Retirement
Following our earlier examination of the Canada Pension Plan and the factors that affect how your benefits are calculated, you may be left wondering if there's a good argument for starting your CPP benefits before you turn 65. To help explore this, we'll look at a scenario involving two individuals, Bob and Sue. Both are turning 60 and have decided to retire, and both are set to receive $700 per month in CPP benefits based on a retirement age of 65.
Bob has carefully considered the situation, and is more than a little deterred by the 36% reduction he'll incur by opting to start receiving his CPP benefits at 60. Therefore, he resolves to wait the additional 5 years in order to collect the full $700 per month to which he is entitled.
On the other hand, Sue decides that she would rather take the money now, and is prepared to accept the reduced monthly payment. Even with the 36% reduction, Sue will still receive $448 per month. Extending this out over 5 years (60 months), Sue will have received $26,880 in CPP benefits by the time she turns 65, while Bob has yet to receive a single payment.
Once Bob does start to receive his benefits at 65, he'll get $252 per month more than Sue. But even at this rate, it will take Bob just over 106 months – or 8.8 years – to make up the amount Sue has enjoyed during the previous 5 years. Consider also that Bob will be nearly 74 years old when he finally “breaks even” and catches up to Sue.
Setting aside the math and taking a more subjective look, Sue will have had access to her pension at a younger age than Bob. While there are exceptions, most of us can expect overall better health and activity levels in our early 60s, while we tend to slow down in the ensuing years. Not everyone follows this pattern, of course, so it's up to the individual to decide between receiving a reduced CPP benefit while younger, or waiting longer for a higher payment amount.
How years with no income impacts your CPP amount
If you retire at 60 but decide to wait until you turn 65 to start drawing CPP, the five years between 60 and 65 where you don't have employment income could actually reduce your CPP benefits. As we explained in our earlier CPP discussion, your CPP benefit amount is calculated based on your yearly contributions from the age of 18 to 65. A total of eight of your lowest contribution years during this time will be discarded from the calculation, which ensures you won't be penalized for those years when you had little or no income.
You can see your CPP contributions for each year on your most recent CPP statement of contributions. This also indicates all the years for which you currently have zero contributions.
By retiring at 60, you will have an additional five years of zero income included in your CPP calculation. If you’ve already allocated several years to cover the time you were at school or not working for one reason or another, adding another five years could well exceed the eight years exempted from the calculation. This means several years of zero income will now be included in your calculation, leading to a reduction in your CPP entitlement.
Taxes
If you have a well-paying workplace pension that begins to pay benefits at 65, or a significant RSP that must be converted to income no later than December of the year you turn 71, you may want to begin receiving your CPP benefits once you turn 60. You'll receive less each month, although for a longer period of time, as discussed above. But this also means your CPP benefit will have less of an impact on the total amount of income tax you will owe. This could make a significant difference when you do start to receive your pension or RSP income.
With so many things to think about regarding your future tax obligations, seeking input from a tax expert could be time well spent. Paying income tax in your retirement years may be unavoidable, but there's no reason to pay more than required.