By Gordon Powers
Although investor attention is focused on RRSPs this time of the year, it’s worth remembering that most adults are already contributing to a pension plan of sorts, courtesy of the federal government. Although you wouldn’t want to be solely dependent on it, the Canada Pension Plan (CPP) is often the first pension that people collect and the one they understand the least.
The CPP, which was established 40 years ago, is financed through mandatory contributions from employers, employees, and the self-employed, as well as investment income. Employers and employees pay equal contributions based on a maximum amount of earnings, adjusted annually.
Contributing Canadians may receive payments as early as age 60 or upon suffering a disability. Your monthly pension from CPP is determined by how much, and for how long, you contributed to the plan over your working life. The pension is designed to replace about 25% of earnings while you paid into the plan with CPP setting a maximum monthly benefit each year.
If you qualify, the disability pension is a monthly benefit consisting of both a flat-rate and earnings-related component. The latter is 75% of the CPP retirement entitlement, calculated as if you turned 65 in the month when the disability pension kicked in. When you actually hit age 65, the total disability benefit is changed to the regular CPP retirement pension.
2006 CPP Payments
You can receive a retirement pension as early as age 60, provided you actually stop working for a bit. Once you start receiving your pension, you can still work as much as you want but you can’t contribute based on any future employment earnings.
If you take CPP before age 65, your monthly pension is reduced by 6% for each year you are under age 65. So a 60 year old would see 70% of the available pension. Similarly, if you elect to start taking it later than age 65, the amount of your pension is adjusted upwards by 6% for each year past 65. Age 70 is the limit though.
While deciding when to take CPP payments is a personal choice that you should make with a financial advisor, it may be wise for many people to take these payments as early as possible. It’s a question of potential longevity versus financial need.
Obviously, the longer you live, the more money you can expect to collect from the plan. Most actuaries estimate that women who retire at age 60 will live to 84, on average. Men who retire at age 60 are expected to live to an average of age 79. You can get a better idea of the variables involved and where you stand by looking at MSN / Sympatico's life - expectancy calculator (http://moneycentral.msn.com/investor/calcs/n_expect/main.asp). It contains a range of probing questions about age, family history and lifestyle practices.
Looking at the maximum payments by taking CPP at the age of 60, you’ll have received a total of $215,822 by the age of 90. By taking it at 65 you’ll have a total of $258,570 and by taking it at 70, your total will be $271,488 by the age of 90. Clearly, the later you take your pension, the more you end up receiving in total if you were to live to 90. But what happens in the meantime?
The bigger issue for most people is how long it takes for those starting at the later ages (65 and 70) to catch up with those opting for the earliest date (60). If you were to take CPP at the age of 65 it would take you 11 years (when you’re 76) to catch up to the total value received by someone who had taken it at age 60. If you started taking amounts at age 70, it would take 21 years (when you’re 81) for you to catch up to someone who took payments at 60. To see how this works, here’s another calculator (http://curc.clc-ctc.ca/earlycpp.html) to play with.
This simple look assumes that you spend the money as you get it. If even just some of the contributions were invested though, it would take even longer for the 65 and 70 values to catch up to the total value achieved by taking CPP at the age of 60. Inflation is going to be another variable to consider since CPP payments are indexed to the Consumer Price Index annually.
So, if you live to be much older than 75, taking CPP early would mean a lower total pension income over your lifetime. That’s why some people who expect to live into their eighties or nineties choose not to start CPP until age 65. On the other hand, you might be looking for some help with costs such as children’s education, mortgage payments or travel.
It all boils down to whether you want more now or more later. The higher monthly and total payments received by those who defer CPP payments are real. But it takes many years to collect the same amount as someone who starts early. More importantly, there are no guarantees that you will live that long.
It gets more complicated still if you’re involved with corporate pension plan that is ‘integrated’ with the CPP. This would include most public service employees and teachers, for instance. Integration means that your corporate pension is adjusted to take into account the benefits you’ll receive from CPP. The aim is to provide you with a combined pension income – from both your company plan and CPP – that equals approximately 2% of your average salary multiplied by your years of credited service in the pension plan at work.
If you opt for an early CPP pension at a reduced rate, the CPP benefit will be ‘stacked’ on top of your corporate benefit until you turn 65 but your corporate pension is generally not adjusted for CPP until age 65. In this instance, taking CPP early would take advantage of the five-year window during which your corporate pension would be unaffected.
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