When should you start taking CPP? Take it too early or too late and you could sell yourself short

If you’re preparing for retirement, you’ll need the Canada Pension Plan (CPP) and Old Age Security (OAS) to provide a solid foundation of retirement income. Taken together, the two plans will likely provide more of your retirement income than you think.

But with so much at stake, you’ll want to get the timing right as to when to start these government pensions. If you take them early, your payments will be reduced, but you’ll get them for longer. If you take them later, the payments will be larger.

Deciding when to start taking them is an important decision, and it’s not an easy one to make.

Fortunately, the government has set up your pension timing choices to be reasonably fair. Still, there are a number of individual factors that can nudge your timing decision earlier or later based on your particular situation and preferences. I have a look at them below.

But first, a little primer on CPP and OAS basics.

While age 65 is considered the “standard” age for beginning both CPP and OAS, you can in fact start taking CPP any time between ages 60 and 70, and you can start OAS any time between 65 and 70.

If you start CPP earlier than 65, the payout is reduced by 7.2% for every year earlier you take it, to adjust for you drawing more payments over a longer retirement. If you start CPP or OAS later than age 65, your payout is enhanced to compensate you for drawing fewer payments over a shorter retirement. (In that case, the enhancement is 8.4% per year for CPP and 7.2% per year for OAS.)

Most Canadians who start their pensions at 65 receive the maximum OAS pension of $ 7,362 per year for people that age (as of December 2019), but less than the maximum CPP age-65 pension of $ 13,855 per year in 2019. OAS payouts are based on length of Canadian residency, whereas CPP payouts are based on contributions according to a complex formula. Both pensions are indexed for inflation.

The government set the adjustment factors for timing your pensions years ago to be “actuarially neutral,” which means they were intended to confer no general financial advantage for starting your pensions early or late, assuming you have average life expectancy.

However, that concept hasn’t been updated for today’s very low interest rates. Nor has it been applied consistently (as shown by the fact CPP and OAS deferral factors are different). But it should at least give you confidence that you can make whatever decision suits you knowing the deck isn’t stacked against you in any dramatic way.

Now we discuss factors that may nudge you to start your government pensions as soon as you retire and are eligible or, alternatively, defer them until later.

Three reasons for starting early

Your health is poor. If you’re in poor health and you are anticipating a significantly shorter-than-average lifespan, then it generally makes sense to take a reduced rate and start your pensions as early as you can after retirement. That should allow you to maximize how much pension income you draw over your remaining lifetime.

You need the cash flow. If you don’t have much in the way of savings, it often makes sense to start government pensions as soon as you are retired and eligible.

That’s pretty obvious if you are a low-income Canadian with little or no other source of income. In that case, your government pension income is probably essential for supporting yourself.

However, starting government pensions early can also make sense if you have very limited savings but you don’t have a particularly low income, because you have other modest income sources like an employer pension. Since it’s a good idea to maintain a decent amount of savings for a “rainy day” fund to cover a sudden need, it probably makes sense to draw government pensions early if it allows you to preserve your meagre savings for later.

You’ve spent lots of time out of the workforce. Technical factors in the complex way CPP is calculated can work against deferring CPP to a modest degree if your working career had a late start or long breaks in it.

If you’re in that situation and you fully retire in your early 60s, but defer starting CPP until age 65, then these additional “zero income” years can dilute your CPP payout by up to about 2.5% a year. You’ll still be rewarded somewhat on a net basis for deferring the start of CPP, but it tends to make deferral somewhat less attractive.

Two reasons for starting later

You have an above-average life expectancy. If you have good reason to believe that you’ll live an exceptionally long life, then you can expect to collect more money by delaying government benefits as long as possible up to age 70.

You want a reliable income that isn’t affected by low interest rates. It’s important to understand that if you start government pensions immediately upon retirement, you free up money in your nest egg to invest for later. Or conversely, if you defer government pensions, you generally need to draw more heavily from your portfolio during the deferral period.

I mentioned how the government originally set the deferral factors in a way that was reasonably fair to both options assuming you have average life expectancy. However, if you have ample savings and no employer pension, deferring your pensions is a particularly effective way to build up your capacity to generate relatively safe and reliable income, if that’s an important objective for you.

Or as has been expressed by certified financial planner Jason Heath of Toronto-based Objective Financial Partners: “It forces you to draw on your risky volatile assets — ones where you don’t know how they will perform over the balance of your life. Conversely by deferring CPP and OAS, it increases your solid guaranteed, inflation-protected, defined-benefit-type income.”

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While the deferral option described above has always made sense in the right situation, it has become a little more attractive in the current low interest rate environment. That’s because the alternative of generating reliable income from relatively safe investments like government-insured GICs and top-rated bonds is more difficult with interest rates so low.

Bottom line: Consider how the different pension timing factors affect you and then do what fits your situation and preferences. One more thing — if you reach 65 and only want to defer one government pension and not both, then defer CPP rather than OAS because the deferral rate is a bit higher.

David Aston, CFA, is a freelance personal finance and investment journalist. He has an M.A. in economics and is a Chartered Professional Accountant. In January, he will be publishing a new book, “The Sleep-Easy Retirement Guide,” available at bookstores across the country.

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