For many retirees, CPP and OAS make up a significant portion of their retirement income. A disruption to either of these income sources can be very stressful. Even more so because this disruption follows the unexpected death of a partner or spouse.
Many retirees may not realize, but OAS and CPP survivor benefits are significantly reduced, anywhere from a 40% reduction to a full 100% reduction!
For lower income households, pension benefits like CPP and OAS can provide 50%-75% of their retirement income. For very low income households, CPP and OAS, when combined with other low-income benefits like GIS, can easily make up 100% of retirement income for some couples. Losing these benefits can be a big change to their retirement plan.
Even for higher income households, who may have significant assets in either RRSPs or TFSAs, it’s not uncommon for CPP and OAS to make up 25%-30% of their retirement income.
A disruption to this income can be devastating for some retirement plans, and what many people may not realize is the extent to which some of these benefits can be reduced when a partner passes away.
Although difficult and unpleasant to even think about, the impact of a partner passing is an important consideration for many retirement plans. It’s important to understand what changes there might be to both retirement income and retirement spending if the unfortunate were to happen.
For some plans, those which have a large amount of investment assets, the risk is smaller. Investment assets inside RRSPs and TFSAs can be transferred through spousal rollovers with no tax consequences. So, the disruption to these plans may be smaller.
But for most plans, the risk and disruption of an unexpected death can be quite large, especially in certain circumstances. In the worst-case scenario, the loss of CPP and OAS combined can represent more than $20,000 per year in lost retirement income!
In the last blog post we looked at the financial considerations when deciding to take CPP early or late. But personal finance is never just about the money. Half of personal finance is personal. The “best” path varies from person to person even when the numbers are exactly the same. When it comes to taking CPP early or late these personal considerations can make a big difference.
There are many “soft benefits” to taking CPP early or late. These benefits can make taking CPP early look more favorable… or it can make taking CPP later look more favorable… it just depends on how much YOU value each benefit.
Before deciding to take CPP early or late it’s important to understand what your goals are for retirement. Not just financial goals but personal goals. What do you want to do in retirement? What does your retirement look like? This may inform some of your decisions around these “soft benefits”
It can also help to have a financial plan and see how taking CPP early or late helps you achieve your financial goals. Everyone is different, and the decision to take CPP wont be the same for everyone.
Should you take CPP early or late? Are you considering taking CPP early? Are you wondering if you should delay? Should you take it early at age 60? Should you wait until regular retirement age at 65? Should you delay until age 70, the last date possible?
When to start taking CPP is just one of the many difficult decisions soon-to-be retirees face as they approach their retirement date.
It’s a big decision, and like many financial decisions there are many aspects to consider when deciding when to take CPP.
When a soon-to-be retiree is deciding to take CPP early or late there are both financial considerations as well as non-financial considerations to weigh.
Taking CPP late can provide a financial benefit if you plan to live past a certain age. This is a number and it’s easier to evaluate but it’s based on longevity, which is a big unknown.
Taking CPP late also has non-financial considerations. There are “soft benefits” to delaying CPP. Depending on how much you value these soft benefits they can be worth quite a bit as well.
Even when two people have the exact same financial situation, they may choose different times to start CPP simply due to these longevity questions and soft benefits.
When deciding to take CPP or delay its first important to get basic understanding of how CPP works and how CPP payments change each year as you delay.
The Canada Pension Plan is expanding this year and that’s going to make retirement easier in the future. This expansion is part of a multi year effort to increase the size of CPP payouts in the future. The increased CPP benefits will make retirement easier for many people. It will mean less personal savings are needed for retirement and if you continue to save at the same rate as today you might actually be saving too much!
CPP is one of the best pension funds in the world. Actuaries have stated that CPP is solvent for 75+ years. That means anyone contributing to CPP now has very little to worry about when it comes to future CPP payments.
Despite Canada Pension Plan being one of the best pension in the world I still come across comments from people who are negative about CPP and OAS. They prefer not to count these retirement pensions in their financial plans. Instead they prefer to save more for retirement.
While I understand the desire to be prudent, this line of thinking makes things more difficult than they need to be. Retirement pensions like CPP and OAS provide an enormous amount of retirement income and ignoring them just means you have to save more.
Ignoring CPP and OAS is like running in a windstorm with a parachute tied to your back!
Why add that extra resistance when it’s already hard enough to save for retirement?!?
The good news for many people is that CPP enhancement will now fund even more of their retirement. Future CPP payments will make up an even higher % of retirement income. Before CPP reform the original goal for CPP was to cover 25% of earnings (up to the max) but with CPP enhancement the goal is to increase this to cover 33% of earnings (with a higher max too!). The result is that CPP payments will be up to 50% higher in the future!
This expansion will happen in two phases and the impact on your financial future will depend on how much you’re earning today and how long you’ll contribute under the new rules.
Unfortunately, if you’re retiring this year you won’t see much of an increase. But if you’re retiring in the next 5, 10, 20+ years you’ll likely see your CPP payments increase anywhere from $1.44/month up to $500+/month depending on timing and contributions! That’s an extra $6,000+ per year at age 65 or $8,500+ per year if delayed to age 70! And double that for couples!
The new Canada Pension Plan expansion won’t impact everyone equally, some people will gain more than others. Let’s look at the two phases of the expansion and how it will impact us.
The “4% Rule” is a common rule in personal finance. It’s a basic rule of thumb that suggests you can withdraw 4% from a well diversified portfolio and have a reasonably high chance of having money left over in 30-years.
Like any personal finance rule, it’s a bit of an oversimplification of a rule that contains many nuances. This rule is based on a famous study called “The Trinity Study”. That study was built on top of the work of Bill Bengen who used historical stock/bond/inflation rates to determine that a retiree can withdraw 4% of their initial portfolio value, adjusted for inflation each year, and have a reasonably high chance of success.
This is an amazing piece of work and has enabled many individuals to formulate their own retirement plans. But for Canadians it might be too low & too pessimistic.
When using the 4% rule it’s important to remember that “success” in the Trinity Study and in Bengen’s analysis means that there is at least $1 left after 30-years. It does not mean that investment principal will be left untouched. It’s very possible that a retiree could end up with just $1 in their account after 30-years and that would be considered success.
The nice thing about the 4% rule is that it’s pretty easy to find your target “retirement number”. All you have to do is estimate your annual retirement spending (including tax!) and multiplying by 25. If I wanted to retire with $50k/year before tax, according to the 4 percent rule, I would need $1,250,000 (25x $50,000/year)
The issue with the 4% withdrawal rule is that for Canadians it’s too low, it’s too pessimistic, and it leads people to forget about other types of retirement income and perhaps save too much. If you’re retiring in your 50’s to early 60’s then you could start withdrawing at a higher rate and still be successful.
(Disclaimer: Everyone’s situation is different. What works for one retiree may not work for another. Make sure to review your retirement plans with an advice-only financial planner to ensure your plan is successful)
Retirees in their 50’s or early 60’s will be eligible for two large government benefits just a few years after retirement. CPP and OAS can easily provide 25%+ of a retirees annual spending. Ignoring these benefits will mean you might save too much! Aiming for a portfolio that is 25x your annual spending is overkill because it doesn’t take into account these large government benefits.
For many retirees in their 50’s and early 60’s they can withdrawal MORE than 4% from their portfolio at the beginning of retirement. This is because a few years down the road they’ll be eligible for CPP and OAS. Once these benefits kick in their withdrawal rate will be much, much lower.
But, the earlier you retire the closer to the 4 percent withdrawal rate you need to be. Retiring early means you need to have closer to 25x your annual spending to bridge the gap between early retirement and government benefits. Bridging a 5-year gap between age 55, when retirement starts, and age 60, the earliest CPP can begin, is much different than retiring at 45 and waiting 15+ years for CPP.
Not only does retiring early create a larger gap between your retirement date and CPP/OAS but there are other risks too. One of the biggest risks is a change to OAS.
OAS is funded through government revenue. This means it’s not guaranteed the same way CPP is guaranteed. In fact, we’ve already seen OAS change twice in the last decade. OAS briefly went from age 65 to age 67 and then back again. This didn’t affect people who were already 55 but for those 55 and under they saw their earliest OAS date pushed later and later.
Still, for anyone in their early 50’s to early 60’s it’s reasonable to assume CPP and OAS will be available in its current form (but nothing is 100% guaranteed!)
Let’s look at two scenarios, one where retirement starts at age 55 and the initial withdrawal rate is above the “4% safe withdrawal rate”, and a second scenario where retirement starts at age 45 with the same withdrawal rate. For each scenario we’ll look at the success rate (how likely it is that we won’t run out of money before age 100).
One of the biggest financial planning opportunities for regular people is around government benefits. Unless you’re earning an extremely high income you will probably receive some form of government benefit over the course of your life.
As a student, you may receive GST/HST credits. When you have a family, you may receive the Canada Child Benefit. And when you’re a senior you may receive Old Age Security and the Guaranteed Income Supplement.
Understanding how government benefits work can help you optimize how much you receive both now and in the future. A few simple changes can increase your benefits by $1,000’s per year and help you save more, increase your financial security, and general increase your peace of mind.
Some families may be doing this already, but not realize it. Other families may not be doing it at all, and losing $1,000’s.
Most benefits are based on your net income and most benefits have claw back rates associated with them. As your income increases, your benefit will go down based on this claw back rate. But not all income is created equal, and some types of saving will increase your benefits.
One of the best ways to optimize your benefits is by carefully planning RRSP contributions. RRSP contributions decrease your family net income and increase your benefits. This increase in benefits can provide a big incentive to save. Depending on the number of children, for some families, the increase in benefits from an RRSP contribution is worth more than the tax refund! In total, some families can get back $0.60-$0.70 for each $1 they contribute to RRSPs.
On the other side, when you’re ready to withdrawal from your RRSPs, these withdrawals need to be carefully planned. RRSP withdrawals increase family net income and can potentially trigger claw backs on GIS and OAS. With claw backs on GIS reaching up to 75% it’s important to plan RRSP withdrawals carefully to avoid losing 50%-75% of every $1 you withdraw from RRSPs in retirement.
If you’re earning a normal/average income understanding government benefits can potentially provide a big boost to your long-term financial security. Ignoring government benefits can make things unnecessarily difficult.