Working past 65? Beware this Canada Pension Plan oddity

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The government works in mysterious ways. The intent behind some of their pension rules is mystifying at best and counterproductive at worst. A great example is a little-known anomaly in the Canada Pension Plan rules that Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management, recently brought to my attention. It involves what happens to CPP benefits and contributions at the age of 65 under different scenarios.

The anomaly is best described by an example. Consider two seniors, Hart and Borden. They are twins who were separated at birth. Both started to work at the age of 23 and continued to work right up until 65. They both contributed the entire time to the Canada Pension Plan so they are entitled to the maximum pension, which happens to be $1,114 a month in 2017. (I will ignore the pennies.)

Here is where their paths diverge. Borden retires at 65 in order to work out the kinks in his highly problematic golf swing. He doesn't need his CPP pension immediately, so he defers the start of it until 70. Even though Borden is not required to contribute to the CPP between 65 and 70, his starting pension at 70 is 42 per cent greater than it was at 65 (we will ignore inflation). As a result, Borden's monthly CPP pension starting at 70 is $1,582.

Hart wisely decides not to work on his golf swing because he knows it won't do him any good. Instead, he continues to work right up until 70. Just like his twin, Hart defers the start of his CPP until 70. The difference is Hart is forced to continue contributing to the CPP between 65 and 70. Annual contributions are $2,564.10 (ignoring inflation) so by 70, Hart has contributed $12,820 more than Borden. In spite of that, Hart is entitled to the same $1,582 of pension as Borden.

That's right. Hart has paid into the plan for five years longer, but gets nothing for it. This happens because Hart and Borden deferred the start of their CPP pensions until 70. If they both started to collect CPP at 65, the situation would be different. They would both receive $1,114 a month, but Hart would also accrue extra pension credits because of his contributions to the CPP between 65 and 70. By 70, Hart would receive about $197 a month more than Borden.

Let's see if we can figure out why the government would have established the rules in this fashion. One possibility is they are trying to discourage people from working past 65 by making them pay more to get the same CPP benefit. It seems unlikely that this is their motive considering the government-appointed Advisory Council on Economic Growth recommended that the age of eligibility for the Old Age Security pension, CPP and the Guaranteed Income Supplement be increased beyond 65 to "meet the reality of an aging society."

Another possibility is they are trying to encourage people to start their CPP pension at 65, whether they need the pension or not. It is not clear why they would do that since it doesn't jibe with the fact that they encourage deferral of CPP by providing an increase of 8.4 per cent for each year the starting age is postponed. Besides, why make Hart take his CPP pension at 65 when he is still working and has no need for the benefit?

The most likely theory is the rationale is lost in the shrouds of time and the rule did not change with the times. As I have suggested in past articles, deferring CPP until 70 can make a great deal of financial sense if you have enough savings (or income) to tide you over until 70. It is unfortunate that people who continue to earn employment income would be penalized for doing the smart thing.

The easiest fix is for the government to eliminate the requirement to contribute to the CPP after 65, even if you continue to work. This is the only way that Hart and Borden are treated equitably if both defer commencement of their CPP benefits until 70.

Frederick Vettese is the chief actuary of Morneau Shepell and author of The Essential Retirement Guide: A Contrarian's Perspective.