Introduction
Understanding how to optimally integrate CPP income into your financial strategy is a less than straightforward concept for Canadians. There are several quantitative and qualitative considerations to reflect on as we look to decide when to begin receiving income from this program. Below is a non-exhaustive list of what Canadians should keep in mind:
The scope of this blog will focus on discussing the mechanics of CPP, considerations around when you may consider collecting, as well as a case study that compares the impacts of collecting CPP sooner than later for a retired family. We will not be discussing the long-term viability of CPP but encourage those interested in this topic to consider listening to the recent Rational Reminder podcast episode, where PWL’s very own Cameron Passmore, Ben Felix & Mark McGrath interviewed Canada’s Chief Actuary, Assia Billig and discussed this topic in depth.
What is CPP and how does it work?
CPP is a contributory pension plan that provides inflation-protected retirement income that is eligible to begin as soon as age 60. This is valuable for a couple of distinct reasons:
This blog is meant to deliver a high-level understanding of the CPP program and will not dive into the new enhancements, post-retirement benefits, drop-out provisions, or any other technical components.
For those interested in understanding what level of income they can expect at ages 60, 65, & 70 from this program, you are able to log into your Service Canada to verify this information based on your CPP participation to date. Canadians can collect their entitlements as early as age 60 with a 36% income reduction, at age 65 with no reduction or as late age 70 with a 42% income bonus. This becomes particularly important when we think about life expectancy, as Canadians with expected longevity can receive more CPP income over their lifetimes by deferring CPP to age 70 and collecting the full bonus. It is common for individuals who opt to work past age 70 to not receive CPP during their employment, although it is important to note that there is no further deferral bonus past age 70.
This CPP retirement income can be ‘shared’ with your spouse/common-law partner on their tax return, which creates an opportunity to leverage their potentially lower tax brackets and reduce your expected taxes as a family. More information on this can be found here.
Lastly, if one were to pass away while either continuing to contribute to CPP or was in receipt of CPP income, some form of benefit is payable to the surviving spouse. This entails a $2,500 lump-sum payout, as well as the continuation of a portion of the deceased’s eligible CPP income. For a Canadian retiree collecting CPP income, this typically represents a 66% continuation of their CPP income to the surviving spouse (up to the maximum CPP income threshold), although there is a unique calculation required to understand this further.
The above-listed elements of this program positions us to review a case study next, to help understand how the timing of when to receive CPP income can notably influence one’s financial strategy.
Case Study: Meet the Smith Family
For our case study, we’ll be reviewing the strategy & circumstances of John & Jane Smith, a recently retired couple in Ontario who have built meaningful retirement assets but are seeking guidance as to whether they should generate their retirement income from their investment portfolio, CPP income, or perhaps a combination of the two. Below are some facts about their situation:
Scenario A: John & Jane collect CPP at age 65
In this scenario, John & Jane have decided to collect CPP at age 65. This results in less retirement income needed to be withdrawn from their investment portfolio since CPP (and OAS) can fund a meaningful portion of their retirement spending needs.
I have evaluated this scenario using a Monte Carlo analysis which simulates five hundred unique sequences of investment returns associated with a 60% equity, 40% fixed income strategy to understand how this impacts John & Jane’s retirement. My finding was that there was an 84.40% chance that John & Jane could spend $8,000 per year, after tax & indexed to inflation until Jane is 97. They are expected to leave a $4.575 million-dollar (future dollars) legacy to their estate at Jane’s age 97.
Scenario B: John & Jane collect CPP at age 70
In this scenario, John & Jane have decided to collect CPP at age 70. This results in more retirement income being generated from their investment portfolio from age 65-70 until CPP income begins. This scenario also has a major enhancement: John and Jane each are expected to receive 42% more CPP income since they deferred to age 70.
After evaluating this retirement scenario using the Monte Carlo analysis, John & Jane had a 95.60% chance of spending $8,000 per month after tax, indexed to inflation until Jane’s age 97. They were expected to leave a $5.185 million-dollar (future dollars) legacy to their estate at Jane’s age 97.
Conclusion & Final Remarks
Deciding when to collect CPP is a major financial decision and can have a meaningful impact on your financial strategy. This program represents retirement income that is not subject to the fluctuations of stock & bond markets which in my professional opinion, can improve spending outcomes in retirement, especially when faced with a market downturn and fixed spending needs. I do believe that this decision requires a bit of speculation/forecasting (the good kind) as it relates to how one long is expected to live based on health and longevity within their family.
As observed in the case study above, John & Jane were able to meaningfully improve their retirement outcomes by deferring CPP (and OAS) to age 70. This decision led to a ~10% higher success rate of funding their desired retirement spending even as market volatility was present and enhanced the legacy that they could leave to their family/charity at Jane’s age 97. While this was a very simple case study that did not simulate how retirement outcomes would be impacted if life expectancy were reduced, I hope that this blog has shed some light as to why it may be valuable to defer receipt of CPP until age 70.
It is not always our default recommendation to defer CPP to age 70 and therefore for families in proximity of making this decision, I would highly support connecting with your Financial Planner to better understand how your unique financial plan is impacted by this decision and hopefully with the aid of this blog, you are better equipped to have a robust discussion about this element of your holistic financial strategy.
