Most of us will get more from Ottawa than we think. A married couple with no savings or company pension can expect $24,000 a year from all government sources when they retire.

The average combined payout from just the Canada Pension Plan and Old Age Security is now almost $11,000 per retired person per year. So don’t forget to factor this in when calculating how much you’ll need to save for retirement.

Deciding when to start taking your CPP is one of those classic personal finance dilemmas. And, like many such dilemmas, there’s no easy answer. Your CPP pension is a cornerstone of your retirement. It provides you income for life, adjusted for inflation, based on the contributions made by you and your employer while you worked. But—unless you’re an actuary with lots of time on your hands—you’re probably not sure how the complicated calculations that determine your pension work. And you may have heard that CPP changes are in the works—and wonder how that affects you.

Years ago, you weren’t able to start CPP early, so it was simple: you usually drew it at 65, and you got what you got. “Now you get a choice, which is sort of nice,” says actuary Malcolm Hamilton, a partner with Mercer Human Resource Consulting. “But you don’t have any easy way to make that choice, which is sort of not nice.”

Fortunately, we can help. We’ll outline how CPP works, describe the coming changes, explain the calculations, and provide guidance about the factors you should consider before making your decision.

The new CPP
Changes will soon make the CPP more flexible. Right now you have to actually quit your job—or at least earn very little—before you can collect CPP. Once you start your pension it’s essentially set, subject to inflation increases. But come January 1, 2012, you can continue to work and also start drawing CPP. If you do collect your pension and work at the same time, you’ll be required to make further contributions that will add to your entitlement. (The contributions are compulsory until 65, and voluntary thereafter.) You might find this handy if you plan to work part-time in your 60s and you need your CPP benefit to round out your income.

But the changes will also force you to accept a greater reduction in your payouts if you start CPP early. Currently your payout is reduced by 0.5% for each month you start CPP before age 65 (that’s 6% per year). Starting next year the reduction will be 6.24% annually, and it will eventually rise to 7.2% in 2016.

The good news is that if you’re into delayed gratification, there’s a corresponding increase to your CPP payout if you start your pension later than 65. (See “What’s new with CPP?" for more details.)

So far, taking CPP early has been by far the most popular option. About 65% of those who are eligible start their pension before 65, another 30% start it right at 65, and only 5% wait until later. But popular or not, does it make financial sense for you to take CPP early?

It’s not that easy to say. The new adjustments to CPP were designed to ensure that if you live an average life span, there is neither an advantage nor a disadvantage to taking it early. The actuaries have done their best to create a level playing field, based on typical circumstances. “If you’re a ‘normal’ person, this should be a matter of indifference,” says Hamilton. If you start CPP early before the changes, you might come out ahead. Even then, the new rates will be phased in so gradually that it doesn’t make a huge difference overall if you’re about to retire.

But what if you’re not “normal” in some way that’s critical to the CPP calculations? In what follows, we’ll describe three major factors that tend to tilt the decision in favour of taking early CPP. We’ll also describe two circumstances that might encourage you to take CPP at age 65 or later.

Reason #1 for early CPP
You’re in poor health. If you’re in your early 60s and your health is poor, your life expectancy may be shorter than average. So chances are you’ll do better by starting your pension early and collecting more payments at a reduced rate, says Hamilton. If your health is poor enough, you may also not be working much and you might need the cash.

Reason #2 for early CPP
You expect to collect GIS. The Guaranteed Income Supplement (GIS) tops up government pensions for low-income Canadians starting at 65. But most kinds of income—including CPP payments—result in a steep clawback: you give up 50 cents of GIS for every dollar of CPP pension. (Old Age Security payments don’t count against you in the GIS calculation.) That’s a good reason to take your CPP entitlement before 65: lowering your benefit after that age may help you keep more of your GIS benefit.

People who collect GIS “live in a perverse world where anything they can do to get their CPP out before 65 is preferred,” says Hamilton. If you don’t actually need the money, draw CPP early anyway and put it into a Tax-Free Savings Account. Taking money out of a TFSA later won’t trigger a clawback on your GIS payments.

Reason # 3 for early CPP
You spent several years out of the workforce. There’s a good chance this little-known technicality applies to you if you spent a lot of time away from work years ago, and you’re now retiring for good. It’s complicated, so bear with me while I try to explain.

Your pension amount depends on averaging your contributions and “pensionable earnings” from age 18 until you start taking CPP. You’re allowed to drop 15% of your lowest-earning years from the calculation, which amounts to seven years if you retire at 65. If you took time off work to raise kids or because you had a serious disability, you get to drop even more of your low-earning years.

The thing is, it’s easy to use up all your drop-out years if you spent a long time getting an education or just “finding yourself.” If you then stop working in your early 60s and don’t take CPP right away, you’ll immediately start adding more years of zero earnings to the calculation. This will lower your average pensionable earnings, which in turn will make your benefit go down. Under these circumstances, you’re clearly better off starting CPP early.

By my estimates, this factor in isolation can reduce your pension by as much as 2% to 3% for each year you delay taking CPP after age 60. So for people in this situation, the overall net cost of starting CPP early is liable to be 3% or 4% per year (that’s the current 6% overall reduction, minus 2% to 3%). That can make early CPP a bargain.

One MoneySense reader was surprised to discover this the hard way. “It makes no sense,” he wrote. “Since my CPP will start shrinking, it would be insane for me to wait any longer.”

Now let’s have a look at a couple of reasons that might encourage you to start taking your CPP benefit at 65 or later:

Reason #1 for later CPP
You have a longer-than-average life expectancy. If you expect to live to a ripe old age, it pays to delay the start of CPP so you can draw larger monthly payments, because you’ll collect more over time. However, it’s hard to tell in your early 60s whether you’re going to be one of those Methuselahs. Having a lot of exceptionally long-lived forebears provides the best clue. “If all your grandparents lived to be 100, then you probably have a long life expectancy, unless you’re in poor health,” advises Hamilton.

Reason #2 for later CPP
You plan to continue working and earning a good income. Starting in January, you’ll be able to start drawing early CPP even if you’re working full-time. But why start your pension if you don’t need it? Delaying the payments not only helps you avoid seeing your payments adjusted downward—it may also keep you in a lower tax bracket. For similar reasons, if you have started drawing a sizeable employer pension early, you probably won’t need the extra income from CPP.

Final thoughts
Any of these factors might encourage you to take CPP early or later, but there’s one that trumps everything: your genuine need of the money. Taking CPP early won’t maximize your lifetime benefit if you live to 103. “But if you have no viable way to live without the income, then you need the income,” advises Hamilton. And if none of the factors we’ve described tilts your decision one way or the other? Well, then you can’t go too far wrong.

As you can see in the chart below, under the current rules, if you live a normal lifespan of 83 years, you’ll get the biggest lifetime payout from CPP by opting to start payments at age 65. That has now changed.

Under the new rules, if you live an average lifespan, you’ll get the biggest lifetime payout by waiting until age 70 to begin drawing on CPP. The government has increased the penalty for taking CPP early across the board, so you’ll get a smaller lifetime payout by taking it early, however long you live.

As a general rule though, the method you should use for choosing when to start taking CPP won’t change under the new rules, which will be gradually phased in until they are in full effect in 2016: If you think you’ll die young, take CPP early. If you think you’ll live until 93, put it off as long as you can.

(Click to view larger image)

Methodology:
1. All figures are in current 2011 dollars, to reflect current purchasing power which removes the effects of inflation. (CPP pensions are indexed for inflation so amounts will keep pace with inflation.) We have based the figures on the example of a CPP pension paying $800 a month if started at the regular retirement age of 65, which is less than the current maximum of $960 a month. No adjustment has been made for the time value of money.

2. Life expectancy at age 60, average of male and female. Source: Statistics Canada.

3. CPP pensions are reduced in 2011 by 6% a year for each year they are started earlier than the regular retirement age of 65, to a maximum of 30%. A larger reduction factor will be phased in during the period 2012-2016, after which pensions will be reduced by 7.2% a year for each year they are started early, to a maximum of 36%. The pension example we used pays $560 a month if started in 2011 at age 60. It will instead pay $512 a month in today’s dollars if started in 2016 or subsequently at age 60. The new adjustment factors will not affect pensions started in prior years.

4. CPP pensions are increased in 2011 by 6.84% a year for each year they are started later than the regular retirement age of 65, to a maximum of 34.2%. A larger increase will be phased-in until 2013, when pensions will be increased by 8.4% a year for each year they are started later, to a maximum of 42%. The pension example we used pays $1,074 a month if started in 2011 at age 70. It will instead pay $1,136 a month in today’s dollars if started in 2013 or subsequently at age 70.

There has been quite a bit of cheering already for the proposed changes to the Canada Pension Plan, which the federal government unveiled this week. But you may want to look closer at the fine print (and do some number crunching) before thanking Finance Minister Jim Flaherty yourself. 

The changes to CPP are supposed to reflect, in the government’s words, “the many different paths people take to retirement today.” True enough. These days, some of us want to retire early, others want to keep working past 65. Many more wish to ease into retirement by working part-time for a while. 

By far the biggest change to CPP will let Canadians keep working while collecting retirement benefits. Under the current rules, if you take early retirement, but want to keep working, you have to stop working for two months or substantially reduce your income for two months. After the two-month period ends you can go back to work or earn more and you’ll still qualify for CPP. The government wants to eliminate that red tape. Under the new rules, which take effect in 2012, you’ll be able to keep your old job while collecting CPP. The idea is that if you work for your old employer part-time, CPP will help supplement your income. So you’ll earn as much as you used to when you were working full-time.

Sounds great, but watch out for two catches. The first is that the government is reducing CPP payments to early retirees. Instead of collecting 70% of your full CPP if you retire at 60, you’ll only get 64%. That’s a significant drop, says Robert Abboud, a certified financial planner in Ottawa and author of No Regrets: A Common Sense Guide to Achieving and Affording Your Life Goals. It adds up to around $660 less in CPP a year for someone who qualifies for the maximum benefits.

Catch number two is you’ll have to pay into CPP if you keep working past 60. That’s a huge change from the current system in which anyone collecting CPP while working doesn’t pay into the program. Abboud figures it will end up costing working retirees hundreds of dollars more a year through payroll deductions. “What they’re proposing doesn’t seem like a winning proposition for my clients’ pocketbooks,” he says.

Abboud isn’t impressed either with another proposed change to CPP–one that will encourage people to work well past 65. Under the current system, anyone who delays retirement until 70 sees their benefits boosted by up to 30%. Under the new program, benefits increase up to 42%.

Again, it sounds great, especially if your RRSPs were decimated by the stock market collapse last fall, and you think you’ll need to work past 65 anyway. But as Abboud points out, the reality of working at 70 isn’t pretty. Most of your peers will have long since retired and it’s hard to keep up with the physical demands of going into the office every day at that age. The best retirement years are actually during our 60s, when we’re still relatively healthy and able to take long vacations and shoot 18 rounds on the golf course with ease.

He’s right. Encouraging people to work longer may be good for the economy and for government coffers. But it’s hardly going to make your retirement more enjoyable. If you work until 70, you may find the best years of your retirement were squandered behind a desk.

The government has an information paper detailing all the proposed changes to CPP. You can read it at http://www.fin.gc.ca/n08/data/09-051_1-eng.asp

 

We feel your pain. So let us reassure you. Despite what you may think, there is a lot of good news about retirement. We’ve talked to a wide-ranging selection of financial experts and we’ve come away with one conclusion — you’re doing far better than you think you are. Join us as we reveal 10 things that most people don’t know about retirement, but should.

1. You’re not behind at all

The ads make it sound as if 55 is a reasonable retirement age. In fact, for most of us it’s not. The median retirement age in Canada is 62 for men and 61 for women, according to Statistics Canada. Who does retire early? By and large, federal government employees, who ditch work at a median age of 58. You can credit their early departures to generous pensions that are indexed for inflation. But even public-sector employees aren’t hanging up their work clothes at 55.

If you look at the math behind retirement, you can see why most of us stick around the office a bit longer than we might like. For every year early that you retire, you pay three penalties: you lose a year of potential savings, you lose a year of growth for your retirement savings, and you gain one more year of retirement expenses.

Consider a woman who hits 55 in good financial shape, with a paid-off condo and $100,000 in savings. She can count on her savings to produce $4,000 or $5,000 a year in returns, but she’s too young to start collecting Old Age Security or Canada Pension Plan. Unless she resorts to desperate measures, such as selling her condo or burning through her savings, retirement is impractical.

But look at what a difference five years can make. If she buckles down and contributes $10,000 a year to her retirement fund during that period, and achieves a 7% annual average return, her savings double to $200,000. That bankroll can generate $8,000 to $10,000 a year in income as long as she lives. At 60, she can also start collecting Canada Pension Plan. If she combines those sources of income with part-time work, a phased-in retirement becomes quite practical.

2. You’ll live longer than you expect

When we’e doing our retirement planning, many of us figure that we’ll live to 80, the average lifespan in Canada. But that average is misleading. It reflects what a newborn baby can expect in the way of lifespan and is dragged down by all the unfortunate people who die relatively young.

If you’ve managed to reach 65 without suffering a terminal illness, you’ll probably live considerably beyond 80. According to StatsCan, a 65-year-old man can expect to live to 83; a 65-year-old woman can look forward to blowing out the candles on her 86th birthday.

And remember — those are averages. Half of retirees live longer, some much longer. Moshe Milevsky, an associate professor of finance at Toronto’s Schulich School of Business at York University, says there is a 41% chance that at least one member of a 65-year-old couple will live to 90. So even if you don’t quit work until 65, there’s a good chance that your retirement could still wind up spanning a quarter or more of your life.

3. You’ll see more of your partner — a lot more
Sure, you love your spouse, but let’s do a little math here. Chances are, for most of your married life at least one of you has worked outside the home. Subtract sleep, travel time and other away time and you’ve seen your beloved for— at most — six hours a day.

In retirement, that figure can easily double. And continued exposure can cause even happy couples to bicker. Fred and Janet Barnes (not their real names) retired to Dickey Lake, Ont., to renovate a cottage after living in and around Toronto for most of their lives.”His perfectionism drove me a little crazy,” says Janet. “My slapdash methods were hard for Fred to take.” The Barneses eventually figured out ways to divide the work so they wouldn’t get on each other’s nerves.

Other retired couples strike different bargains — maybe the kitchen becomes her territory, while the garage becomes his — but whatever the specifics of the deal may be, the important point is to realize that retirement is not just a financial journey. It’s also an emotional odyssey and you should plan ahead to make the most of it.

Beginning in your 50s, you should start thinking about the activities that will fill your day in retirement. “You’re going to need to stay connected,” says Dr. Randy Swedburg, chair of the applied human sciences department at Concordia University in Montreal. Your many options include going back to school, giving your time to charity, or starting your own business.

4. A part-time job is worth $400,000 in the bank

If your retirement savings are a bit smaller than you had hoped, take heart — a part-time job in retirement can go a long way toward making up for an undersized portfolio.

Let’s say that you can make $20,000 a year from your part-time job. That is about what you could reasonably expect a $400,000 investment portfolio to generate in retirement, says Terry Greene, a fee-only planner with MSC Financial Services Ltd. in North Vancouver. So your part-time job is the financial equal of a $400,000 portfolio. Especially if your part-time job consists of doing work youenjoy, you may find that you never want to fully retire.

5. Your employer really does love you

The first wave of baby boomers has already hit 60. Millions more will soon hit retirement age. And there are not that many people coming up behind them. “The demographic trends are suggesting that over the next 10 to 15 years, we’re not going to replace the workforce that currently exists,” says Ted Emond, a senior consultant with Hewitt Associates, a human resources consulting firm in Toronto.

The likely result of Canada’s aging society is a potential labor shortage that will make skilled help more and more valuable with each passing year. HSBC Bank Canada, is already attempting to keep older employees in the workforce by letting them work part-time while collecting pensions. Wal-Mart Canada allows its retirees to come back as consultants or to mentor current employees. Count on more employers to do the same as demographics makes skilled employees tougher to find.

6. Government is more generous than you think

The financial planning industry likes to cast doubt on the future of Canada Pension Plan. In fact, CPP is on solid financial ground after the reforms of a decade ago, according to the federal government’s chief actuary. CPP (or Quebec Pension Plan in the case of Quebecers), combined with Old Age Security, will provide you with an average of $11,500 a year if you’ve worked in Canada your entire life and retire at 65. The maximum you could qualify for is about $16,600 a year.

Don’t forget, too, that you’re eligible for a Guaranteed Income Supplement if you’re a low-income retiree. “For low-income [earners], government programs are going to provide you with the standard of living you’ve always been used to,” says Malcolm Hamilton, a consulting actuary with Mercer, a benefits consulting firm in Toronto.

7. You may be missing free money

A Sun Life Financial survey found nearly 40% of us have access to savings programs in which our employer kicks in money to supplement what we contribute. But one in five
of us who are eligible for such plans doesn’t participate. As a result, we lose guaranteed returns of 25% or more.

You should inquire with your human resources department to make sure you’re not missing out. Many publicly traded companies offer employee stock ownership plans with an employer match. If you buy $80 of your company’s stock each month through such a plan, your employer kicks in an additional $20 a month — an instant investment return of 25%. Other companies offer retirement plans in which the company matches your contribution dollar for dollar — a guaranteed return of 100%. In either case, the money is free and you should grab it.

8. You don’t need a million bucks

Financial planners like to say you’ll need 70% of your current income in retirement. To hit that goal, a middle-class couple will need to amass a million dollars or more in savings. But is the 70% figure truly a good estimate of what you need in retirement?

Probably not. Brian FitzGerald, co-author of The Pension Puzzle and chief executive officer of Capital G Consulting in Toronto, says
you have many more costs while you’re working than while you’re retired, so your need for cash in retirement is considerably less than the 70% figure suggests. “There’s a bunch of expenses you don’t have to incur in retirement,” he says. For instance, most retirees no longer have to worry about paying off a house, funding their kids’ education, making RRSP contributions or commuting to work. And they pay substantially less in income tax because they’re earning less.

So how much of your current income do you really need to maintain your standard of living in retirement? “I’m pretty confident that 50% will do the job for most people,” says Hamilton, the actuary. Of course, if you want to live lavishly and travel constantly, you will need more, but if you’re happy to go on living much as you always have, replacing half of your working income should do the job.

9. RRSPs aren’t always the answer
Canada has five seasons: winter, spring, summer, fall, and RRSP time. But while we’e annually bombarded with ads telling us to stuff money into our RRSPs, don’ think of those four-letter contraptions as your only option in retirement planning.

RRSPs are not your best strategy if you have high-interest debt, such as a credit card balance. Given the 18% or more you’re probably paying on your credit card debt, you should first devote every available dollar to paying down that costly debt. RRSPs may also not be your best option if you’re a low-income earner, since the tax savings that result from making an RRSP contribution aren’t worth much if you don’t pay much tax to start with.

If the federal government goes ahead with its proposal to introduce tax-free savings accounts next year, RRSPs will have an additional competitor for your attention. Ottawa’s proposal, as it now stands, would allow each of us to put up to $5,000 a year into a tax-free savings account, or TFSA. You won’t get any tax deduction
for doing so, but your money will grow tax-free. And you will be able to withdraw the TFSA money without paying any taxes. While the math gets complicated,”I would think people with below-average incomes are better with TFSAs,” says Hamilton, the actuary.

10. There’s a world of possibilities
One option that can instantly multiply your retirement spending power is to leave Canada behind. Mexico, Costa Rica, Malaysia and Panama all enjoy far better weather than we do, and much lower costs of living. “Overall, there is no question you can live here on one-half to one-third what you could in any Canadian city and have a good lifestyle,” says Tom Dawson, 54, who with his wife, Donna, moved to Panama City nearly two years ago from St. Albert, Alta. The 1,800-sq.-ft. condominium they bought overlooks the Pacific Ocean and the Panama Canal, and cost them less than $200,000. Medical care is excellent, locally grown produce is cheap and foreigners who retire to Panama with a pension can qualify for several tempting tax breaks, including an exemption from property taxes.

The federal government offers primers on retiring abroad (click
on www.voyage.gc.ca and search “Retirement Abroad”). Another
useful source of information is The Canadian Snowbird Guide by
Douglas Gray. But no book or website can fully convey the day-to-day reality of a foreign country. Try out a destination before making any permanent decisions. Rent a home for a year and see what daily life is like. If it matches or exceeds your expectations, you may be able to afford the retirement of your dreams on far less money than you expected.