It was another unsettling week in the markets with the S&P 500 falling into bear market territory after the highest inflation rate since 1981 was recorded south of the border.
With stock prices sinking and prices at the grocery store, gas pump and elsewhere rising, this is a good time to recall just how important the inflation protection built into the Canada Pension Plan and Quebec Pension Plan is for your security in retirement.
And, as you likely already know, you can increase your pension by delaying taking it between age 65 and 70. Each year you delay your CPP or QPP past age 65 boosts your payments by 8.4%. If you wait until 70, it adds up to 42% more pension income.
That income is fully indexed to inflation and guaranteed by the government, providing an excellent base on which to layer other sources of retirement income. Its value for both your financial security and your peace of mind in retirement is substantial for most people.
Similarly, the Old Age Security pension, which is also indexed, increases every year you delay taking it past 65. But it’s not as clear-cut a decision as with CPP/QPP because the government claws back OAS from retirees earning over a certain net income ($81,761 in 2022). You should speak to your financial advisor to find out whether delaying your OAS will be advantageous for you.
Fred Vettese, the former chief actuary at Morneau Shepell, is a leading advocate for people postponing taking their government pensions until age 70, providing they have a normal life expectancy and have enough savings to bridge the gap to age 70.
In this article, Vettese demonstrates that delaying CPP/QPP payments until 70 is still advantageous in a high inflation environment, although less so than when inflation was lower. Vettese also makes the point that the strategy is a huge help in reducing the stress of most retirees because more of their total income is fully indexed to inflation.
One group who should keep the value of CPP/QPP in mind is self-employed professionals who are incorporated. Instead of taking all their compensation in dividends, they should pay themselves a salary equivalent to at least the Yearly Maximum Pensionable Earnings. That’s the amount that allows them to make a maximum contribution to the CPP/QPP. In 2022, the YPME is $64,900, allowing for a maximum contribution for a self-employed person of $7,000.
While highly helpful in combatting the effects of inflation, your indexed government pension likely won’t be your only protection against higher prices in retirement.
In his excellent book Retirement Income for Life, Vettese also makes the observation that retirees tend to spend less as they grow older and this naturally compensates for at least some of the increase in prices, assuming that inflation is reasonably under control.
He cites several studies from developed countries that indicate spending falls by 1% to 2% per year for retirees, starting in their late 60s. This corresponds to the experience of many of my older clients.
As well, if you’re a prudent investor, you’ve already taken a big step towards outpacing inflation, a study by Dimensional Fund Advisors suggests. The study looked at the average real returns (net of inflation) for different U.S. asset classes from 1927 to 2020.
“While average real returns were mostly lower in years with high inflation compared to years with low inflation…all assets except one-month T-bills had positive average real returns in high-inflation years,” says Dimensional in a summary of the study. “Overall, outpacing inflation over the long-term has been the rule rather than the exception among the assets we study.”
While past performance is no guarantee of future results, the study gives another reason to stick with your investment plan in these volatile times.
It’s not easy to keep a clear head when markets are falling and the cost of living is rising. But recalling the protection you already have against higher inflation and trying to maintain an objective view of events are the best ways to reduce stress and avoid wealth-destroying decisions at times like these.