I’ve written extensively about the issues around taking CPP early. It’s one of the big conundrums of Canada Pension Plan and my conclusion has always been that it makes sense to take CPP as early as you can in most cases. Does the results change given that there are a new set of rules coming? Here’s four questions to ask yourself in determining if it makes sense to take CPP early.
Will you still be working after 60?
Under the old rules, you had to stop working in order to collect early CPP. The work cessation rules were confusing, misinterpreted and difficult to enforce so it’s probably a good thing they will be a thing of the past.
Starting January 1, 2012, anyone turning 60 can start to collect Canada Pension Plan as soon as they turn 60. You don’t have to stop working. So now, the conundrum of taking CPP early will be an issue as soon as you turn 60. You can still be working and apply to collect it early but the catch is you have to keep paying into CPP even if you start collecting it early. The good news is paying into it will also increase your future benefit.
What is the mathematical break-even point?
Under the old rules, the decision to collect CPP early was really based on a mathematical calculation of the break-even point. With new rules coming, every Canadian needs to understand the math. Here’s an example of two twins I used before:
“Janet and Beth are twins. Let’s assume they both qualify for the same CPP of $502 per month at age 65. Let’s further assume, Beth decides to take CPP now at age 60 at a reduced amount while Janet decides she wants to wait till 65 because she will get more income by deferring the income for 5 years.
Under Canada Pension Plan benefits, Beth can take income at age 60 based on a reduction factor of 0.5% for each month prior to her 65th birthday. Thus Beth’s benefit will be reduced by 30% (0.5% x 60 months) for a monthly income of $351 starting on her 60th birthday.
Let’s fast forward 5 years. Now, Beth and Janet are both 65. Over the last 5 years, Beth has collected $351 per month totaling $21,060. In other words, Beth has made $21,060 before Janet has collected a single CPP cheque. That being said, Janet is now going to get $502 per month for CPP or $151 per month more than Beth’s $351. The question is how many months does Janet need to collect more pension than Beth to make up the $21,060 Beth is ahead? It will take Janet 140 months to make up the $21,060 at $151 per month. In other words, before age 77, Beth is ahead of Janet and after age 77, Janet is ahead of Beth.”
Another way to phrase this question is “When are you going to die?” This math alone is a very powerful argument for taking Canada Pension Plan early.
Under the new rules, the mathematical break-even point changes because they will be increasing the reduction from 0.5% per month to 0.6%. In the above example, Beth would get $321 instead of $351 at age 60. This moves the break-even point to age 74 instead of 77.
If you want to see the new breakeven points for 2012 to 2016, visit Taking CPP early: The new breakeven points
When will you most enjoy the money?
When are you most likely to enjoy the money? Before age 74 or after age 74? Even though the break-even point is three years sooner, for most people, they live the best years of their retirement in the early years. I call these the ‘go-go’ years (which is one of three phases of retirement).
Some believe it’s better to have a higher income later because of the rising costs of health care. Whatever you believe, you should plan for. It might be worthwhile to look around your life and see the spending patterns of 70, 80 and 90 year olds to assess how much they are really spending. Are they spending more or less that they did when they were in their active retirement years.
What happens if you Leave money on the table?
Let’s go back to Beth who could collect $321 at age 60. Let’s pretend she gets cold feet and decides to delay Canada Pension Plan one year to age 61. What’s happened is she ‘left money on the table.” In other words, she could have taken $3852 from her CPP ($321 x 12 months) but chose to leave it to get more money in the future. That’s fine as long as she lives long enough to get back the money she left behind in the first place. Again, it comes back to the math. For every year she delays taking CPP when she could have taken it, she must live one year longer at the back end to get it back. By delaying CPP for one year, she must live to age 75 to get back the $3852 she left behind. If she delays taking CPP till 62, then she has to live till 76 to get back the 2 years of money she left behind. Why wouldn’t you take it early given this math? The main reason is you think you will live longer and you will need more money the older you get.
My two cents
I think if people understand the math of Canada Pension Plan, most people will take it early. In 2012, you can take it early even if you are working. The bad news is you will get hit with a bigger reduction with the new rules. Some say its also bad news because you will have to keep paying into CPP if you are working (under the new rules). To me, that’s not such a bad thing because paying into it also increases your future benefit so it’s not like you are not going to get your money back. I don’t think the increased reduction is enough of a deterrent because a bird in your hand is better than two in the bush.