Wealth Insights - May 2016

Wealth Insights

May 2016

Should You Take CPP Early?

How you answer five key questions can help you decide

It's a good bet the Canada Pension Plan will be a valuable part of your retirement income mix. The mystery is knowing the best time to start collecting those payments.

There's nothing that says you must begin collecting CPP at age 65. Wait until 70 and you'll enjoy a monthly benefit that's more than double what you receive at 60. Then again, taking CPP early, even with the smaller payments, can make sense for any number of reasons.

Here's what to consider before you decide.

How the CPP age adjustments work

The Canada Pension Plan adjusts payments based on what age recipients elect to receive benefits. Responding to growing pressures on our pension system, the government has adopted a carrot-and-stick approach. Take CPP early, receive less. Wait, and receive more.

Age 65 is neutral territory. If you opt to take CPP then, you'll receive your full benefit based on the number of years you've contributed to the plan and your pensionable earnings. That benefit is indexed to inflation to maintain your purchasing power.

Want to take the money as soon as possible? You can as early as age 60. But your payment will be reduced 0.6% for each month you're removed from 65. That means your benefit will be 36% smaller if you start collecting at 60.

On the other hand, if you can hold off receiving CPP until after age 65, you'll boost your payment to the tune of 0.7% for each month you delay. Taking CPP at 70 results in a payout that's 42% larger than at 65. Note that's the maximum enhancement; you won't receive a larger benefit if you start collecting after turning 70.

Assuming you're eligible to receive the maximum standard CPP payment of approximately $1,093 per month, you could collect anywhere from $700 to just over $1,550 monthly, depending on when you start your payments. So large a potential difference to your monthly income warrants some careful consideration on how to proceed.

What to review

After years of seeing CPP deductions fly off your paycheque, it's natural if your first reaction is to want CPP benefits as early as possible. But don't assume that's the wisest choice. Here are five key questions to contemplate.

1. How urgently do you need the money?

If you've turned 60 and stopped working, you may need CPP to help replace your paycheque. Clearly if you don't have sufficient resources to make ends meet, taking CPP early is a practical choice.

If you don't need the money, perhaps because you have a generous company pension or are still working part-time, it can be sensible to hold off collecting to get a more generous amount later on. Those fatter payments can mean having to save less on your own to fund retirement.

2. Will the extra cash cause you to lose benefits or pay more tax?

Canada Pension Plan benefits are considered taxable income. That's important for two reasons.

First is the potential impact on your Old Age Security payments. If CPP pushes your net income above $73,756 (for 2016), you'll have a portion of your OAS benefits clawed back through the OAS pension recovery tax. That's why if you don't need the income right away, consider delaying CPP and preserve more of your OAS for longer.

Secondly, if your income is approaching the next tax bracket, receiving CPP might take you over the edge. So, not only will you be facing lower payments because you started collecting early, you could lose more of that income to tax much sooner.

3. How active do you plan to be?

If climbing Kilimanjaro or exploring Europe's backroads are high on your retirement to-do list, you're more likely to check these off early on, before advancing age slows you down.

An active lifestyle of travel and adventure takes cash. That's when having CPP payments a little sooner might come in handy.

4. If you don't spend it, what else could you do with the money?

Early CPP payments don't have to be spent. They can be invested.

Say you take CPP five years early at age 60. Even assuming the maximum discount factor of 36%, you can have as much as $700 each month or $42,000 extra dollars available to tax-shelter in a TFSA or RRSP by the time you reach 65. Invest that money well, and you might wind up better off than by postponing your benefit in exchange for a higher amount.

Having cash in your hands also gives you flexibility in putting money to work in different ways – reducing high rate debt, for example.

If you're in a 40% tax bracket, paying down 18% interest on a credit card is equivalent to earning a 30% guaranteed return on a fully-taxable investment. That kind of payback will shave years off the break-even age when you're analyzing whether to take CPP early.

5. Could you fall into the drop-out trap?

If you retire early, but had a number of years over your career when you weren't working, the math used to figure out your CPP benefit can go against you.

The Canada Pension Plan allows you to drop up to 8 of your lowest earning years in its calculations, helping boost your payment (there are additional provisions for situations like child-rearing.)

The problem? Say you retire before age 65, but delay taking CPP. If you have already maximized your drop-out count, any additional zero-earning years will be included in your benefit calculation, negating some of the extra income you would normally see by waiting to collect.

Take a moment to review your CPP contribution history and understand the implications, before you apply for benefits.

Working in Retirement

Want to work and collect CPP benefits at the same time? While you're employed, you're required to make CPP contributions up to age 65, with the option of contributing as late as age 70. Those contributions go to creating a post-retirement benefit you'll receive when you stop working, or at age 70, whichever comes first.

Having employment income while collecting CPP is another angle to consider in deciding the optimal time to begin receiving benefits. While it's true the extra time on a payroll will add pension income down the road, it might not be enough to offset the payment reduction from taking CPP early. Plus, layering earnings on top of CPP increases your net income which could affect your tax rate. Your advisor can help you sort through the trade-offs and make the best choices.

Get the right advice

Taking the guesswork out of deciding how best to manage your CPP benefits starts with understanding the facts. Your Westminster Savings financial planner has answers to turn the complicated decisions into a practical plan that can make a difference for your retirement.

Call us at 604-517-0100 or send us your question online and we'll respond to you within one business day.