When to take CPP – another spin of the wheel

A favourite topic for the financial media is when to take the Canada Pension Plan (CPP). Some advocate taking it at 65, others advocate delaying until age 70. Different viewpoints arise because of how the problem is framed and the assumptions that follow. A recent report by the Canadian Institute of Actuaries & Society of Actuaries provides a clear framing and a clear conclusion based on the stated assumptions. We doubt it will be the last word on the topic, and we consider some reasons why.

The Canada Pension Plan (CPP) is summarised in the CPP Basics box.

CPP Basics

Retirement Benefits for an Individual:

CPP can be taken as early as age 60 or delayed until age 70
The maximum annual CPP at age 65 is $14,110 (2020). The average payment is $8,359.
Taking CPP early at age 60 decreases the CPP by 36% to a maximum of $9,030.
Delaying CPP has two advantages:
- Payment is increased by 42% at age 70 (0.7% for each month delayed)
- The payout is linked to wage growth which is currently assumed to be 1.1% more than the rate of inflation[1]

The combined impact is a 50% increase in the real (adjusted for inflation) payout at age 70 to a maximum of $21,165.

The CPP payout at age 65 is less than the payout at age 70. Conversely, the total payout period is 5 years less when the payout is delayed to age 70. The total payout (number of retirement years times the annual payout), depends on how long the retiree lives. If the retiree lives long enough the total payout will be greater by delaying CPP. This would be easy to evaluate if the payout period (i.e. mortality) was known in advance. It is clear, for example, that if a retiree was going to die at age 71 the one year of the enhanced CPP would not compensate for missing out on 5 years of the lower payout. This leads naturally to the idea of a break-even age. If a retiree lives beyond the break-even age, then she has gained more CPP income by delaying CPP to age 70.

An estimation of the break-even age is as follows. Assume a retiree lives N years after age 70. If the retiree retires at age 70 his annual payout is CPP*1.5, where CPP is the CPP he would have received at age 65. His total income will be:

CPP* 1.5* N

If he retires at age 65 then his income is:

CPP*(N+5)

The break-even age is the value of N when these two values are equal, which is when N=10, so the break-even age is 75.

But wait, this is clearly not a fair comparison. In both instances the retiree stops working at age 65, but if CPP is delayed to age 70 he must rely entirely on other sources of income. If the retiree started CPP at age 65 then he would have some income before age 70 but less than he would have received if he had deferred to age 70. A fair comparison would be to compare two situations where the income is the same. We consider two options:

Option 1. Delay CPP payments to age 70 using funds from elsewhere to provide for withdrawals from age 65 and 70 that matches the income drawn from CPP at age 70.

and

Option 2. Take CPP at 65 and use funds from elsewhere to provide for additional withdrawals that total the same income as Option 1.

This is a fairer comparison because it compares different methods of achieving the same income, and this is the basis for the Canadian Institute of Actuaries & Society of Actuaries study. This leads to additional potential complications:

Where does the supplemental income come from?
To achieve the same standard of living the focus should be on after-tax income.

The study assumes that the retiree has enough RRIF/RRSP savings to provide the supplemental income in both cases. Once we incorporate RRIF/RRSP savings the outcome will be impacted by how the savings are invested. The study considers two investment options (i) Risk-free and (ii) Risky.

The risk-free option is assumed to be 1% plus the rate of inflation (an allocation to a ladder of GICs over 1-5 years would be a good approximation). The risky option assumes an average nominal rate of return of 4% with a 4% variability as measured by the standard deviation. The study considers this be the characteristics of a 25% equity, 75% bond portfolio.

A significant simplification that arises from this framing is that “Mortality assumptions and financial market returns are the only direct factors affecting the financial trade-offs in terms of cash flow and savings”

In other words, once it is assumed that there are sufficient RRIF/RRSP funds available the choice of the preferred option is not influenced by other sources of income (earnings, pensions or non-registered savings) and taxes.

Our interest is in the conclusions of the study and so we leave the reader to access the detailed analysis in the report.

With the risk-free investment the break-even age is 80. Only those who die before age 80 receive more income from taking CPP payments at age 65. According to actuarial tables on Canadian mortality, only a fifth of females who are alive at age 65, and a quarter of males, die before age 80[1].

Risky investments have the potential for a higher return. Delaying CPP means consuming more of the RRIF earlier potentially missing out on higher returns, making this option less attractive. While everyone who lives beyond 80 would benefit from delaying CPP to age 70 when investing risk free, only 75% benefit when pursuing a risky investment strategy, but this changes rapidly so that by age 85, 97% benefit. The expected longevity of a Canadian male alive at age 65 is 86.4 years and 88.9 years for a female.

The overall conclusion is that for most people deferring CPP to age 70 results in more income during retirement. Despite this, very few (less than 2%) Canadians defer CPP to age 70 for a mix of reasons: a lack of other retirement sources (a key assumption of the study), a lack of understanding of the opportunity ( which the study attempts to correct) and perhaps a preference for a “bird in the hand” or fear of missing out.

As others[2] have pointed out, the latter is a widespread, but misplaced, concern. If you die early then your income, while alive, is the same for either option. If you die late the deferred CPP option is a better choice, so there is no downside to you. The tendency is to reframe the problem if you die early and be concerned that your beneficiaries will suffer because the RRIF/RRSP has been depleted. This is true but was not the original objective. If the goal is to maximise the RRIF/RRSP for beneficiaries, then the best option is to take CPP at age 65 as the RRIF is depleted more slowly.

One factor that can reduce the benefit from delaying CPP is the withdrawal rule. The study assumes a constant withdrawal. Recent research indicates a variable withdrawal, that reflects the performance of the RRIF/RRSP and the future pension liability, leads to higher total income than a constant withdrawal. Delaying the withdrawal of RRIF/RRSP funds as long as possible augments this benefit.

The authors of the study contend that the conclusions hold true whether for an individual or a married couple, noting that the survival benefit is calculated from the CPP at age 65, whether it is delayed or not.

One advantage of deferring CPP is that a great proportion of the retiree’s income stream in later life is from a government benefit and protected from family pressures, elder abuse or simply impaired judgement by the retiree. These considerations are poorly researched but worthy of consideration.

In most cases deferring CPP is a sound investment decision for those able to maintain retirement income with other savings and who want to maximize their retirement income. The question is not why delay, but why not?

[1] https://www.osfi-bsif.gc.ca/Eng/oca-bac/ar-ra/cpp-rpc/Pages/cpp30.aspx

[2] Retirement Income for Life, Frederick Vettese (2018)