Owen Winkelmolen, an advice-only financial planner and founder of financial planning firm PlanEasy.ca.Supplied
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This is the latest article in our series, Planning for the CPP, in which Globe Advisor explores the decisions behind when to take CPP benefits and reviews different aspects of the beloved and often-debated government-sponsored pension plan.
As part of the series, we invited readers to ask questions about their Canada Pension Plan (CPP) retirement benefits and find experts to answer them. This week, Owen Winkelmolen, an advice-only financial planner and founder of financial planning firm PlanEasy.ca in London, Ont., answers questions about the pros and cons of taking CPP benefits early and investing them:
Should I take my CPP at 60 and invest it? I know the returns will depend on stock market returns over time, but can you do some calculations on average returns of, say, 5 per cent? What are the pros and cons of this strategy versus waiting until 65 or 70?
There are many pros and cons to delaying CPP benefits. Your question alludes to the famous CPP break-even age question, so let’s explore that first.
Let’s assume your CPP at 65 would be $1,000 a month and your CPP at 60 would be $640 a month, which is 36 per cent lower for starting five years early. If you take the CPP starting at 60, there would be $38,400 in CPP payments made between 60 and 65. However, if you take the CPP starting at 65, these monthly payments are $360 more.
The simplistic break-even analysis for delaying CPP would suggest that your break-even happens after 107 months, $38,400 divided by $360, or around the age of 73 and 11 months. But as your question astutely points out, that doesn’t include investment returns, so how does the break-even age change when we add investment returns?
If we add real investment returns of 3 per cent (5 per cent nominal returns and inflation of 2 per cent), the break-even happens later, at 76 and four months. Investing those early CPP payments between 60 and 65 (or drawing less from your investment portfolio during that time) means the break-even point gets pushed further out. If you delay the CPP from 60 to 70, the break-even point happens even later, at 81 and three months.
This analysis includes several assumptions:
- That your marginal tax rate is the same now and in the future. If your marginal tax rate is lower or higher in the future, this will impact the analysis.
- That the zero-earning years being added between 60 and 65 will not be a drag on your CPP benefit; this only applies to someone who has made a maximum contribution over 39 years.
- It doesn’t include the impact of variable investment returns and inflation rates.
- It doesn’t consider Guaranteed Income Supplement (GIS) clawbacks after the age of 65 for lower- and moderate-income retirees. GIS clawbacks are triggered by CPP benefits and other taxable income, so a higher CPP benefit after 65 may not be as attractive.
- That you have a long and healthy retirement and can reach the break-even age.
If you invest all your CPP income (taken at 60), what sort of return do you need to do better than waiting until 65? That’s assuming you can still work until 65, or have other investments you can live off.
To answer this question, we’ll build on the previous answer.
Intuitively, you may think a higher investment return will help you reach your CPP break-even point faster, but this isn’t the case. The opposite is true.
Notice how, in the previous answer, the break-even age moved later when we added investment returns? That’s because delaying CPP benefits requires you to draw down on other investment assets to close the income gap. Drawing down on investment assets has an opportunity cost in the form of lost investment returns. The higher your expected investment returns, the larger the opportunity cost.
In the above example, the break-even point for delaying taking the CPP from 60 to 65 with real investment returns of 3 per cent happens at the age of 76 and four months.
Assuming higher real investment returns of 4 per cent (6 per cent nominal returns and inflation of 2 per cent), the break-even point happens later, at 77 and five months.
If we go in the opposite direction and assume lower real investment returns of 2 per cent (4 per cent nominal returns and inflation of 2 per cent) then the break-even point happens earlier, at 75 and four months.
When you have a more conservative portfolio – or a portfolio with higher investment fees – and the expected rate of return is lower, then delaying the CPP and drawing down on your investment portfolio has a lower opportunity cost.
Everything else being equal, delaying the CPP and drawing down on your investment portfolio is slightly more attractive for conservative investors or investors with higher investment fees. Delaying the CPP is slightly less attractive for aggressive investors or investors with lower investment fees.
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