Monday, April 27, 2020

Another Emotional Reason to Take CPP Early

For some reason, people seem wired to want to take their CPP and OAS benefits early, myself included. They grasp for reasons to justify this emotional need even though a rational evaluation of the facts often points to delaying the start of these pensions to get larger payments. I recently read about another emotional reason to justify taking CPP and OAS early.

We can choose to start taking CPP anywhere from age 60 to 70, but the longer we wait, the higher the payments. Less well known is that we can start taking OAS anywhere from age 65 to 70 with higher payments for waiting loger. It’s hard for us to fight the strong desire to take the money as soon as possible, and we tend to latch onto good-sounding reasons to take these pensions early.

But the truth is that most of us have to plan to make our money last in case we live long lives. Taking CPP and OAS early would give us a head start, but the much-higher payments we’d get starting at age 70 allow us to catch up quickly. If we live long lives, taking larger payments starting at age 70 is often the winning strategy.

Here I examine reasons to take these pensions early, ending with a longer discussion of the reason newest to me. Many of these reasons are inspired by other writing, such as a Boomer and Echo article on this subject. However, you’ll find my discussion different from what you’ll see elsewhere.

Let’s start with the best reason.

1. You’re retired and out of savings.

This is a good reason to take pensions early if you’re really running out of savings other than a modest emergency fund. However, just wanting to preserve existing savings isn’t good enough on its own. It makes sense to do a more thorough analysis to see what you’re giving up in exchange for trying to preserve your savings.

2. You have reduced life expectancy.

If you’re sufficiently certain that your health is poor enough that you’d be willing to spend down every penny of your savings before age 80, then this is a good reason to take pensions early. This is very different from “I’m worried I might die young.” If as you approach age 80 you would try to stretch out your savings in case you live longer, this has repercussions all the way back to how much you can safely spend today. Almost all of us have to watch how we spend now in case we live a long life. In this case you need to do a thorough analysis to see what you’re giving up in exchange for taking pensions early.

3. You have long periods before age 60 with no CPP contributions.

If you don’t work after age 60, but delay taking CPP until 65, the 5 years without making CPP contributions can count against you. Everybody gets to drop out the lowest 17% of their contribution months in the CPP calculation. So, if you never missed a year of CPP contributions from age 18 to 60, you can just drop out the years from 60 to 65, and you won’t get penalized. But if you had many months of low contributions over the years, then having additional low months from 60 to 65 will reduce your CPP benefits.

I am in this situation. However, from 60 to 65 you go from receiving 64% to 100% of your CPP plus any real increase in the average industrial wage. Taking into account all factors, I expect my CPP to rise by about 47% by delaying it from 60 to 65. This is less than it could have been without the penalty of not working from 60 to 65, but it is still a significant increase.

Delaying CPP further from 65 to 70 is a simpler case. There is a special drop-out provision that allows you to not count the contribution months between 65 and 70. CPP benefits increase from 100% of your pension at 65 to 142% at 70.

CPP benefits rise significantly when you delay taking them. Even if you can’t use your 17% drop-out for all the contribution months from age 60 to 65, you may still benefit from delaying CPP.

4. You want to take the CPP and OAS and invest.

People don’t generally get this idea on their own. It often comes from a financial advisor. You’re unlikely to invest to make more money than you’d get by delaying CPP and OAS, particularly if you pay fees to a financial advisor.

5. The government might run out of money to pay CPP and OAS.

The government might introduce wealth taxes on RRSPs too. Despite what you might have heard from financial salespeople, CPP is on a strong financial footing. Many things may change in the future. It doesn’t make sense to overweight the possibility of cuts to CPP or OAS.

6. You want the money now to spend while you’re young enough to enjoy it.

My wife and I are retired in our 50s. When I analyze how much we can safely spend each month, the number is higher when we plan to take both CPP and OAS at 70. That’s right; we can spend more now because we plan to delay these pensions. It works out this way because CPP and OAS help protect against the possibility of a long life. Larger CPP and OAS benefits protect us even more, so we can spend more now safely. Your situation will be different, but you need to look at the numbers to see if taking CPP early really allows you to spend more now, or if you’ll just end up reducing your spending to preserve the savings you’ll need as you age.

7. A bird in the hand is worth two in the bush.

This isn’t much of a reason, but it sounds clever. However, by delaying the start of CPP from age 60 to 70, benefits typically rise by a factor of between 2 and 2.7 (above the normal inflation increases). So, if taking CPP early is a bird in the hand, then a delayed CPP is more than two birds in the bush.

Here is an example to illustrate how delaying CPP increases payments. Twin sisters Anna and Belle have identical life histories in all the details that affect CPP. Anna just started her CPP benefits of $850/month at age 60. Belle plans to wait until 70 to take CPP. Now fast-forward 10 years to when the sisters are 70. Inflation will grow Anna’s benefits to about $1000/month (assuming continued modest inflation). Belle’s starting benefits will be between $2000 and $2700/month, depending on the details of the sisters’ life history and how much the average industrial wage rises in real terms over those 10 years. Anna got a head start collecting benefits for 10 years while Belle got nothing. But Belle will catch up fast with her much higher benefits. If they live long lives, Belle will be much further ahead.

8. You’re wealthy and have a complicated tax reason for taking OAS at 65.

OAS claw-back can make tax planning complex. There are situations where people can preserve some of their OAS from claw-back by taking it at 65 instead of 70. As long as the analysis takes into account all material factors, then this can be a good reason to take OAS at 65.

9. You don’t want to leave your spouse destitute if you die young.

This is the new reason I read about in Jonathan Chevreau’s recent MoneySense column, where he focuses on the potential loss if a spouse dies young. I’ll focus the rest of this article on this new reason.

The basic idea of delaying CPP and OAS is to spend some of your savings before age 70 in trade for guaranteed higher CPP and OAS benefits after you’re 70. But what if you’re married, and you die just as you’re getting to age 70? You’ve been spending more of your savings because you haven’t started your CPP and OAS benefits, and suddenly your pensions are gone. Do you really want to leave your spouse destitute?

This is a powerful emotional image. I certainly wouldn’t want to leave my wife broke after I die. For anyone looking for an emotional reason to take their pensions early, this is a good one. However, in my usual style, I prefer to think through the numbers.

If I die at age 70, my family’s after-tax safe spending level would drop for 3 main reasons:
  • Loss of most of my CPP (my wife would get a small CPP survivor’s pension instead)
  • Loss of my OAS
  • Higher income taxes due to my wife having to declare all family income rather than splitting it between the two of us
I routinely analyze my family’s finances based on the plan to delay all pensions to age 70. This time I’m looking at what happens with this plan if I die at age 70. To start, I calculate my wife’s CPP survivor pension using Doug Runchey’s explanation. Then I eliminate my CPP and OAS and calculate how much extra income tax my wife would pay when we would no longer split our income between us.

The result is that if I die at age 70, our family after-tax safe spending level would drop by 23%. This sounds bad, but the family expenses would drop by more than 23%. I wouldn’t be eating at home or in restaurants. She wouldn’t need my car and all its associated expenses. She’d save the cost of my mobile phone, my golf trips, my clothes, and many other things. From a purely financial perspective, if I died my wife’s standard of living would rise. If my wife died, the decrease in family after-tax safe spending level would be less than 23%, so my standard of living (from a purely financial point of view) would rise as well.

So, there is no reason to worry about my wife’s finances if I die (or vice-versa). But suppose I decide I can’t stand the thought of a 23% drop in safe spending level, and I plan to start CPP and OAS pensions as early as possible. Then our family safe spending level starting right now would go down a few percentage points. For the rest of the time we’re both alive, we wouldn’t be able to spend as much. This is the cost of taking pensions early. The gain of taking pensions early is that if I die at 70, my wife’s standard of living would rise by even more than it would rise under our existing plan. This is a bad trade for us.

Of course, our situation isn’t universal. Other couples will get different results. If one spouse would actually see a serious drop in standard of living if the other died young, finding a way to prevent this bad outcome makes sense. However, Chevreau’s article (where he quoted retired advisor Warren Baldwin) takes it as given that one spouse would be in financial trouble if the other died. My main point is that you need to think this through rather than get too hung up on the emotional image of a grieving spouse who is destitute.

I’ve made several references to doing a “thorough analysis” to see if you’d benefit from delaying CPP and OAS. This isn’t easy. The most common mistake I see people or their advisors make begins with “Let’s assume you have an average life expectancy.” This is usually a mistake. If your wealth is vast enough that you’ll never spend it all, and you just want to maximize your expected legacy, then assume whatever you like. But if you’re trying to make your savings last your lifetime, then you have no choice but to plan for a long life because it might happen. I’ve seen enough sad cases of people running out of money late in life.

I expect the most common reaction to this information will be “Yeah, well, I’m taking CPP and OAS as soon as I can, because [reason that ignores the upside of delaying pensions].” I certainly thought this way before a more careful analysis. But the benefits of delaying these pensions are clear for my situation. My guess is that the majority of healthy people with enough savings to live comfortably until they’re 70 would benefit from delaying CPP and OAS.

8 comments:

  1. This is an excellent and helpful analysis - thanks! I find that reason #3 in particular is often ignored in similar articles or blogs. As someone who had a low income as a student for a number of years after age 18 but who hopes to retire before age 60, this can be an important factor to consider.

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    1. Anonymous: Thanks. It's true that having holes in your employment history reduces the gains from delaying CPP, but I found the amount of reduction to be small compared to the gains from delaying CPP. Your mileage may vary.

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    2. Interesting. I'm far enough away from retirement that I haven't actually run the numbers for my personal situation, but will keep that in mind.

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  2. Well done as usual. I really liked your analysis of how spending would go down after the first spouse dies.

    CPP and OAS are both indexed of course. I seem to recall reading somewhere that if CPI goes negative (seems possible) that the benefits would never be adjusted to the downside. Anyone know if this is true? If it is, it would certainly add another reason to defer.

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    1. Hi Garth: Here is a quote from a government website confirming your recollection:

      "If the cost of living decreased over the 12-month period, the calculation of the percentage increase would produce a negative amount. However, as prescribed under the Canada Pension Plan Act benefit amounts do not decrease, they stay at the same level when there is a decrease in the cost of living."

      I didn't investigate any further, but I assume that when CPI rises again, CPP payments would not go up for the part of the CPI increase that made up for the previous CPI decrease.

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  3. Interesting and thought-provoking article as always, MJ. However, are you confident of your calculation that one surviving spouse (in your case) would have expenses well below 77% of the couple? I've thought this through for my parents, and less carefully for myself and my wife, and come to the conclusion the passing of one spouse would have very low impact on total expenses. Yes, food and personal expenses would halve, but seems nearly everything else would stay essentially unchanged, unless a major lifestyle scaleback were consciously adopted. House and yard maintenance, furnishings, appliances/major electronics - unchanged (assuming house fully paid or, but still). Car - unchanged (I guess this depends on the fact that both my family and my parents have one car per family, not per person). Travel - reduced, but by much less than 50% (travelling single is expensive, moving to group tours even more so). Entertainment - possibly increased, since alone one needs to get more out of the house. Depends on the individual, of course, just colour me surprised that your own analysis indicates a significant expense reduction in this unfortunate (but forseeable) eventuality.

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    1. Hi Martin,

      Every so often I actually go through all our spending over a year to see where the money goes. It's amazing how hard it is to come up with accurate figures unless you actually look at the records. Off the top of my head, I know our total spending over a year, but if I just sit down and try to write down how much we spend in different categories (without looking at actual records), it's hard to come up with even two-thirds of the costs. It's easy to come up with big costs, but it's easy to forget every-day little things that add up significantly.

      Looking at our actual spending, I estimate that just over one-third is my personal spending. My wife spends less than I do, but her personal spending is still over one-quarter of total spending.

      I don't claim that we are typical in any way. We travel more than most, sometimes together and sometimes not. We eat out a lot more than most. I have an expensive car.

      As you pointed out, we do have significant costs that are common, but for us they amount to less than 40%.

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