Two conundrums of Canada Pension Plan
Janet is turning 60 and is wondering about the two basic conundrums of Canada Pension Plan (CPP). First, she would like to know if she should consider taking CPP early and secondly, if she should she split her CPP with her 67-year-old husband Will. Her first instinct is to wait to take CPP because unlike her husband, she does not have a pension plan. While she does not need much income while Will is still alive, she feels she needs more income when Will passes away because his pension will drop 40% when he passes away.
Taking CPP early
Canada Pension Plan is normally taken at age 65. That being said, Janet can take CPP as early as age 60 and as late as age 70. To evaluate this lets introduce you to Janet’s twin sister Beth. 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 CPP benefits, Beth can take CPP at age 60 based on a reduction factor of 0.5% for each month prior to her 65th birthday. Thus Beth’s CPP 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.
From a lifestyle perspective, it can be argued that Beth is more likely to enjoy the cashflow from age 60 to 77 a lot more than Janet will enjoy the extra cashflow after the age of 77.
This example is very simplistic. It does not take into account taxes, investment returns or indexing of benefits. Regardless, taking CPP early is simply about getting more money sooner. Waiting just means you have to live longer to make up the lost income.
After debating taking CPP early, the next step for Janet is to figure out if she should split her CPP benefits with her husband. Let’s assume Janet takes CPP early and gets the $351 per month. Her total income is quite low and she only pays tax at the 25% marginal tax rate. Will on the other hand, makes $800 per month in CPP and his total income is much higher in the 36% Marginal Tax bracket with $50,000 of annual retirement income. As a result of the sharing, Will’s CPP amount will drop from $800 per month to 575 per month. Janet’s income will increase from $251 per month to $575 per month. The outcome is $225 per month of income will move from being taxed at 32% to being taxed only at 25%
The key to determining if CPP sharing is feasible is to look at whether the higher CPP earner is in a higher marginal tax rate than the lower CPP earner. Remember, it’s not just about the higher income earner making more money but rather whether they are in a higher tax bracket.
CPP remains one of the cornerstones of creating retirement income. Planning ahead will help you to know when to take CPP and whether to split benefits with a spouse are key issues.