Canada Pension Plan (CPP) and Old Age Security (OAS) are government programs that provide retirement income to Canadians. CPP is a plan that employers and employees pay into. OAS is paid from general government funds to all Canadians who have lived in Canada. You can receive the maximum amount of OAS after living here for 40 years (after age 18).
How much income you can receive
The average Canadian receives less than the maximum CPP, because of years with no or low earnings. CPP pays on average $710.41 per month (maximum $1,175.83). OAS pays maximum $614.14. An individual who has lived and worked in Canada could expect approximately $1,324.55 per month of taxable retirement income from the government. That’s almost $15,900 per year, or almost $31,800 per couple (if they both worked), which is a strong base of guaranteed retirement income. It’s also indexed to inflation meaning that it increases with the cost of living each year. To find out how much you personally can expect, log on to My Service Canada Account or CRA My Account for Individuals and view your statement.
When should you start?
CPP gives you the choice to begin receiving retirement income as early as age 60 or as late as age 70. In recognition of life expectancy and the time value of money, payments are reduced by 0.6% for every month before age 65 or increased by 0.7% for every month after age 65. As an example, the average payment of $710.41 drops to $454.66 at age 60, or increases to $1,008.78 at age 70. We can choose to begin OAS income at age 65 or wait as late as age 70, increasing 0.6% for every month. The maximum payment is be $835.23 at age 70.
Should you begin drawing retirement income from CPP and OAS earlier or later? The optimal decision is not clear because we don’t know how long we will live. Based on life expectancy, we’ll likely receive more total income from government benefits if we start later. However, there are many reasons you may want to start taking income from government benefits as soon as you retire. If you start government benefits months or years after you retire, you’ll have to draw income from your RRIF, TFSA or other investments. In that case, your CPP income will be higher, but you’ll have a lower balance in your own investments due to withdrawals. This decreases the amount of retirement income you can sustainably draw from your own investments.
CPP provides retirement income that is calculated based on your average earnings while you contributed. For most people, the calculation will drop out the seven or eight lowest earning years. For someone that retires at or before age 60, the years before age 65 still count in that calculation and could reduce your benefit. Starting CPP as soon as possible can avoid counting low-earning years if you retire before 65.
Taxation and clawback
Government benefits are taxable income. Retirement income from CPP and OAS add to your taxable income for the year, affecting your tax bracket and potentially reducing your net spendable income. Further, OAS is clawed back in years of high income; if an individual has taxable income over $77,580, they will have to repay a portion of OAS. To keep total income lower, it’s better to begin receiving benefits as soon as you retire and your taxable income drops.
Flexibility of income in retirement
Income from CPP and OAS are inflexible. Once you begin receiving it, you can’t change the amount or pause the payments. RRIFs are more flexible in that you can adjust the amount or dip into them in case of need. Beginning early to draw income from government benefits reduces the amount of income required from your own investments, which in turn maximizes flexibility. In addition, government income lasts as long as you live. Because income from government benefits is inflexible, it makes sense to activate this income before other sources.
Some people have guaranteed income in retirement, such as a pension. Most people prefer to have enough guarantees to cover their necessities. Beyond that, they are comfortable drawing on market-based investments to pay for wants. Without a pension, to produce guaranteed income in retirement, you can buy an annuity, choose safe investments or delay government benefits for the increase. If your own savings are in cash (e.g. a savings account, GIC or an short-term investment), it’s probably best to spend cash first and delay CPP and OAS. On the other hand, if your investments are generating a return better than 6%, it’s advantageous to start CPP and OAS payments earlier and keep your own assets invested.
Planning for the survivor
Modern life expectancy is relatively long, and when we look at a couple, chances are good that one of the two people will live to be quite old. That also means it’s likely that one spouse will outlive the other. The CPP survivor benefit is quite small and is capped by the CPP maximum. There is no survivor benefit for OAS. When both spouses draw retirement income from CPP and OAS, they can preserve their own investments. RRIFs, TFSAs and even non-registered investments will roll tax-deferred to the surviving spouse without reduction.
There is not just one right answer for everyone between: starting CPP early, starting at age 65, or delaying CPP and OAS to age 70 (or somewhere in between). If you haven’t saved quite enough or you need to maximize your guaranteed income, it makes sense to start as late as possible. Having a higher taxable income, having larger investment accounts, for greater flexibility or having a spouse are all reasons to start as soon as earned income drops. But there is another approach that might work for you: working longer.
You can maximize your wealth by working an extra year or two. This would allow you to delay taking CPP and OAS, increasing your monthly guaranteed income. It would also allow your own investments to grow longer. And because market growth has a much greater impact than your savings, you could redirect the amount you previously committed to saving. Some ideas might include additional vacation, bringing donuts every week or buying lunch every day. That would make the additional time at work enjoyable and memorable. I’ve heard from multiple people that work is more tolerable when it’s optional.
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