Before deciding when to take your Canada Pension Plan retirement pension you need to consider the impact of a number of factors that affect how much you will receive. These include the age-dependent increase in yearly payment provided, drop-outs, inflation, marginal taxes, the break-even age and survival probability.
This post is one in a series to help you decide when to take the CPP pension. Click on Download Zipped Excel Spreadsheets which all of these posts refer to and that you can customize for your situation. Because each person’s circumstances are different it is hoped that these posts and the spreadsheets help you make a decision. (The posts below will be adjusted later or replaced when the enhanced CPP, due to be implemented starting in 2019, has been fully documented by the government.)
|1. What is Involved||2. The Rules||3. Factors Involved|
|4. Analysis||5. Spreadsheets|
The factors discussed below have an effect on the age you work until and when you start taking the CPP pension. Each is considered independently so you can see the impact and then combined at the end of the post.
The CPP pension that you receive depends on the age that it starts as shown in the above chart. This chart (generated by the spreadsheet), assumes that you made enough lifetime income to exceed the Yearly Maximum Pensionable Earnings (YMPE) for all eligible years (i.e. 100% of Max), will be 60 in 2018 and retire at 60.
- • If you take the pension at 60 you would receive $8,710.43 ( = $13,610.04 per year x 64% change from age 65). This is the black line at the bottom.
- • If you delay taking the pension until you are 65, you would receive $13,610.04 as shown with the green line.
- • Finally, if you delay until you are 70 you would receive $19,326.26 ( = $13,610.04 x 142%) as shown with the orange line.
The difference between taking the pension at 60 and at 70 is $10,615 per year! However, for age 70, there is a difference of 10 years during which you receive the lesser amount. Is it worthwhile delaying the pension?
Cumulative CPP Payments
An important criteria for helping decide when to take the CPP pension is how the cumulative payments for each age compare.Chart 2 (from the spreadsheet) above shows the cumulative CPP payments for the person mentioned above. For example, at age 85
- • the person will have accumulated $226,471 at age 85 If Taken At 60 as shown by the solid black line.
- • However, if delayed to age 65 it will be $285,811 at age 85 as shown by the solid green line labelled Delay to 65.
- • Delaying to 70 it is $309,220 at age 85 as shown by the orange line labelled Delay to 70.
The Break-even Age
In Chart 2 above, notice that the delay lines are below the “If Taken At 60” line up to a certain age. This age is the break-even age. Because the cross-over is hard to see on the chart, the spreadsheet provides an Expand Chart button as well as the exact age in a table. The chart below is a part of Chart 2 shown in the previous section with the area around the break-even ages expanded.
The break-even ages for the example above are as follows:
- • Waiting until 65 to take the pension (the green line) will cross the If Taken At 60 black line at the actual break-even age of a little below 73 (on the spreadsheet it is 72.9).
- • Waiting until 70 (the orange line), the actual break-even age is a little over 77 (on the spreadsheet it is 77.2).
These break-even ages are well-known and used in a lot of articles written on this subject. This is one useful article: Some math on taking CPP early or late by A. Mayers from 2014.
These break-even ages are not the same for all people as they will change depending on the factors discussed below.
If you live to the break-even age, each year after that you will have accumulated more than if you took it at age 60.
Impact of Inflation
The CPP retirement pension increases each year by the increase in inflation for the previous year as explained on this Government of Canada page. Also, the maximum amount available will increase each year but not by the inflation rate. Instead it uses the average industrial wage, which is close to, but not the same as inflation as shown in Chart 12 below (from the spreadsheet). This is used to set the YMPE, which is then multiplied by 25% to get the maximum CPP benefit at age 65 (less a small percent because it uses a 5-year average).
Because there is no way to estimate the change in the YMPE, the inflation rate is used instead on the spreadsheet.
The impact of inflation is significant on the payments per year, the break-even age and the accumulated amounts. Including inflation usually reduces the break-even age because the increase in payments each year for these ages is larger than for age 60 (because the starting pension payment is larger). Inflation also increases the cumulative return at any age after the break-even age.
The new break-even ages and cumulative amounts for the example above are as follows with an inflation rate of 1.4% (the rate for 2017):
- • Delaying to 65 the actual break-even age is reduced by .8 to 72.1 while the actual cumulative amount at age 85 is $353K (vs $285K with no inflation).
- • Delaying to 70 the break-even age is reduced by .9 to 76.3 while the actual cumulative amount at age 85 is $395K (vs $309K with no inflation).
Impact of Marginal Taxes
You must pay taxes on the CPP pension. The effect of the taxes can be estimated by applying the marginal tax rate on the payments, but this does not help in deciding if the pension should be delayed or not.
It is more useful to apply the marginal rate to only the difference between the delayed payment and the payment if taken at age 60. This will reduce only a portion of the delayed payment, leaving a smaller available amount that can then be used to determine a new break-even age. While you will continue to receive the actual yearly payment, the portion above the if taken at 60 will have to go to paying the taxes that are due with the marginal tax rate. This leaves you with less money to spend than the actual amount received. Including the effect of marginal taxes will always increase the break-even age and decrease the cumulative return.
For the minimum marginal rate for all provinces including the federal portion, as given in Canadian Marginal Tax Rates – 2017, which ranges from 20.1% in British Columbia to 31% in Quebec, the effect on the break-even age is very significant. Use the charts and accompanying spreadsheet to decide on the marginal tax rate that applies to you when you have retired. Enter it into the spreadsheet.
The new break-even ages and cumulative amounts for the example above are as follows with a representative marginal tax rate of 25%:
- • Delaying to 65 the adjusted break-even age is increased by 2.7 years to 75.6 while the adjusted cumulative amount at age 85 is reduced to $260K (vs $285K with no inflation).
- • Delaying to 70 the adjusted break-even age is increased by 2.5 years to 79.7 while the adjusted cumulative amount at age 85 is reduced to $266K (vs $309K with no inflation).
Life Expectancy and Survival Probability
Life expectancy is a key factor in determining if you should delay taking the pension. Use the spreadsheet provided with the Life Expectancy and Survival Probability post to see how long the average person will live at various ages.
Life expectancy is the average age to which one might be expected to live. Keep in mind that when you see a life expectancy it is a 50% probability of survival. For example, for a male that is 60 years old this year, the life expectancy is age 83. For a female it is 86.2. However, at age 75 the survival probability is 76% for a male and 84% for a female.
The Options page on the spreadsheet for these posts include the survival probability for all years used.
Based on your family history, your present heath and other factors, you can assess whether these generalized life expectancies apply to you. Also keep in mind that these are the average for a large population so you may decide that another age applies to you.
Impact of Low-Earning Years and Drop-outs
The initial CPP pension payment at any age is calculated using a maximum of 39 years from age 18 to the age being considered. Because there are 47 years between 18 and the “base-line” age of 65, the government requires that 8 years (or 17%) be dropped from the calculation. They apply these drop-outs to the low-earning years as it always results in a greater initial payment.
Before age 65, the government says that the 17% can also be used for dropping out low-earning years. For example, for age 60 there are 42 years from age 18, which means that up to 7 years can be dropped.
The situation changes above 65 as the years up to 70 can be used to replace lower-earning years or they can be ignored without counting as a drop-out.
Even if there is no income in the years from 60 to 70, they must be included in the calculation as indicated above. This can have a significant impact if there are already some low-earning years.
To show how this can affect delaying the pension, consider that the person described above (always exceeded the YMPE for all years) instead had a few years of income below the YMPE. This could be in the early years when the person went on to post-secondary education from 18 to 22 for a total of 5 years. These years would still be dropped at age 60 and still result in a 100% of the YMPE.
However, if the pension is delayed to age 65, the 5 years of no income from 60 to 65 would now be included in the calculations. Because there are a total of 8 drop-outs permitted, this means that 2 of the 10 years with no income are left exposed and are included in the calculation. This results in a new percentage which is 37/39 = 94.9% of the YMPE at age 65. Because the ages from 65 to 69 can be ignored, the same 94.9% applies. This results in the following changes (no inflation, no marginal taxes):
- • Delaying to 65 the actual break-even age is increased by 1.5 years from 72.9 to 74.4 while the actual cumulative amount at age 85 is reduced to $271K (vs $285K).
- • Delaying to 70 the actual break-even age is increased by 2.8 years from 77.2 to 78.0 while the actual cumulative amount at age 85 is reduced to $293K (vs $309K).
Including inflation of 1.4% and marginal taxes of 25% to the above, the numbers change as follows from the case of 100% of the maximum with no inflation or marginal taxes:
- • Delaying to 65 the adjusted break-even age is increased by 3.3 years from 72.9 to 76.2 while the adjusted cumulative amount at age 85 is increased to $308K (vs $285K).
- • Delaying to 70 the adjusted break-even age is increased by 2.2 years from 77.2 to 79.3 while the adjusted cumulative amount at age 85 is increased to $325K (vs $309K).
As warned earlier, the widely used break-even ages of 73 and 77 for delaying to ages 65 and 70, are not valid in real-world situations when inflation, taxes and low-earning drop-outs can increase them to 76.2 and 79.3, respectively. And this is for an exceptional case of earnings that exceed 100% of the YMPE for all but a few years.
The child-rearing drop-out provision permits low-earning years when the child is less than 7 years old to be dropped from the calculation. Specifically, if the years have zero income or are below the year’s basic exemption, they can be dropped. These years are indicated on the Statement of Contributions with a B in the Notes column. In addition, other years can be dropped if they are below the average pensionable earnings. The government will select the months to drop-out that increase the pension payment. The spreadsheet works in years, instead, and drops-out those years that are less than the average % of the maximum earnings for the year selected as the “Work To/Take At” as explained in the Spreadsheet post. Usually, all of the child-rearing years are dropped, unless they are high-earning years.
A more realistic example (see the Analysis post for details) is that of a person that uses the child-rearing drop-outs and 1.4% inflation and 25% marginal taxes. This results in about 80.3% of the YMPE for age 60, 72.0% when delayed to age 65 and 73.7% when delayed to age 70. The following (as calculated using the spreadsheet) shows that the break-even ages are even higher and the cumulative amounts are even lower:
- • Delaying to 65 the adjusted break-even age is 78.4 while the adjusted cumulative amount at age 85 is $236K.
- • Delaying to 70 the break-even age is 80.1 while the adjusted cumulative amount at age 85 is $254K.
Impact of Working to 65
Many articles indicate that 62 is the average retirement age in Canada. Also, there is a trend for more people to work much later than age 60. So, what happens regarding your CPP pension if you decide to continue working until age 65 instead of stopping at 60?
- • You must continue to pay into CPP. This will cost you 4.95% of your pensionable earnings or 9.9% if you are self employed.
- • Your contribution years will increase. For 65 it is 47 years.
- • Your drop-outs will increase by 1 to 8 years.
- • Your Average % of Maximum Earnings may increase and if they do, your pensionable earnings will increase.
Up to age 60, you must drop-out at least 3 years to get down from the 42 contribution years to the 39 included years. You can drop-out another 4 years (for a total of 7 years) to get rid of more of the low-earning years to get the highest % of Maximum Earnings possible.
Once you work to 65, you now have 8 years that must be used for drop-outs and they will be allocated to whichever years are the lowest-earning, no matter where they occur in the 47 years. As a consequence, it is difficult to determine if your Average % of Maximum Earnings will increase or decrease.
However, your Average % of Maximum Earnings will increase if during the 5 years between 60 and 64 you earn more than 5 years below 60 so that the below 60 years can be dropped-out (if not already dropped).
Example 1: To illustrate, consider the example above of a person with income that is 100% of the YMPE from age 18 to age 64, and the person works to the end of age 64 (also at 100% of YMPE). Using the spreadsheet (see the Analysis post for details), there is no change in the yearly payments, break-even ages and the cumulative totals at age 85. That is, there is no advantage to what you receive as a CPP pension at age 65 to continue working to 65. Keep in mind that while there is employment income, there is also up to $2,737 in yearly CPP payments that must be paid. There will be a loss of up to $13,685 over 5 years. This represents about 1 year of the CPP pension payment at age 65.
Example 1a: However, for the person of Example 1, if there are 5 years that do not exceed the YMPE, then the comments made in the previous section apply (only working to 60 and delaying to 65 results in an increase in break-even age but a reduction in yearly and accumulated payments). Working the extra 5 years will restore the 100% of the YMPE and increase the payments to what they were for delaying the pension. Is this worth the extra CCP payments? The increase at age 65 in payments is 14,589 – 13,845 = 744. It will take 18 years to make up for the $13,685 paid in CPP payments.
If you have income over the Yearly Maximum Pension Earnings for most of your working years, working past 60 will not result in any gain in your CPP pension. You should really consider the Post Retirement Benefit discussed below.
If you are earning less than the YMPE, you need to use the spreadsheet to get an answer.
Take the CPP at 60 and Continue Working
If you are going to work after age 60, you have the option of taking the CPP pension at age 60 (or any age prior to when you stop working). This causes the post-retirement benefit (PRB) to be automatically activated. At the end of each year, you will receive the PRB which is calculated as follows (for details, see Runchey, How to calculate your CPP Post-Retirement Benefit):
- the percent your contributions are to the maximum (YMPE) for the year of the earnings
- times 1/40th or 2.5% of the maximum retirement amount for the coming year
- times the age adjustment for the coming year.
Note that you must still contribute to the CPP and the number of years worked does not change from what it is at age 60.
For 2018, this benefit is a maximum of $28.35 per month or $340.20 per year at age 65. If you started the pension at age 60, at age 61 you would receive a PRB of (your income / YMPE) x 340.20 x 71.2% . Each year the same formula applies but the age adjustment percent increases as does the YMPE. Each year’s amount is added to the previous years.
The Statement of Contributions only go up to the current year. Consequently, you must fill in the table on the spreadsheet with values that you expect up to age 70. As a result, there may be additional drop-outs up to age 65. Starting at age 65 to 70, some of the income may be larger than those of previous years and they can be used instead. If they are less, they can be ignored.
Is this a good alternative to working and not receiving the pension? The best way to get an answer to this question is to compare how long it takes for the cumulative amounts with the PRB to equal that of the pension if it is started at the age work has stopped.
For the person used above that exceeds 100% of the YMPE for all working years, including those from 60 to 64, the results for no inflation or taxes is as follows:
- • Working to 65 the actual break-even age when compared to the PRB payments is 77.4 while the actual cumulative amount at age 85 is $286K. However, the PRB cumulative at age 85 is $260K.
- • Delaying to 70 the actual break-even age using the PRB is 79.6 while the actual cumulative amount at age 85 is $310K.
Using inflation and marginal taxes of just increases the break-even age and decreases the difference in the cumulative amount. For 1.4% Inflation and 25% marginal taxes:
- • Working to 65 the adjusted break-even age when compared to the PRB payments increases to 81.5 while the adjusted cumulative amount at age 85 decreases to $321K which makes it only 10K larger than the PRB cumulative amount of $311K.
- • Delaying to 70 the adjusted break-even age is 81.5 while the adjusted cumulative amount is $340K.
Taking the PRB should always be considered when you work past 60, especially when you have exceeded the Yearly Maximum Pensionable Earnings for most of your working life and expect to do the same after 60. Some of the break-even ages are very close to the life expectancy, and there is not much of a loss in the cumulative benefit at later ages.
Impact on Income Taxes
As indicated earlier, the CPP payments for delaying to age 65 and 70, or working to age 65 are significantly greater than when taking the pension at 60. As a result, you need to consider if this additional income will affect you receiving the Guaranteed Income Supplement (for low income) or puts you into the range where the Old Age Security clawback (for high Income) comes into effect. It may be beneficial to take the pension early if either of these come into play.
Conversely, if you take the PRB and continue to work past 60, the extra CPP pension payments may put your income into a higher marginal tax bracket and negate some of the advantage to taking the PRB.
For the example of the person used above that exceeds 100% of the YMPE, chart 4 below (for working to age 65 and then taking it at 65 or delaying to age 70) shows just how much the income is greater than the PRB income. For taking it a 65, the extra is more than $5K while for delaying to 70 it is between $10K and $15K more than is the PRB was used. The break-even ages are shown as circles and diamonds. This extra income compared to the PRB shown by the dashed line (which goes from $10K to more than $15K) will surely put the income into a higher marginal tax bracket. This chart is explained in the Spreadsheets post.
By now it should be clear that the initial values used for the break-even ages are significantly impacted by inflation and marginal taxes and if you make use of the Post-Retirement Benefit.
Also evident is that if you know you are going to live past 80, the best option is to work as long as possible and/or to delay taking the CPP pension for as long as possible to gain the most accumulated funds.
However, this cannot be guaranteed, so another approach is to determine the latest break-even age that is possible for your circumstances that you are comfortable you will live to receive the pension.
Many different scenarios can be tried on the spreadsheet. The ones selected above are only representative of the impact of each of the factors involved.
Putting the CPP Pension into Context
There is more to do that just deciding when to take the CPP retirement pension. As mentioned previously, the CPP is only one of the many incomes you will need to ensure that you have enough to meet expenses and the pay taxes. There are three free spreadsheets that you can examine in the following posts: Estimating How Much You Need in Retirement, Understanding Your Canadian Sources of Retirement Income and Estimating Capital Totals at Retirement are the best that I can do with Excel. They do not include taxes, such investments as shares and dividends, spouses, expense details such as a mortgage, payroll deductions or an automatic movement of assets to match expenses.
Consequently, a few years ago I developed a comprehensive application called Lifetime Finances. It uses your assets, income (including the CPP pension and OAS) & expenses during your lifetime to project whether you will outlive your money. It can be used at any age and provides a yearly cash flow (income less expenses, including taxes) from today to 45 years after retirement. If desired, changes can be made in any year to such items as interest and additions to and selling of assets. You can see what it provides by clicking on this link to FinanceBase-Lifetime Finances. It can be downloaded free in a demo mode for 31 days. After that a license is required.
Please try it as it has a lot of features, takes less than half an hour to enter all of your data and can be updated each year or when your circumstances change.