Weighing options on government pension plans
If you’re in your 60s and facing the prospect of extended job loss because of the COVID-19 crisis, now might be a good time to brush up on what your government pensions have to offer.
To be sure, starting your payouts from the Canada Pension Plan (CPP) and Old Age Security (OAS) isn’t something you should do to tide yourself over for a few months until the economy starts up again.
But it makes sense to consider starting these government pensions if it looks like your COVID-related job loss will turn into more or less permanent retirement.
In what follows, we describe how much CPP and OAS could pay you and how to decide when to start them. The best decision depends on your preferences and personal circumstances, including how the COVID-19 crisis may have affected your portfolio.
Since you may want to keep open the option of returning to work at some point — even if just part-time — we also describe how you would build a CPPrelated entitlement called the PostRetirement Benefit (PRB), which applies if you go back to work after already having started your regular CPP benefits.
Let’s start by reviewing the CPP and OAS basics. While age 65 is considered the traditional “standard” age to begin both pensions, you can in fact start CPP between age 60 and 70, and OAS between 65 and 70. If you start CPP earlier than 65, the payout is reduced by 7.2 per cent per year. If you start CPP or OAS later than 65, your payout is enhanced by 8.4 per cent per year for CPP and 7.2 per cent per year for OAS.
CPP payouts are determined by a complex formula based on contributions from both you and your employer over your working years. OAS is paid out of general federal government funds based on long-time Canadian residency.
Most Canadians who start their pensions this year at age 65 receive the maximum OAS pension for that age of $7,362 a year (as of April-June 2020), but less than the maximum CPP age-65 pension of $14,110. Both pension payouts are indexed for inflation. (In addition, there is a third pension benefit paid to low-income Canadians starting at age 65 called the Guaranteed Income Supplement.)
It doesn’t generally make sense to start CPP and OAS if you’re just temporarily out of work. While you might welcome the income for a few months, you won’t need the money when you’re working again. At that point, you’ll probably be back in a relatively high tax bracket so the pension payouts will be taxed more heavily.
And you would have gotten a bigger payout if you had waited until you permanently retire, when you probably need the money the most.
However, if you’re expecting to return to work part-time earning just a little income, that’s a grey area. In that case, the best decision will depend in part on how much employment income you think you’ll generate each year and for how many years.
The government set the adjustment factors for timing your pensions years ago so that they were reasonably fair either way and were meant to confer no general financial advantage for starting early or late, assuming you had average life expectancy. While that concept hasn’t been applied consistently (CPP and OAS deferral factors are different) nor updated for current low interest rates, in my view you should time your decision to suit your personal circumstance without feeling that the overall deck is stacked against you in any dramatic way.
Individual circumstances can nudge your decision in either direction. If you’re in great health and have cause to believe you have exceptionally long life expectancy, that might tilt your decision toward deferral (since you’ll collect larger payments for longer). If you’re in poor health and anticipate shorter-than-average life expectancy, consider starting payouts as early as you can. There are also technical factors in the exceedingly complex way that CPP is calculated that can affect your decision to a modest degree.
The size of your nest egg and how that money is invested can also impact your decision. If you start your government pensions immediately upon retirement, you free up money in your nest egg to invest for later. Conversely, if you defer government pensions upon retirement, you generally need to draw more heavily on your portfolio during the deferral period to provide money to live on.
Of course, if you don’t have many savings or other income, it generally makes sense to start government pensions as soon as you retire and are eligible. If you need the cash flow, take it.
If you have a fairly sizable portfolio, the COVID-19 financial crisis can potentially nudge your decision either way. By now, you’re probably familiar with the advice to stay the course during a stock market sell-off and avoid selling stocks at distressed prices, which for retirees typically entails drawing cash flow from the relatively unaffected fixed income and cash sides of their portfolios. But central banks have driven down interest rates to ultralow levels to combat the COVID-19 crisis. As a result, pension deferral rates look relatively attractive compared to the paltry interest you can earn by keeping the fixed income side of your portfolio intact. In that situation, pension deferral makes a lot of sense.
If your portfolio isn’t so ideally structured and drawing down now requires you to sell stocks at distressed prices, then starting CPP and/or OAS right away might be the right choice. In that case, your CPP and OAS payouts can help meet your cash flow needs while giving your depleted stock portfolio a chance to recover undisturbed.
Post-Retirement Benefit If you start CPP benefits then later go back to work, your new job doesn’t affect your regular CPP benefits, which continue to be paid at the same rate. However, you generally start to build up a Post-Retirement Benefit. Participation is compulsory if you’re younger than age 65, but voluntary after that.
Contributing voluntarily to PRB after age 65 almost always makes sense if you’re an employee because your employer is then obligated to match those contributions, so you get all the benefit while only making half the contributions. On the other hand, if you’re self-employed and therefore contribute both the employee and employer portions, the decision is not so clear-cut.
The way PRB works is as follows. If you go back to work, your contribution in the first year results in an annual benefit that starts the following year. The maximum annual contribution that you and your employer could be required to make is $2,898 each in 2020 (which applies if you had annual employment earnings of $58,700 or more). That contribution, in turn, would result in an annual PRB payout of $388 starting next year, according to projections by government pensions expert Doug Runchey at drpensions.ca. (The precise 2021 payout hasn’t yet been determined.)
The size of the PRB payout is roughly equivalent to the enhancement to your CPP entitlement that you would have received had you not yet started CPP benefits (although there are complicated exceptions if you’re younger than 65). Similar to regular CPP, PRB payouts are indexed for inflation and adjusted for age. If you earn and contribute less than the maximum, your contributions and payouts are reduced roughly in proportion.
COVID-19 senior’s payout One more thing. The federal government announced last week it would be making a onetime tax-free payout of $300 to seniors “eligible” for OAS to help offset COVID-19 costs. Program details are still unclear, but the government’s use of the word “eligible” appears to mean the benefit won’t just go to seniors receiving OAS, but to all seniors who could receive OAS regardless of whether they have chosen to start payouts or not. Essentially, all long-time Canadian residents 65 or older are eligible for OAS. (Seniors eligible for GIS will get an additional one-time tax-free payout of $200.)
David Aston, a freelance contributing columnist for the Star, is the author of “The Sleep-Easy Retirement Guide.” He is a personal finance and investment journalist. He has an M.A. in economics and is a Chartered Professional Accountant. Reach him via email: davidastonstar@gmail.com