Risks To Starting Your CPP Too Early

Every time I write about the Canada Pension Plan (CPP), I find it to be a controversial topic. Some people need their CPP retirement pension, so they have to apply early. Others apply right away because they feel they are entitled to this money and want it as soon as possible after years of contributing and paying taxes, so how dare anyone suggest they wait? Some are worried they will deplete their assets and either run out of money or leave a smaller inheritance for their heirs if they do not apply as soon as they are eligible.

I think some applicants have a clear advantage in applying early or late. For others, it may be more of a coin toss. It turns out I gave the wrong advice to my own mother, even though it was the best advice at the time.

Life Expectancy

You can start CPP as early as age 60 or as late as age 70. The earlier you start, the lower your monthly payments, but you will receive more months of payments over the rest of your life.

The so-called normal retirement age in Canada is 65. The median life expectancy for 65-year-old men is 89, and for women, it is 91. This is the age to which 50 per cent of 65-year-old Canadian men and women are expected to live.

Many people are shocked by this statistic. They point to the Canadian life expectancy of 83 as being disconnected from this much later age. However, the commonly quoted general life expectancy is the age at which the median (average) Canadian died in the previous year. So, although the average Canadian may die at age 83, this is across the population and is reduced by those who die at a relatively young age. Once you make it to age 65 in the first place, you are in a new cohort: 50 per cent of people are expected to live to age 90 (again, 91 for women and 89 for men).

The average CPP retirement pension at age 65 is currently $811 per month. The maximum is $1,307. But if we stick with the average, what would be the impact of deferring CPP to age 70?

The $811 would grow between the ages of 65 and 70. It would be subject to a guaranteed 8.4 per cent annual increase per year, or 42 per cent in total after five years. It would also be increased based on the cost-of-living increase, which was a whopping 6.3 per cent alone for 2023. If we assume just a two per cent annual increase, in line with the Bank of Canada’s inflation target, that $811 pension at age 65 would instead increase to $1,272 per month by age 70 if it was deferred.

A recipient starting at age 65 would receive $50,659 of total CPP before age 70, but if they waited until 70, they would get a larger monthly pension and begin the process of catching up. They would catch up by age 80 and then come out ahead from that point onwards.

If someone expects to live into their 80s, they will receive more cumulative CPP payments by starting at age 70 than if they started earlier. And since half of today’s 65-year-olds will live to 90, most people would be better off deferring their CPP—at least if we consider the total payments received.

Risk Tolerance

But of course, if you start your CPP earlier, you can invest the money. Or you can avoid drawing down your existing investments. The Toronto Stock Exchange returned 8.68 per cent annualized for the 30 years ending 31 December 2022. The S&P 500 returned 9.88 per cent in Canadian dollars. This assumes all dividends were reinvested.

However much I hope North American stocks return nine per cent annualized for the next 30 years, I would not count on it. My governing body as a financial planner, FP Canada, suggests about 6.45 per cent for a 50/50 portfolio of North American stocks when doing a straight-line calculation to account for the variability of returns or sequence of returns risk. And that is before fees. Since most investors will not be 100 per cent in stocks and they also pay investment fees, I think a more reasonable, albeit conservative, assumption for a balanced portfolio, net of fees, is probably four per cent annually.

A retiree with an income of about $50,000 might pay about 25 per cent tax on their CPP. This is a very rough estimate that depends on their sources of income, province or territory of residence, and tax deductions and credits. So, if we assume a 65-year-old starts their CPP at age 65, pays 25 per cent tax, and invests their money in a Tax-Free Savings Account (TFSA), when would the breakeven point be compared to doing the same at 70?

At age 84, the 70-year-old waiting five years, earning a higher monthly pension, and playing catch-up would have more in their TFSA. And since half of the 65-year-olds contemplating a deferral of their CPP will live to 90, most 65-year-olds should defer their pension using these assumptions.

But what if you could invest at eight per cent per year? If you could, the breakeven would be much later—age 97. However, I question the likelihood of a 65-year-old being able to earn eight per cent net of investment fees for life. Most people have a declining risk tolerance over time or pay fees on their investment products or to their advisors. Or they make other bad decisions like buying high or selling low that prevent them from earning full market returns. Plus, if there is a poor sequence of returns in the early years of retirement, that makes it less likely to achieve such a high long-term return.

Even if we split the difference between my conservative four per cent and a more aggressive eight per cent, the breakeven at a six per cent return is age 88. If we picked a lower or higher tax bracket than 25 per cent, the breakeven calculations are virtually unchanged.

No Pension Income

What if you live to 110? Pension income is a nice-to-have insurance policy that protects you against the risk of living too long. Consider it longevity insurance. A declining number of retirees have defined benefit pensions, and the CPP is a nice, reliable, indexed pension to rely upon.

So, if you have a pension, maybe you hedge your bets by starting CPP early. But if you do not, as is the case for more and more retirees, CPP deferral may be a good risk management strategy.

Registered Retirement Savings Plan (RRSP) Value

If you have a large RRSP, the sooner you can start taking withdrawals, the less of a ticking tax time bomb you have. Unless you are in a high tax bracket, it may make sense to consider RRSP withdrawals before you must convert your RRSP to a Registered Retirement Income Fund (RRIF) at age 72.

If you can take RRSP withdrawals in your 60s, assuming you retire young, you may pay less lifetime tax compared to waiting. Especially because if one spouse in a couple dies young, the survivor has all income after that taxed on one tax return instead of two. And on the second death, a large RRSP/RRIF balance may be taxed at over 50 per cent.

As a result, early RRSP and late CPP may be a strategy for some retirees.

Do-it-Yourself (DIY) Investor

Self-directed investors may feel more confident in their ability to invest their CPP payments and come out ahead. But I would argue that a DIY investor is better at dealing with their investments and withdrawals from those investments in their 60s instead of later.

Then in their 70s and 80s, a deferred CPP will cover more of their retirement income and reduce the reliance on their portfolio when they are likely less able to manage their investments, especially if one spouse in a couple is more in charge of their investments.

Guaranteed Income Supplement (GIS)

If you are a low-income senior, there is a Guaranteed Income Supplement (GIS) that may be payable starting at age 65. The lower your income, the more you get. CPP income can reduce eligibility for this supplement by 50 cents on each additional dollar of income.

Although low-income CPP recipients may need their CPP pension that much earlier for cash flow, others who can rely on savings, TFSAs, or other alternatives may be able to receive more government support while at the same time growing their CPP pension.

Conclusion

There are other considerations impacting the CPP timing decision. You can start CPP before age 65 or as early as age 60. If you do not have enough years of contributions, your pension could be reduced by deferring the start of it and having more years with no contributions. Mind you, the reduction is much less than the increase for a later start date.

If you are still working after 65, you can continue to contribute to CPP, and the benefits depend on whether you are self-employed or not and whether you have already earned the maximum pension.

Your marital status and your spouse’s CPP entitlement and age also could have an impact on your CPP planning.

My advice to my own mother on CPP when she turned 60, was to defer it. She was semi-retired, healthy, vibrant, and checked off all the boxes. She got sick and died when she was 66. You just never know how long you are going to live, and CPP is primarily dependent on longevity.

If you are in good health and have a good family history, deferring CPP as late as 70 is worth considering. Most 65-year-olds will be better off for having done so. Some will make the wrong choice, but all choices, financial or otherwise, need to be based on the pros, cons, and probabilities of success.

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.