Tuesday, January 12, 2021

Is Delaying CPP “Actuarially Neutral”?

You can start your Canada Pension Plan (CPP) payment any time from age 60 to 70.  The longer you wait, the bigger the monthly payments.  We often hear that CPP is designed to be actuarially neutral, which means that you expect to get the same total amount from the system no matter when you start taking payments.  However, the truth of this statement changes depending on whose point of view we consider.

In his thoughtful book The Sleep-Easy Retirement Guide, David Aston writes that CPP is “designed to be ‘actuarially neutral’” and “you won’t usually go too far wrong if you start [payments] any time after you retire and are eligible.”  This isn’t true for most of us.

If we look at this from the point of view of the CPP system itself, it’s true that they care little whether you start payments early or late.  As long as their guess is right about how long the average person will live, they know how much they’ll pay out.  To be even one year off in their average longevity estimate would be considered a large error.

Next, let’s look at this from the point of view of people who are wealthy enough that they’ll never spend all their money.  Then timing CPP becomes a game of trying to maximize the estate they leave for their heirs.  For a wealthy person of average health, CPP timing doesn’t make much difference averaged across all possible lifespans.

But what about the vast majority of us who do need to be worried about running out of money in retirement?  Suppose Mary is in her 50s, has average health, and her life expectancy is about 82.  For planning purposes, Mary might decide that a reasonable range for how old she’ll get is somewhere between 70 and 95.

What should Mary do with this information?  She could decide she’s worried about dying young and make sure she spends all her savings by the time she’s 70.  This has the obvious disadvantage of leaving her eating cat food in her 70s and beyond.

Mary could go the other way and stretch out her savings until she’s 95.  This has the disadvantage that if she doesn’t make it to 95, she won’t get to spend some of her money.

Which is the more serious problem?  I’m much more worried about running out of money than leaving some money unspent.  While some people might choose to spend a little extra when they’re young enough to enjoy it, I’m guessing that most people would choose to stretch out their savings in case of a long life rather than spend it all quickly so they leave no money behind.

So, how does this thinking carry over to when we should start CPP?  If Mary has to plan for a long life to age 95, she’ll get a lot more out of CPP if she starts her payments when she’s 70 instead of starting them earlier.  The total amount of money Mary will have available to spend between now and when she’s 95 is greater if she delays the start of CPP to age 70.    Even the modest CPP payment penalty that can arise if Mary makes no CPP contributions between age 60 and 65 doesn’t change this conclusion.

Doesn’t this mean Mary will have to suffer between now and when she turns 70?  Not as long as Mary has enough savings to spend in place of the CPP payments she won’t get in her 60s.  Even though Mary is in her 50s today, as long as she has enough savings to bridge the gap through her 60s, the decision to start CPP at 70 allows her to spend more starting today.

From the typical Canadian’s point of view, the rules for increasing CPP payments when you start taking them later don’t look actuarially neutral.  We are forced to plan for the possibility of a long life, and this makes delaying CPP to age 70 look profitable for those who are healthy and have enough savings to get through their 60s.


  1. Excellent arguments and explanations. Well done!

  2. The CPP may be actuarially neutral for the average person with average mortality. Once someone starts gaming the system then it is possible to come up with rationales to justify taking it early or late. These assumptions may be correct... but many will be wrong. Who anticipated covid lockdowns and early mortalities. Isn't this gaming the system akin to people who feel they can time the market and pick specific stocks, vs those who prefer to buy the whole market in an ETF?
    One needs to be aware of the rules and assumptions of systems like CPP in order to make good decisions, and this article contributes to better understanding ... but i get skeptical of the cascade of assumptions that goes into some calculations of when to take CPP as there are so many variables in the "algorithm".

    1. Hi Eric,

      My point is that CPP isn't actuarially neutral for the average person because he or she might live a long life. When it comes to longevity, it's not how long you will live that matters to CPP and OAS, it's how long you might live. Once you decide how far you intend to stretch out your savings in case you live to 95 or 100, that gives you what you need to decide if it makes sense to delay CPP and OAS. Trying to predict the future of COVID and other uncertain things is futile.

  3. Hi Michael, I know we've traded thoughts along these lines before, and I believe we're largely on the same page. But I'm throwing them out again to contribute to the discussion.

    I liken spending my savings to allow me to increase my CPP as "buying" an inflation indexed annuity from the Canadian government. To determine if someone is coming out actuarily ahead, you would compare the opportunity cost of the foregone CPP benefits with the additional CPP benefits as a purchased annuity, then compare that to the cost of a similar annuity on the insurance market.

    I think one of the biggest problems here is the availability of such products is virtually non-existent (inflation indexed annuities in Canada are difficult to find in my experience). For any such products that do exist, I bet it is difficult to get pricing information in order to make comparisons like this simple.

    I did some very rough math a long time ago and don't recall specifics. But I believe that if you compare the cost of the CPP annuity to the cost of a non-indexed annuity that provides the additional benefits, delayed CPP looks expensive (but you get much better benefits long term). If you compare it to an annuity that provides the additional benefits you might expect at age 95 due to inflation increases, the CPP option looks inexpensive. Neither of these comparisons is really helpful anyways. The conclusion that I came to when looking at this is that delaying CPP is a good deal if you have the savings to comfortably get you to age 70.

    1. Hi Returns Reaper,

      You're right that the annuities market is very opaque. You can find fixed annuity quotes online, but I've never been able to get an online quote for an annuity with rising payments (say, 2% per year).

      For those who don't think about the enormous difference between a fixed annuity and CPP (a CPI-indexed annuity), the fixed annuity's cost can appear to be competitive. But once you factor in the indexing, the fixed annuity's price isn't competitive at all, as you say.

  4. To put another spin on the same idea, say it is actuarially neutral. Well, term life insurance is actuarially negative for the buyer (the insurance company makes a profit), that doesn't mean buying it is a bad idea for many, many people.

    1. Good point @Potato. This is why I feel the most useful comparison is to compare the cost to delay CPP (in extra spending from savings) with the cost of an equivalent annuity. If your situation would benefit from an annuity, then you need to consider whether it is more beneficial to purchase one from an insurance company, or from the government. The difficulty here as discussed earlier is that the availability of good comparables in the private sector is lacking. I feel the CPP-based annuity has the right characteristics for longevity insurance; namely, it is inflation indexed. While a 2% increasing payout on an annuity mitigates this somewhat, these products seem rather rare and still don't provide insurance against unexpectedly high inflation.

      The question as to whether it is beneficial to purchase an annuity in retirement is a topic unto its own. But I think is something that should be seriously considered when guaranteed income streams in retirement fall short of income needed to maintain a comfortable lifestyle. An exception here might be if you have excessive wealth and have virtually no chance of running out of money before you die, even if you live to a very old age.

      Personally, I intend aim to have a guaranteed income that meets my basic needs for as long as I live, then use my remaining capital for more discretionary spending to enjoy retirement. Even if others agree with this approach, I expect the definition of "basic needs" is likely vary widely from person to person. I'm not even sure I have a good definition of it yet, but I'm still many years from retirement.

    2. Hi Potato and Returns Reaper,

      Good points. This makes it clearer that it's wrong to say that “you won’t usually go too far wrong if you start [payments] any time after you retire and are eligible.”