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

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

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

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.

How about taking the lower CPP income early as a tax reduction strategy? If someone expects to have a relatively high income in retirement, would the lower cpp income work to reduce one's income tax burden?

ReplyDeleteIn my simulations, a superior strategy for people with large RRSP balances is to start drawing from RRSPs early to live on until CPP starts at 70.

DeleteExcellent analysis as always! Well done. And in addition to the excellent returns, the reduced longevity risk allows those of us who defer to safely spend more from day one in retirement. Can this benefit be quantified as well?

ReplyDeleteYes. I'm able to spend more today before I've even turned 60 because I'm planning to delay CPP and OAS until I'm 70. I've quantified this for myself. My spreadsheet shows how much more I can spend each month (starting today) compared to taking CPP at 60 and OAS at 65. I'll have to give that some thought about how to quantify that in general for others.

DeleteHeads up on this "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."

ReplyDeleteTrue for CPP but not for QPP. 65-70 are included are contributory periods in the QPP payment calculation. If you don't have enough available drop-out months to exclude months after 65, the case for delaying to 70 may be weaker in QC than ROC (rest of Canada).

Also, QPP allows 15% drop-out as compared with 17% for CPP.

I repeated my calculations with the QPP differences described above. The results were that the penalty for not working from 60 to 70 makes a substantial difference. For those planning to age 100, the optimal age to start QPP remains age 70 if you only suffer roughly half the maximum penalty or less, but declines to about age 66 when you suffer the maximum penalty.

DeleteThanks. I did present value calcs using a QC tool, and got approx same, 66-67, as I have do not enough drop out room. (twice returned to full-time uni, 6 years overseas , switch to part-time before 60).

DeleteGreat analysis. The graphs make the difference! Excellent!

Truely impressive analysis and explanation Michael. Much appreciated.

ReplyDeleteWOW! This is by far the best explanation on CPP / OAS and how taking it early impacts your potential return. Thanks so much for posting this!

ReplyDeleteExcellent work as always. I have been trying, unsuccessfully, to replicate your graph of "Real Return of 1-Month Delay Starting CPP (Planning Age 100)". I suspect my error is in the return calculation.

ReplyDeleteFor example the choice to delay from age 65 less one month (CPP=1031.20) to age 65 (CPP=1038.07) provides an extra 6.87 for life (419 months) compared to one extra payment of 1031.20 (420 months) assuming no penalty.

How have you calculated your return of about 7.8%?

Thanks!

Using your rounded figures, we use the RATE() function to get the monthly return of RATE(419, 6.87, -1031.2) = 0.615%. Then annualize this:

Delete(1+monthly rate)^12-1 to get the annual rate of 7.64%.

Michael, I can think of one more complication to your calculations of returns on postponed OAS: GIS, which is only available for those receiving OAS. It is my understanding that If RRSP withdrawals are postponed till 71, then during 65-71 window GIS may constitute a significant contribution to spending budget while RRSP keeps compounding.

ReplyDeleteAm I correct here?

That's true, but it doesn't enter into many cases. None of my calculations make any difference for people who don't have enough savings to postpone CPP and OAS. So, we're talking about people with at least close to $1 million in investable assets. It's not rational tom live on next to nothing from 65 to 70, so there must be some assets to draw on or some income coming in that allows for spending at least, say $50k/year. To get the GIS, income must be very low, so we're talking about people spending assets. But it can't be RRSP assets, because that produces income that messes up GIS. It could be spending down a TFSA or non-registered assets (but those non-registered assets couldn't produce too much income to mess up the GIS).

DeleteIn the scenario we're left with, my simulations say its usually better to draw from RRSP assets starting from 65 to minimize lifetime taxes. So, I don't know of a scenario where the optimal answer for a fairly wealthy person to arrange his or her finances to get the GIS.

There are some advisors who advocate this for their clients, but I suspect their motive is to keep their clients from spending early from their invested assets, even if this isn't good for the clients.

If you can come up with a scenario where it makes sense to claim GIS, I'd like to see it.

To reach a 'no taxable income' situation one does not have to live a poor life. Funds in non-registered accounts should not produce dividends and interest, RRSP should be kept intact. TFSA should be used to bridge the gap between CPP+OAS+GIC and living expenses. Seems like a loophole in tax code.

DeleteDo I miss something?

In the simulations I've done, deferring CPP and RRSP withdrawals to 70 and 71 in order to qualify for GIS (with OAS at 65) is not optimal. It leads to large RRSP withdrawals and high taxes later. I've found that you get higher lifetime after-tax spending for life by deferring CPP and OAS, and starting to draw from RRSPs right away to top up to some tax bracket (that depends on your wealth level). This leads to more spread out use of TFSA assets and non-registered assets which works better tax-wise. Your mileage may vary.

Delete