Keehn offers asset location advice to readers wealthy enough that their RRSPs and TFSAs are full, and the overflow is in non-registered investments.  She says to put stocks in non-registered accounts and bonds in the registered accounts.  However, this is the least tax-efficient approach.  It appears optimal if you trick yourself into taking more risk by setting an asset allocation that ignores taxes.  See Asset Allocation: Should You Account for Taxes? for a full explanation.

Another chapter tells a story about Katie who focused on paying off her mortgage by the time she was 55 but had no investments.  The lesson here was that Katie should have invested for a higher return than she got from her mortgage payments.  If we consider extra mortgage payments to be a form of saving, I think Katie’s mistake was that she saved too little.  If she only directed savings to her mortgage, it should have been paid off sooner, giving her more time to build investments.  I agree that a balanced approach of paying off a mortgage and building investments at the same time is a good idea.  However, focusing on just one or the other can be reasonable, as long as the total amount saved is adequate.

Although the cases where I mildly disagreed with Keehn are over-represented in this review, the book is filled with excellent advice.  I read books like this to better understand why people manage their money poorly and how to help them.  It’s clear that Keehn is an expert in this area.

In conclusion, this book is a strong attempt at a difficult problem: engaging people (women in this case) in personal finance lessons.  Readers may see themselves in some of the stories and follow some of Keehn’s good advice.