Canada Pension Plan: How do the changing rules affect you?
CPP rule changes.
If retirement's on your horizon, rules being introduced to the Canada Pension Plan may affect you and your retirement income.
These reforms are being phased in through 2016 and offer important advantages and flexibility in managing your CPP benefits. But you'll have to think carefully about how the rules might affect your plans, especially if you're looking to retire early, work past 65 or work part-time in your later years.
Here's what you need to know to make the right decisions.
Greater incentive to wait
With the CPP, you can choose to begin receiving monthly payments as early as age 60, however doing so comes at a cost. There's a reduction in the amount received for each month before age 65 that you start collecting. That reduction has been increasing each year since 2012 and is scheduled to continue to increase through 2016.
By 2016 it will add up to a 7.2% cut for each year you're early. So if you choose to start receiving benefits at 60, your monthly CPP payments will be 36% less than if you wait until 65.
Delaying creates the opposite effect. The monthly benefit for delaying your payments each year past 65 has increased, topping out at 0.7% per month (8.4% annually) as of 2013. This means if you wait until 70 to start collecting, your monthly benefit will jump 42%.
It’s now much more tempting to wait to collect.
Going part-time made easier
If you want to work part-time in retirement, at age 60 you’re no longer required to stop work (or substantially reduce your earnings) for two months in order to collect CPP. But if you're under 65, you and your employer will have to make CPP contributions; they're not optional. And if you're self-employed, you'll still need to pay both the employee and employer portions.
The good news is that by continuing contributions you'll increase your pension benefits at the same time you're collecting CPP payments. In the end, combining your CPP and a part-time pay can generate a full-time income without the full-time hours.
If you're over 65, the decision to pay into CPP is up to you. If you choose to contribute you'll earn additional benefits at a rate of 2.5% of the maximum pension amount per year of additional contributions.
How Much Can You Expect?
Service Canada offers a Retirement Income Calculator to help you figure out how much pension income you can expect. By simply adjusting factors like the age you start receiving CPP benefits and changes to your future earnings, it's easy to see what effect different retirement strategies will have. The calculator will be updated with the new CPP calculation information in late November.
CPP calculates your average earnings over the span of your career to determine your benefit.
The plan currently disregards the bottom 17% of your annual earnings over your career, allowing up to a maximum of eight years of your lowest earnings to be dropped from the calculation. This feature is designed to compensate for periods when your income may have been low for reasons such as unemployment, raising children or going back to school.
Phasing in the New Rules
The new CPP rules have been brought in gradually since 2012. If you collected CPP prior to 2012, aren't working in retirement, and won't return to work after retiring, you won't be affected by these changes. The CPP contribution rate of 9.9% hasn’t changed.
Making your best choice
The CPP reforms offer you added flexibility that can potentially improve your pension income. But it may not be as simple as going for the largest benefit. To make the right retirement decisions, you need to dig deeper, consider your broader financial picture and expected lifestyle. Here are some issues to consider:
Cash flow and taxes – Collecting CPP early can have tax consequences you didn't expect. If you already have a healthy income, will adding CPP push you into an even higher tax bracket? If so, not only will you pay more in taxes, offsetting your new benefit, but you'll also lock in a lower payment because of the reduction for early collection. Taking CPP too soon could mean having less after-tax income when you will need it most – in retirement.
Tapping other retirement income sources – If you're thinking about retiring early, deciding when to start your CPP benefits is a priority. But also think carefully about how you'll use your own resources.
To begin, establish what your extra income requirements will really be. The longer you contribute to CPP and wait to collect, the larger your benefit. In turn, this will reduce the amount of money you'll eventually need from other sources.
For example, applying the 2015 maximum payment rates to the rules, a couple aged 60 would receive about $16,665 a year in combined CPP. If they can wait until 70 to collect, their joint benefit leaps to over $36,295 annually, so they'll need much less income from elsewhere. Plus, CPP benefits are fully indexed to inflation.
Waiting to collect can also boost your company pension benefits, RRSPs and other savings. If you belong to a defined-benefit pension plan at work, the size of your benefit will be driven in part by your years of service so staying in the workforce can pay off. Be aware that defined-benefit plans are often integrated with government programs which means your benefit will be reduced once you collect CPP. Pension plans can be complicated, so ask your advisor to help you thoroughly review your company plan and identify what impact retiring early may have on your pension income.
Waiting can also be wise for pension assets that you manage yourself, like a defined-contribution pension plan or your own RRSP. The more time these investments have to grow tax-sheltered, the greater your savings, and the more income your portfolio can generate later. You may even find you're able to meet your income objectives with a lower rate of return, allowing you to take less risk with your investments as you age.
But what if you choose to retire before you're eligible to collect your pension? A tax-smart option is to look to alternative sources like your non-registered savings, your TFSA, or even part-time work to fund the early years of your retirement, rather than dip into your RRSPs.
Split CPP and save tax – If you and your spouse are over 60 and at different income levels, there's an established CPP strategy that can save you tax. You have the option of sharing your CPP benefits with your spouse (or common-law partner) to reduce your income and therefore your household tax bill. But there’s a catch.
Here's how it works. Say you enjoy the maximum CPP benefit and are in a high tax bracket. Your spouse, on the other hand, earned much less while working and receives only a small CPP payment each month. You can elect to direct up to half of your CPP payment to your spouse.
So, what’s the catch? When you elect to split your benefit, your spouse’s benefit is automatically split by the same percentage and assigned back to you. Your income will therefore only be reduced by the difference between the two. However, even with this automatic assignment, as long as your income is higher than your spouse’s, this splitting strategy can still lower your combined taxes.
If you're a high income earner and eligible to collect Old Age Security (OAS), splitting your CPP can help shield you from the OAS ‘clawback’. In 2014 if your income was over $71,592 you'll receive less OAS than you would normally be entitled to. By sharing your CPP payment with your spouse and lowering your taxable income, you can take a bite out of the clawback or avoid it altogether.
Depending on your circumstances, you may be able to split other pension income to further reduce your taxes. Your advisor can help you identify which of your pension sources are eligible for splitting and how to get the most tax savings from this strategy.
The longevity question – If you’re in good health and long lives are routine in your family tree, your decision to take CPP later might be much different than for someone who's living with an illness. After all, planning to have extra income when you're older doesn't help you if you’re unable, or no longer around, to enjoy it.
One study recently reported that if your life expectancy is less than 73 you are better off taking your benefits early, at 60. On the other hand, if it's a good bet you'll live past 81, delaying your benefits until age 70 will not only give you more each month, you'll also accumulate more pension over the years. If your life expectancy falls somewhere in between, the study concludes it's best to start collecting at 65.
Next, think about your lifestyle and how you want to spend your time in retirement. Is hiking in an exotic locale or a daily round of golf part of your plans? You'll probably find it much easier to enjoy these activities at 60 rather than at 70. Spending what's likely to be your healthiest and most active retirement years on the job might not turn out to be the best decision, despite the financial advantages.
The ongoing changes to the CPP are an invitation to review your retirement strategy so you can get the most out of your pension income. If you're between 60 and 65, or soon will be, it's especially important to understand how the new rules will affect you. Your financial advisor will fully review your situation and help you create a strategy today for a better retirement tomorrow.