## Thursday, September 2, 2010

### When to Start Taking CPP

With the change to the CPP penalty for taking your pension early, the calculation of what age is best to start collecting CPP changes as well. Most of these analyses to figure out the best age to start collecting CPP do not take into account possible investment returns.

The old rules used to penalize you 0.5% per month for each month before age 65 you start taking CPP. Now it is 0.6%. In addition, you can grow your CPP payments by 0.7% per month for each month you delay the start of payments past age 65.

So, if we call the CPP payments at age 65 a 100% pension, then if you start at age 60, your pension will be 64%, and if you start at age 70, your pension will be 142%. Note that these percentages stay fixed for the rest of your life. You'll get cost of living increases, but that's it.

For most people, the most logical method of determining when to start taking CPP is by the sophisticated when-you-need-the-money method. If you can't stand the thought of working past age 60 and you think you can get by with a reduced pension, then age 60 it is. Otherwise some other age between 60 and 70 will likely be dictated by when you need the money.

For a lucky few of us who have (or will have) enough money to optimize a little, the choice is more complicated. The usual analysis involves just adding the CPP amounts to figure out what starting age makes you the most money.

With this simple method, if you won't make it to age 74, start taking your pension at age 60. If you will make it to some age between 74 and 82, take your pension at age 65. If you will live longer than age 82, start taking your pension at age 70. You need a crystal ball to follow this advice, but at least it gives some useful idea.

This analysis took into account inflation because CPP payments rise with inflation, but it didn't take into account investment returns. Suppose that a retiree can afford to wait until age 70, but wants to know whether it makes sense to take CPP early and save the money. In this case, investment returns affect the decision.

The following chart shows how the age break points vary with investment returns (after tax and above inflation).

If our retiree expects to make no excess return above inflation, then we get the break points at ages 74 and 82 as in the earlier analysis. However, at 5% real return, the break points jump up to ages 79 and 92.

All this means that positive investment returns make taking CPP early even more attractive than in the simpler analysis.

1. Your math changes for those in the public service, as the CPP is actually factored into the Pension you will be receiving, but still some food for thought.

I plan on living forever, where is infinity on your graph?

2. @Big Cajun Man: I'm no expert on public pensions, but I thought that the pension reduction was a calculation designed to take into account the value of CPP but that it isn't exactly equal to your CPP payments. I don't know if it factors in the actual age you start drawing CPP. If it does not, then my analysis still applies.

Infinity is just above age 95 -- it means that you shouldn't start your CPP until age 70 :-)

3. I'm not sure I understand your calculation. Did you assume the person's investment portfolio started at \$0 at retirement and then all CPP proceeds were invested? That seems a rather artificial situation, but perhaps it is representative after all for those people who don't really need their CPP to pay their expenses.

Many real retirees probably have most of their net worth in their homes (real estate), meaning their real investment returns would be around 0%. However, I suspect 0% would not be the right number to plug into your chart -- would it be better to plug in the expected returns for the actual CPP proceeds being invested?

4. @Patrick: As I said in the post, most people will make their choices based on much different considerations -- mainly when they'll need the money. My calculations are mainly relevant to those who don't need to spend CPP payments. It is based on saving the money and investing it somehow. Generally, any ability to invest part of CPP payments for a positive real return tends to push people toward taking CPP earlier.

5. Hi Michael,

For people who have stopped working before 60 and have worked say 25 years rather than 40, the CPP they will get at age 60 will be MORE than 64% of what they will get at age 65, as the base of CPP calculation base will be 5 years less. Correct?

Thanks.

6. @Al: I can't find anything definitive about your question on the CPP web site. Your question boils down to whether there is any extra penalty for not working for the 5 years from age 60 to age 65 while waiting to collect CPP at age 65. The important question is how the 5 years of not working affect the percentage of a maximum pension amount that you're entitle to. This business would be a lot easier if the government would just publish the exact calculation they perform in computing CPP payments.

7. One thing a person would have to consider if they elect to take CPP early is the income tax consequences. If they are still working at age 65, there is a strong possibility of CPP being tax indirectly due to OAS clawback.

8. The CPP government site does, in fact, state that if you don't work between 60 and 65, your CPP benefit will be reduced, because those years of no income figure into the calculation of your benefit.

9. @Anonymous: That makes sense. Thanks. Do you happen to know where I could find a description of how the government computes the percentage of maximum CPP benefit that you'd get? I've read fuzzy descriptions of what information is taken into account, but I've never seen a precise description of the calculation.