A Misunderstanding About Taking CPP Early to Invest
Recently, Braden Warwick at PWL Capital created an excellent CPP calculator that we can all use. One of the numbers this calculator reports is the IRR (Internal Rate of Return) you’ll get between your CPP contributions and the CPP pension you’ll collect. Some financial advisors (but not Braden) decide it makes sense for their clients to take CPP as early as possible (age 60), and invest the proceeds. Their reasoning is that they believe they can earn a higher return. Here I explain why this logic compares the wrong returns.
The return you’ll get on your CPP contributions depends on the contributions you and your employer have made and the benefits you’ll get. These amounts depend on many factors about your life as well as some assumptions about the future. Typically, the return people get on CPP is between inflation+2% and inflation+4%. (However, it can go higher if you took time off work with a disability or to raise your children. It also goes higher if you ignore the CPP contributions your employer made on your behalf, but I think this makes a false comparison.)
If we examine people’s lifetime investment record, not many beat inflation by as much as CPP does. However, some do. And many more think they will in the future. In particular, many financial advisors believe they can do better for their clients.
But what are we comparing here? These advisors are imagining a world where CPP doesn’t exist. Instead of making CPP contributions, their clients invest this money with the advisor. In this fictitious world, the advisor may or may not outperform CPP. However, this isn’t the world we live in. CPP is mandatory for those earning a wage.
The choice people have to make is at what age they’ll start collecting their CPP pension. The CPP rules permit starting anywhere from age 60 to 70. The longer you wait, the higher the monthly payments get. Consider an example of twins who are now 70. The first started CPP a decade ago at 60 and the payments have risen with inflation to be $850 per month now. The other waited and has just started getting $2000 per month. The benefit of waiting is substantial if you have enough savings to bridge the gap between retiring and collecting CPP, and don’t have severely compromised health.
Those with enough savings to bridge a gap of a few years have a choice to make. Should they take CPP immediately upon retiring, or should they spend their savings for a while in return for larger future CPP payments? Some advisors will say to take CPP right away and invest the money, but this is motivated reasoning. The more money we invest with advisors, the more they make.
One way some advisors justify their advice is by claiming they can invest client money to outperform CPP returns of 2% to 4% above inflation. This claim is questionable to begin with, but more importantly, it is a false comparison. The return you get from delaying CPP is completely different from the return you get over the full span of your contributions and benefits.
For example, the return you get for delaying the start of CPP benefits from age 60 to 61 is typically between inflation+8% and inflation+12%, a formidable return to try to beat through investing. This return comes from the rules on how CPP adjusts your benefits when you start collecting early. The fact that your overall return from CPP is a lower figure has nothing to do with deciding at what age to start collecting.
The strong desire some people have for taking CPP early can be baffling. Many people express envy over the great indexed pensions government workers get, but when they get a chance to delay CPP to grow their own indexed pension, they turn it down.
Braden’s CPP calculator is great as it is, but if I could make one addition, it would be to include the IRR for each year’s delay in starting benefits. This would make it clear how high the return hurdle is for those who advise collecting CPP early and investing the money. Braden chooses the best year to start collecting CPP based on a present value calculation using inflation as the rate. I think this is sensible because CPP is guaranteed and higher investment returns aren’t guaranteed. However, for those advisors who aren’t convinced of this fact, it would be good to make it plain how high future returns would have to be to justify starting CPP early.
This issue is a challenging one to tackle. Many financial advisors have spent their entire careers telling their clients to take CPP as early as possible. It’s hard to admit that you’ve been giving bad advice. But the truth is that most reasonably healthy people who have some savings to live on should consider delaying the start of CPP.
Thank you Michael another on-point post. CPP is the 3 Body Problem of retirement!
ReplyDeleteI’ve devoted many hours to deciding when to start our CPP. Ultimately, I had to model out our entire retirement, including all taxes, credits, pension splitting etc. What I learned in the process is that in our case, it doesn’t matter much when we start CPP if we set our anticipated end-of-life event occurring at age 85. Should either of us die a year or so earlier, the balance tips in favour of starting earlier. My measure for when to start CPP is the projected tax adjusted estate, in today’s value.
Factors that are not generally considered, that do have a notable impact on our considerations include 1. The likelihood that we will both make it to age 85, 2. We have many missing years (arrived in Canada at age 35/33, and retired early 57/52), and, 3. We have pensions that take us close to the next tax bracket up. The two latter factors change things for us vs the blanket delay until 70. It’s not significant, and in all likelihood, the winners and losers are whoever inherits our estate. For us, the earlier start allows us to shovel more money into our TFSAs, and then pull it out later without driving us into a higher tax bracket, or should one of us die early, being hit with OAS clawback in addition to more of the retirement spending money being taxed higher.
It is indeed a complex problem, and my conclusion is that it has to be looked at in the context of a comprehensive and detailed retirement plan.
Thank you, Michael, for your thoughts; much appreciated. I will extend the analysis to age 90 (it's fairly easy to do) and see what we'd be gaining by delaying CPP further into retirement.
DeleteEnsuring a sizable surplus over our retirement expense needs has been an important factor in our plan to this point. We can comfortably use this to bridge until CPP and/or OAS come online at age 70, or we can use it to purchase a more expensive home in a warmer climate, but not both! We are mulling over the potential move, so this perhaps puts us in the category of being potentially low in liquid assets.
Would it be beneficial to convert an RRSP to a RRIF early, starting at age 45, and begin minimum withdrawals while reinvesting the proceeds into a non-registered account, rather than waiting until age 71? Would the additional taxes paid between ages 45 and 71 ultimately result in lower taxes compared to the potentially larger mandatory RRIF withdrawals at age 71? The idea is that starting minimum RRIF withdrawals earlier could help reduce the RRIF balance over time and allow for growth in a non-registered account, providing greater flexibility and control over future tax obligations.
ReplyDeleteBased on the simulations I've done, your question depends on many factors. If you can take money out of an RRSP at a lower tax rate than you'd pay taking it out later, that's an advantage. However, taking money out early reduces the years of tax-free compounding (unless RRSP withdrawals go in a TFSA). How these competing effects balance out depends on the many details. I've only been able to decide on the best course of action for specific cases.
DeleteOne general rule I've found is that it's good to withdraw enough from RRSPs to use up low tax brackets. So the amount to withdraw depends on what other income you have. The challenge is to figure out which low tax bracket is best for a particular case.
Yes, I’ve seen advisors pushing this on the internet. People like Garth. They talk like its a no brainer to take CPP early “because when the government gives you money, you should take it”.
ReplyDeleteI wonder if any of these advisors are fiduciary. This has to fall under “bad financial advice”. I can understand that there are some arguments for taking it early in certain circumstances but claiming that its a clear “win” is just wrong.
The crowd of advisors pushing everyone to take CPP early is definitely large. An Upton Sinclair quote is relevant here: "It is difficult to get a man to understand something when his salary depends on his not understanding it."
DeleteA question about spousal benefits,
ReplyDeleteMy wife and I are closing in on60.I will be getting around80% of max cpp and my wife will be around 25% max.(rough numbers)
Looking at family history and lifestyle,I would say 90% chance she outlives me and 60+%she outlives me by 20+years.
The bigger the guaranteed,inflation protected check coming in every month after I am gone the better.
My plan was to defer my cpp to 70(if I last)
Recent reading suggests when I actually take cpp does not matter,as the spousal benefit is based on 65 regardless.
Is this correct?
That is my understanding based on reading Doug Runchey's article on the subject: https://retirehappy.ca/cpp-survivor-benefits/
DeleteHere is my attempt to understand the CPP survivor benefits: https://www.michaeljamesonmoney.com/2021/02/calculating-amount-of-cpp-survivors.html
The rules are quite complex, so take some time to understand them.
I have read both your article on delaying CPP and the updated one on delaying OAS and they are quite convincing. However, there is this lingering contradiction in mind that might be hard to explain but I will try. The most common discussions on this issue usually discuss a "break-even" age when the amount you will have collected if you delay will surpass the amount you would have collected if you had started early. The implication is that the longer you live, the stronger the argument for delaying. However, because your analyses calculate the rate of return of the decision to delay, the later your planning age is, the lower the rate of return for each delay scenario. The general conclusion is that the longer you plan to live the weaker the argument in favour of delaying. Is that correct? Is there a way you can explain these seemingly conflicting conclusions. Is it simply because the "break-even" arguments usually ignore investment returns on the early benefits?
ReplyDeleteHi Craig, I think you misread the charts. The latter 3 charts in the linked article are for planning ages of 100, 90, and 80. As you move from one chart to the next, the planning age decreases and the rates of return decrease. So it is as you would expect, the later the planning age, the higher the investment return required to justify taking CPP early.
DeletePerhaps you're focusing on the ages within a single chart. It's true that delaying the start of CPP from 60 to 61 is more compelling than delaying from 61 to 62, and so on. However, this is not related to the planning age.
If I've misunderstood your question, then we can try again.
Thanks, I think I get it. So, if I am looking at the planning age of 90 table for CPP, the rate of return at age 70 looks like around 3% above inflation. So that rather than a break-even age, we have a break even rate of return. If I think I can beat inflation by 3% on average until I die then I should take my CPP earlier. This confirms my plan to delay until 70. My plan currently doesn't anticipate beating inflation by 3% and I'm certain by my 80's I will be more conservative. Also, I like the idea of "annuitizing" my savings by spending them first in return for guaranteed, inflation protected income. Thanks
DeleteYour thinking is very similar to mine.
Delete