Understanding government benefits II
I want to thank all of the readers who have provided feedback on my articles in the retirement series both positive and constructive. As a result of the feedback, I wanted to write this last article on retirement to address some of the many questions and requests for more information.
Should I take CPP early?
Most of the time I am going to argue that it is in your best interest to take CPP early. To refresh your memory, CPP is based on how much you contributed to the plan and also how much money you earned prior to retirement. The maximum for this year is $762.92 at age 65. You can apply for CPP as early as age 60 but your pension will be reduced by 0.5% for every month prior to your 65th birthday.
In this example, collecting CPP at age 60 would net you an income of $534.04 per month (a 30% reduction – 60 months x 0.5%). From age 60 to age 65 you would collect a total of $32,042.64 (pre-tax). Deferring the CPP income to age 65 for a higher amount means that you will have to make up for this lost income. Mathematically, it will take you to age 77 to breakeven.
For most people, they are better off enjoying the $32,042.64 while they are younger and physically able to do more things.
I understand that this is a very simplified analysis. I have not taken taxes nor investment returns into account but I would estimate that over 80% of Canadians should take CPP early if they are able to.
Avoiding OAS clawback
The Old Age Security (OAS) clawback starts once your income reaches $53,960. Once your individual net income exceeds this threshold, the government starts to clawback your OAS by 15% for every dollar of income over the threshold. The threshold is per individual taxpayer, not per couple.
The OAS clawback affects your taxes in the current year. Your OAS payments are impacted by the previous year’s tax return. If your income exceeds this amount for the 2000 tax year, the clawback will affect your OAS payments starting sometime in 2001. Therefore, it is this year’s net income that will determine your OAS payments for next year. The clawback is determined on a year by year basis.
This is precisely the reason why you must be aware of what your annual income is likely to be. By the time your taxes are being prepared, it will be too late. If your income is close to the $53,960 income in retirement, plan ahead. Income splitting techniques are probably the best place to start when it comes to managing your income.
A case example
I want to share with you a real-life example that incorporates both these issues.
Mark is 67 and collecting CPP, OAS and a company pension. He is currently flirting with the OAS clawback zone at $53,960. Mark’s wife, Dana is 60 and she must decide whether it is right to take CPP early. Dana’s initial instinct is to defer CPP to a later date as they do not need the income and she feels she will need a higher income should something happen to Mark because of the reduction in his pension income.
I suggested that Dana consider taking the CPP early instead of deferring it for a number of reasons:
- If something were to happen to Mark, all of the income would be transferred into Dana’s name. This would definitely push Dana’s income into a higher tax bracket. From a tax perspective, Dana will be in the lowest Marginal Tax rate for the next 5 years, which will allow her to draw the CPP at a lower tax rate.
- If Dana and Mark do not need the extra income. Investing that income (even on an after-tax basis) will help them with Dana’s concern if something should happen to Mark. After crunching the numbers, this issue did not make a significant difference but it satisfied Dana’s emotional concern.
- Finally, if Dana elects to collect CPP, she can then apply for CPP splitting. The biggest benefit of CPP splitting is to get some of Mark’s CPP income into Dana’s name to help him avoid the OAS clawback.
The advice in this example was specific to Dana and Mark but it provides a good example of some of the issues that retirees face when dealing with their government benefits.