For many widows, their biggest risk is outliving their savings and relying solely on government pensions. Delaying your Canada Pension Plan (CPP) is a great option to help widows (and other retirees) protect themselves against longevity and investment risk.
Executive Summary
From my experience, the biggest risk facing retirees is outliving their savings due to a long life and/or poor investment returns. I refer to this risk as longevity and investment risk. So, it makes sense to transfer some of this risk to the federal government, which can be accomplished by deferring CPP and OAS until age 70.
However, an overwhelming number of Canadians decide to collect CPP at age 65 or younger (ie 60). Generally, they use a “bird in the hand argument” to justify their decision. Sadly, this approach fails to consider the increasing value of a deferred CPP and OAS pension.
If CPP is deferred for five years, the benefit is at least 42% greater than the amount expected at age 65 and the OAS is 36% greater. That’s an 8.4% guaranteed increase per year for CPP and 7.2% for OAS. Plus, they’re both inflation protected, which is a significant bonus, considering that Canada’s inflation rate hit an 18-year high over the summer1.
Given the current five-year guaranteed investment rates are approximately 1.55% per year, the guaranteed increases in CPP and OAS are too good to pass up2.
If you’re planning to retire in the near future and wondering when is the best time to take CPP and OAS, read the remainder of my article, then contact me for a personal assessment. What to learn more? Listen to my podcast, Richard Dri – in my own words, to learn more about disaster plans and how they ‘re an integral part of your senior life and end of life planning.
Risks facing widows and widowers
In my previous article about CPP, I discussed my disappointment at the amount I receive from my CPP survivor pension. Which leads me to ask myself the question. When is the best time to collect CPP? My conclusion is that deferring CPP to a later age (possibly to age 70) reduces longevity and investment risk and creates a guaranteed, inflation-protected retirement income stream for life.
As a financial planner for almost 30-years, I find the biggest concern for retired or pre-retirement clients is the real possibility of outliving their savings and relying solely on government pensions, such as CPP, OAS and/or GIS.
According to Statistics Canada, the average man lives to approximately 80 while the average woman lives to approximately 84, and the ages creep higher for those who are already 65+3.
If you retire from paid work at age 55-65, which is not recommended, a retirement lasting 20-30 years should be expected and planned. During this period, the retiree will experience three major risks:
- Longevity risk
Which is the risk of living beyond the ages of 80-84, and is entirely possible knowing the statistics from Statistics Canada (above). - Investment risk
Which is the risk of poor investment returns that can happen over the lifetime that someone actively invests. While investing is never guaranteed, some investment options have, historically, been more stable than others, such as the Dri Dividend Model. - Inflation risk
Which is exactly as it sounds, it is the risk of higher than expected inflation. While the Canadian inflation rate averaged 3% from 1915 to May 2021. We saw an 18-year high over the summer, with inflation currently at 4.7%4.
These risks raise the question of, what can I do to minimize them? Below, I’ve outlined the major reasons why you should consider deferring CPP (possibly until age 70).
When can you collect CPP?
CPP is based on the number of years you contribute to the plan. The potential contribution period begins at age 18 and ends at age 65, hence 47 years of potential contributions. For the purpose of calculating the benefit, the plan excludes up to eight years of low or no earnings. In 2021, the maximum CPP benefit at age 65 is currently $1,203.75 per month but the average CPP payment in June/21 was only $619.685.
One of the great benefits of CPP is that it can be collected as early as age 60 and can also be deferred to age 70.
Collecting CPP before 65
If you decide to retire before 65, you may collect CPP benefits as early as age 60 but the amount is reduced by 7.2% for each year you start receiving your CPP before the age of 65.
For example, if you retire at 60, the CPP benefit will be 64% of what you would have received at age 65 (this is an approximate calculation because CPP has a few quirks that may increase your entitlement).
In dollars and cents, if you were entitled to the current maximum CPP at age 65 of $1,203.75 and decided to retire early and start collecting your CPP at age 60, your monthly payment would be $770.40 per month.
Should you defer CPP?
The plan provides the option to defer CPP up to age 70 and provides an increase of 8.4% for each year that you wait beyond age 65 to collect.
For example, if you defer CPP to age 70, the benefit is at least 42% higher than the amount available at age 65. I say at least because it could be higher if you continue working and contributing to the plan and/or from an increase in the national average wage ( $58,700 in 2020).
For simplicity, I have excluded the CPP enhancements that began in 2019. For information, visit canada.ca. But, for the purpose of this explanation, it’s sufficient to say that CPP could be higher in the future.
In dollars and cents, if you were entitled to the maximum current CPP at age 65 of $1,203.75 and decided to defer your CPP to age 70, your monthly CPP payment would be approximately $1,709.32.
Longevity risk
Ironically, perhaps the biggest retirement risk facing a widow or widower is outliving their savings. Once the decision is made to stop paid work, the constant withdrawal of money from your savings raises the question of whether you’re withdrawing too much money.
Withdrawing too much can lead you to run out of savings, thus forcing you to live solely on government pensions like CPP, OAS and/or GIS. For full disclosure, retirees may also have ex-employer pension plans.
We can reduce the longevity risk by transferring part of the risk to someone else, like our government. By deferring CPP (possibly to age 70) the payments increase by 8.4% for each year they’re deferred and payment is guaranteed to be payable for life.
Investment risk (including inflation)
Historically, stocks have performed well when evaluated over long-term holding periods such as 10-years or more. According to Investopedia: The S&P 500 Index originally began in 1926 as the “composite index” comprised of only 90 stocks. According to historical records, the average annual return since its inception in 1926 through 2018 is approximately 10%–11%.[cite] The average annual return since adopting 500 stocks into the index in 1957 through 2018 is roughly 8%6.
However, the S&P index has also had several major drawdowns that have ranged from 10% to 50%. It’s these types of drawdowns that not only scare investors (of all skill levels), but also causes some investors to reduce their retirement lifestyle expenses to compensate for the investment losses.
Again, some of the investment risk can be transferred to someone else, like our federal government. Remember, as mentioned above, the CPP benefit is GUARANTEED for life, regardless of the performance of the stock market, real estate or whatever other market you may invest in, such as crypto.
Why do so few Canadians defer CPP?
According to Benefits Canada: a 2020 research paper by Ryerson University’s National Institute on Ageing and the FP Canada Research Foundation, found fewer than 1% of Canadians delayed CPP/QPP benefits until age 70 in 2009, while more than 95% took CPP/QPP at age 65 or earlier the same year7.
If CPP reduces longevity risk and investment risk, why do so few Canadians choose not to defer CPP until age 70? From personal experience with clients approaching retirement, I find three common answers to the dilemma:
- Premature death
Some people are afraid of dying young and leaving money on the table, so they start collecting CPP as soon as they’re eligible (age 60) regardless of the discount. I completely understand this argument because my late wife died at age 57 and didn’t collect any CPP. But to be fair, I receive a survivor benefit and so does my university age daughter. So when I hear this argument, I ask retirees to focus on the financial risks of living a long life and forget what happens after our death. - Underfunded CPP
Some retirees think CPP is underfunded and if they wait, the benefit will be reduced or eliminated. Fortunately, this reason is simply not true. Based on changes enacted in 1990, CPP is fully funded despite the large number of baby boomers retiring each year. The actuarial calculations are performed every three years and as of December 31/2018, “the Chief Actuary of Canada indicated that the CPP is sustainable over a 75-year projection period8.” - Losing their nestegg
Some retirees will draw from their registered accounts to reduce the shortfall caused by delaying CPP until age 70. I can appreciate that it’s difficult to watch the gradual reduction of your retirement portfolio, and after a lifetime of savings, the decumulation of assets can be very humbling. In this case, I ask retirees to focus on their entire retirement plan and not solely one component of the portfolio. So, while their RRSP assets are declining, their CPP benefit is increasing. One option to offset this gradual reduction is a dividend paying portfolio, such as the Dri Dividend Model.
In short, there are certainly a few valid reasons for taking CPP early (ie health reasons) but in general, deferring CPP is a valid retirement option for retirees.
How does a retiree compensate for the lost cash flow caused by delaying CPP?
Generally (but not always), I recommend that clients increase their withdrawals from their non-registered assets to compensate for the shortfall in cash flow caused by delaying CPP between the ages of 65 to 70. Of course, this assumes sufficient assets in non-registered and/or registered accounts to compensate for the loss. If the retiree doesn’t have sufficient assets to compensate for the cash reduction, a CPP deferral may not be possible.
Alternatively, if you’re still living in the family home that raised your children, but is now a large home for one or two. Consider downsizing and using any assets to bolster your investment portfolio.
Should you also defer Old Age Security (OAS) to age 70?
If deferring CPP is a valid retirement option, then can we make the same argument to defer OAS?
OAS is available from the age 65 (It isn’t available earlier) to age 70. If a retiree decides to defer OAS, they will receive a 7.2% increase for each year they defer (until 70), so a five year deferral provides an OAS increase of 36%.
Again, the positive argument to defer OAS assumes that the retiree can generate sufficient cash flow from other assets (first non-registered assets then registered assets, and finally TFSAs) to compensate for the reduction in cash flow during the years of 65 to 70. If this assumption applies, then delaying OAS is also a viable retirement option for retirees.
Final thoughts
If you’re widowed or close to retirement and you fear that running out of savings is the biggest risk facing your senior years, then it makes sense to transfer some of the investment and longevity risk to the government by delaying CPP and OAS. Remember, CPP is guaranteed for life and is indexed each year for wage inflation. In fact, CPP deferral increases the guaranteed CPP benefit by 8.2% for each year deferred, and OAS deferral increases the guaranteed OAS benefit by 7.2% for each year deferred.
This assumes that you have sufficient savings to compensate for the delayed cash flow caused by waiting five years to collect CPP and OAS, and isn’t always as easy to calculate, so if you are thinking of retiring and wondering when you should collect CPP, please schedule an appointment and let me calculate the best time to collect CPP and OAS.
In fact, if you have any goal in mind — big or small — that requires some financial planning, but you’re struggling with where to start, reach out to our team. We have the expertise and life experiences to help guide you to achieving your goals.
Contact us today to learn more about the options available to you. CLICK HERE.
Learn more:
- Lessons learned since becoming widowed
- Your RRSP questions
- Maximize your RRSPs and TFSAs
- Live well, stay rich, never retire
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1 https://www.reuters.com/business/canadas-annual-inflation-rate-hits-44-september-highest-since-2003-2021-10-20/
2 https://www.scotiabank.com/ca/en/personal/rates-prices/gic-rates.html
3 https://www150.statcan.gc.ca/n1/pub/84-537-x/2020001/xls/1980-2019_Hist-eng.xlsx
4 https://tradingeconomics.com/canada/inflation-cpi
5 https://www.canada.ca/en/services/benefits/publicpensions/cpp/cpp-benefit/amount.html
6 https://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp
7 https://www.benefitscanada.com/archives_/benefits-canada-archive/helping-employees-understand-the-benefits-of-delaying-cpp-qpp/
8 https://www.cppinvestments.com/the-fund/our-performance/sustainability-of-the-cpp
source https://richarddri.ca/why-widows-especially-should-defer-cpp-to-age-70/
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