Canada Pension Plan – Coping With the Boomer Generation

The federal government’s planned changes to the Canada Pension Plan (CPP) have two goals, dealing with an increasingly aging population and making it easier for people to work longer if they wish.

The revisions highlight two issues that you will want to discuss with your financial advisor:

  1. When you should start drawing your federal pension.
  2. The tax implications of taking CPP earlier or later than the age of 65.

Among the most important changes that Ottawa plans to start phasing in from 2011 to 2016 are:

  • Eliminating the “work cessation test” starting in 2012, which means, you will be able to take CPP early while still working.  Currently you have to quit your job for at least two months.
  • Revising the calculations of taking benefits earlier or later than age 65.
  • Allowing additional contributions.

If you currently collect CPP or will collect the benefits before the changes come into force you won’t be affected.

The Nuts and Bolts of Benefit Calculations

CPP benefits are adjusted to reflect how much you contributed over the years.  Currently the amount you are entitled to drops or rises 30per cent depending on whether you take the pension at age 60 or age 70.  In other words, pension amounts decline or increase 0.5 per cent a month, or per cent each year.

Under the new rules, however, benefits taken at age 60 will gradually decline to a maximum 36 per cent while benefits taken at age 70 will gradually increase to a maximum 43 per cent.  The way it will work is that starting in 2011, benefits taken after age 65 will increase over three years to 0.7 per cent a month, or 8.4 per cent each year.  Conversely, starting in 2012, early CPP benefits will drop over a period offive years to 0.6 per cent a month, or 7.2 per cent a year.

Continued Contributions

Under the changes, if you take the pension early and continue to work, you and your employer will each be required to continue CPP contributions.  That means that even if you take early CPP you can continue to build your pension.  Currently contributions end if you take the benefits early and return to work.

If you remain on the job after age 65 you will be able to contribute or not, your choice.  If you choose to continue putting money into the plan, your employer will have to match the contributions.  You will want to discuss with your financial advisor the implications of this, as continuing to put money into the plan could push your pension above the maximum allowed.  The 2009 maximum is $10,905, or $908.75 a month.

How This Can Affect Your Retirement Plans

Despite the changes, the perennial conundrum will remain.  Should you take CPP early or wait until you are 65 or even older?  This decision should involve discussion with your financial advisor as no single strategy fits everyone.  Your planning will depend on, among other things, whether you need the money and, if you don’t, what you would do with it, spend or save.  It also depends on your age expectancy.  If your health is poor, taking it early may be the only choice if you want to see any of the pension.  Be sure to take into account the effect on survivor payments.

Let’s say you plan to work until you turn 65 in 2014 when your basic annual pension amount will be $6,220.  If you delay taking the pension for a year that amount would rise 8.4 per cent to $6,742.48.  That payment would then be subject to inflation adjustments.  If you continued to work even longer and kept contributing, the payment would continue to grow.  (See below for calculations related to taking CPP early.)

Your Chartered Accountant advisor can help you decide what choice would work best for you and your family.  You will want to discuss the expected future values of such assets as Registered Retirement Savings Plans and Tax-Free Savings Accounts for both you and your spouse or common-law partner, as well as annuities, equity in your home and investments outside your registered plans.

And you will want to consider the tax implications and pension splitting.  Taking early CPP while you are still working can potentially push you into a higher tax bracket, which could boost your tax liability beyond the benefit of taking the pension.  On the other hand, delaying CPP could both push you into a higher tax bracket and affect your Old Age Security amount, which is subject to clawbacks at higher income levels.

Calculating the Benefits

Assume that your health is good, your Registered Retirement Savings Plan is in decent shape, you plan to keep working beyond age 65and you don’t really need the CPP benefits.  Should you take the pension early anyway?

Let’s say your basic amount at age 60 would be $7,200 ($600 a month).  By taking the pension early you would receive $36,000 in payments by the time you reach age 65 (double that by the time you hit 70).

That is money you could add to tax-deferred RRSPs or Tax-Free Savings Accounts.  But for the sake of illustration, let’s say you deposit those $600 cheques at the beginning of each month into a savings account paying 3.5 per cent compound interest (when rates start to rise again).  You would wind up with a limp sum of $40,108 by the time you were 65 ($87,161 at age 70).  These amounts represent the future value of periodic payments of $600 at 3.5 per cent per annum.

From that point on, the lump sum would earn compounded interest of about $1,426 a year (119 a month).  Add this to your $600 pension payment and you have $719 a month.  That calculation excludes taxes and cost of living increases.  It also does not take into consideration the rise in benefits if you were still contributing to CPP.  (The annuity for age 70 would be $3,100 a year, or a rounded $258 a month, in addition to your $600 pension cheque.)

Notwithstanding the interest earnings, taking CPP and saving it means you accumulate a lump sum for emergencies and have a larger estate to transfer.

A rule of a thumb commonly bandied about is that if you need CPP, wait until age 65 or later to get as much as you can.  If you don’t need the money, take it early and invest it.  Talk to your financial advisor.

Conclusion

If you have any questions regarding the above income tax or business issues, do not hesitate in calling Joe Truscott at 905-528-0234 or email Joe at joetruscott@josephtruscott.com.