CPP: Maximizing your Benefit
Posted 24 Aug 2015 by Rick Irwin, CFP, CLU
There are many misconceptions around the level of income that will be received with the CPP. Some people naively assume they will get the maximum benefit while others are more pessimistic and discount it entirely as a potential source of retirement income due to fears that it won’t be around when they need it.
How much will I get?
The current CPP maximum for 2015 is $1,065.00 per month. Many people mistakenly think they’ll receive the maximum as they’ve worked their entire lives. However, the average CPP payout is around $550 per month. The reasons for this are:
- Not having paid in long enough. To receive the maximum CPP benefit, you need to have contributed to the plan for the majority of time that you were eligible to contribute. This period spans a 47-year period, from age 18 to age 65. The government does have a “drop out” provision that allows you to subtract a number of low or no income years from the calculation (with an additional amount for child rearing). The magic number of years is 39. In other words, you will not receive the maximum CPP benefit unless you contributed to the plan for at least 39 years between the ages of 18 to 65.
- Not having paid in enough. Your CPP payment in retirement is based on your salary during the 39 years of the contribution period. If you paid in at the maximum level (which is based on a figure called the Yearly Maximum Pensionable Earnings, or YMPE) in each of the 39 years you will receive maximum CPP in retirement. If you didn’t pay in at the level of YMPE for any of the 39 years, however, your CPP will be reduced proportionately. The YMPE for 2015 is $53,600.
- Drawing CPP early. Most Canadians chose to take CPP early, at age 60. In fact, Service Canada stats shows that 2/3rds of CPP eligible Canadians take it early. In addition to any reductions for the above reasons drawing CPP early means a reduction of 36% of the benefit you would have been entitled to (as of 2016). This penalty used to be a 30% reduction, based on a 0.5%/month, but was gradually increased to 0.6%/month over the last several years to make it more punitive to draw early.
With many Canadians entering the workforce later due to education, and the desire for an early retirement, assuming that you will receive full CPP is probably a faulty assumption for many.
Will it be there when I need it?
There used to be a time when financial plans counted CPP as a “gravy” item rather than the core building block that it is today. But the government enacted significant reforms in 1998; increasing the combined employee/employer contribution levels from 5.8% to 9.9% and establishing the independent Canada Pension Plan Investment Board and enabling this body to invest in stocks, Canadian and global, real estate and infrastructure assets. The CPPIB has delivered strong returns since then and in 2010 the government’s chief actuary confirmed that the CPP is sustainable for the next 75 years. Given this backdrop, when I prepare retirement income projections I do count CPP as a key, reliable, income source.
Do I have to stop working to draw CPP?
Under the former rules, to begin to draw CPP at age 60 you needed to stop working for a period of two months. Then, once you began to draw CPP, you were unable to continue to contribute to CPP and increase your retirement income if you returned to work; your CPP income was capped at the level it was when you began to draw it. Recent changes allow you to take CPP without requiring an interruption in employment. If you continue to work the new rules allow you (in fact require you, at least up to age 65) to contribute to the plan at the same time you are collecting CPP benefits. Each year that you work your CPP income will be increased by an amount called the “post retirement benefit (PRB).” The maximum PRB for each year is equal to 1/40th of the maximum CPP retirement pension amount. If you contribute less than the maximum amount, the amount of the year's PRB will be reduced proportionately.
What if I take CPP later?
When the government increased the reduction amount for drawing CPP early (from 30% to 36%), apparently in an effort to push Canadians to hold off on drawing this pension, they also increased the income enhancement if you chose to take CPP later in life. Under the old rules the increase to CPP was 30% if you took it at age 70 instead of 65; under the new rules if you defer CPP to age 70 your income will be 42% higher. With a $2500 lump sum death benefit and 60% survivor benefit however you need to carefully weigh life expectancy against this enhanced income level. It’s estimated that the new break-even point (the point at which you are better to have deferred taking CPP versus taking it earlier) is age 75. If you aren’t drawing CPP for these 5 or 10 years then it would mean either a reduction in retirement income during what are considered to be the peak active years or that you would be drawing from other retirement funds such as RRSPs that contain 100% survivor benefit, so careful consideration of all the elements is crucial.