CPP Deferral debate - Fred Vettese article discussion

Preparing for life after work. RRSPs, RRIFs, TFSAs, annuities and meeting future financial and psychological needs.
gaspr
Contributor
Contributor
Posts: 287
Joined: 10 Feb 2015 11:39

Re: Clippings 2017

Post by gaspr »

longinvest wrote: 11 Mar 2017 15:52 Let me put it this way:

If my goal in life was to get back as much money as possible from CPP/QPP and OAS, with the best probability of achieving so, then I should take the pensions as early as possible.
So if this is true, the implication is that it would be to the advantage of the pension administrators (CPP/QPP/OAS) to increase the incentives to delay. I wonder if this might be a real possibility.
User avatar
AltaRed
Veteran Contributor
Veteran Contributor
Posts: 33398
Joined: 05 Mar 2005 20:04
Location: Ogopogo Land

Re: CPP Deferral debate - Fred Vettese article discussion

Post by AltaRed »

I took my CPP in 2011 at 62 (retired at 57). Was much better for me to not risk more 'opt out' years, and of course the discount was less then too.

This is the kind of micro-accountant stuff that I assert (from a pragmatic point of view) that doesn't necessarily play out in real life:
In 2017, Jacques’ CPP pension at 60 would be $713 month. This is calculated as the maximum pension less a reduction of 36 per cent. With inflation at 2.2 per cent a year, the monthly payments will gradually climb to $886 by the time he hits 70. If he holds off on collecting CPP until 70, the monthly pension at 70 will be about $2,056! (This assumes wage inflation beats price inflation by 1 per cent a year.)
I don't doubt the math, but can you realistically imagine the average working stiff buying into assumptions that his/her wage inflation will beat price inflation (of precisely 2.2% per year) by 1 percent/year?

I do agree that IF someone wishes to continue working past 65, then delaying CPP and OAS is a 'no brainer'. Why pay higher MTRs on CPP and OAS if one does not have to do so AND get proportionately higher CPP/OAS as well.
Imagefiniki, the Canadian financial wiki The go-to place to bolster your financial freedom
gaspr
Contributor
Contributor
Posts: 287
Joined: 10 Feb 2015 11:39

Re: CPP Deferral debate - Fred Vettese article discussion

Post by gaspr »

But they are not referring to individual wage inflation here. They are referring to Canada wide wage inflation, no?

I think that deferring is a "no brainer" for anyone who
-is in good health
-has no bequest motive
-has savings to bridge the gap
longinvest
Veteran Contributor
Veteran Contributor
Posts: 3956
Joined: 10 Sep 2012 17:26
Location: QC

Re: CPP Deferral debate - Fred Vettese article discussion

Post by longinvest »

OK. Let me do the calculation for the average Canadian. The average monthly CPP pension, at age 65, is $644.35. That's approximately half of the maximum monthly pension of $1,114.17 corresponding to a $53,480 YMPE (Year's Maximum Pensionable Earnings).* We can check this: $53,480 X 25% / 12 months = $1,114.17.

* Canada Pension Plan – How much could you receive.

ASSUMPTIONS

Let me make some additional assumptions: (1) This worker had a well-paid but spotty work record. (2) He stopped working at 60 and he would get $644.35 monthly in inflation-adjusted (2017) dollars if he waited until age 65 to claim his pension. (3) He has accumulated a big-enough portfolio in his RRSP to draw money during the deferral period, should he choose to wait before claiming his pension. (4) He is single (to keep things simple). (5) He has no bequest motives (in other words, he is not trying to maximize the size his after-death portfolio); he would rather spend more while alive.

SCENARIOS

Let me analyze two scenarios.
  1. He claims his CPP pension early at age 60.
  2. He claims his CPP late at age 70.
We (and he) have no idea at what age he will die.

We will do all calculations in inflation-adjusted dollars (or, if you prefer, in 2017 dollars).

PENSION AMOUNTS

First, let's calculate the amounts he would get at age 60 and at age 70. I will assume that wage inflation is 1% higher than inflation (as measured by the CPI).

As he would get $644.35 at age 65, we can assume that he has accumulated $644.35 X 12 X 4 X (65 - 18) X (1 - 17%) = $1,206,532.49 in pensionable earnings between ages 18 and 60. As he had a spotty work record, his $0 earning years already exceeded the 17% drop out provision at age 60.

So, at age 60 he would get**:
$1,206,532.49 / ((60 - 18) X (1 - 17%)) X (1 - 5 X 12 X 0.6%) X 25% / 12 / (1.01^5) = $439.08

** In other words, he worked for 34 years with an annual salary of $35,486.25 between ages 18 and 60.

Similarly, at age 70 he would get:

$1,206,532.49 / ((65 - 18) X (1 - 17%)) X (1 + 5 X 12 X 0.7%) X 25% / 12 X (1.01^5) = $961.65

Remember that these are inflation-adjusted amounts. In a 2% inflation world, he could have drawn a $397.69 pension at age 60 which would have grown to a $484.78 pension at age 70, or he could have waited until 70 to get an initial $1,061.74 payment, if we expressed these amounts in nominal dollars.

RESULTS

OK, now that we have the pension amounts, let's look at the two chosen scenarios.

For simplicity, let's assume that the retiree has a $500,000 portfolio in his RRSP. At age 60, his target portfolio withdrawal is 3.5% of this amount (his assumed SWR). That's $17,500 per year.

Of course, in real life, he is likely to use the much safer VPW approach, which would give him an initial 4.5% of current portfolio at age 60 for a 50/50 portfolio***. But, remember that the VPW amount is variable; it goes up and down, from year to year, based on market returns. So, it is safe enough to consider that in most years, he well get an inflation-adjusted withdrawal of $17,500 or more.

*** The portfolio allocation does not need to be 50/50. I needed to choose an allocation to extract a percentage from the VPW table at age 60. Note that usually the SWR doesn't change with allocation, except when the stock allocation is too low or too high. For simplicity, I'll use the 50/50 allocation for the rest of this example.

Choice #1: pension at 60

If he claims his CPP pension at age 60, he will get a total of:
12 X $439.08 + $17,500 = $22,769.96

That's in addition to any other pension and withdrawals from his taxable account and TFSA.

Choice #2: pension at 70

If he chooses to defer until age 70, and he doesn't want to increase risk, he has to put aside enough money into a GIC ladder to fill the gap. Let's assume the he is able to get an annual return that matches inflation, with his ladder. In order to fill the gap between age 60 and age 70, he needs to put aside:
10 X 12 X $961.65 = $115,398 into a GIC ladder (and cash for the early payments)

As a result, his RRSP is now composed of $115,398 in a GIC ladder and cash, and ($500,000 - $115,398) = $384,602 in a 50/50 portfolio. Applying 3.5% on the portfolio part yields an annual $13,461.07 withdrawal target in addition to the GIC/cash gap withdrawals.

So, if he claims his CPP pension at age 70, he will get a total of:
12 X $961.65 + $13,461.07 = $25,000.87

That's in addition to any other pension and withdrawals from his taxable account and TFSA.

ANALYSIS

As you can see in the RESULTS section, the calculations are very simple (as long as one knows the CPP pension amounts at 60 and 70).

By setting aside the gap money into cash and a GIC ladder (within the RRSP), when delaying until age 70, this money is not exposed to market risk. It is exposed to very little inflation risk, as it is usually possible to find 5-year GICs with a higher interest rate than the Bank of Canada's 2% inflation target.

By delaying the pension to age 70, the retiree has insured himself an additional $6,270.84, annually, that is not subject to market risk or longevity risk, and that increases with inflation every year.

By delaying the pension to age 70, the retiree is able to increase his annual CPP+RRSP income from $22,769.96 to $25,000.87 starting at age 60! This is ($25,000.87 - $22,769.96) / 12 = $185.91 per month. That represent 42% of the age 60 CPP pension.

In other words: Delay CPP until age 70 and safely spend 42% more starting at age 60 while also increasing the lifelong inflation-indexed CPP pension by 119%!

This is pretty simple, folks. In absence of bequest motives, there's little justification not to allow oneself to safely increase spending by 42% at age 60 by delaying CPP until age 70 and filling the gap with a GIC laddder and cash, as long as one has a big-enough portfolio to do so. But, emotionally, it's a difficult thing to do; one has to keep his hands off the available pension for a long 10-year period.

I hope my explanations were simple and clear enough. But, don't hesitate to help me clarify further, if needed.
Last edited by longinvest on 26 Mar 2017 16:58, edited 4 times in total.
Variable Percentage Withdrawal (finiki.org/wiki/VPW) | One-Fund Portfolio (VBAL in all accounts)
gaspr
Contributor
Contributor
Posts: 287
Joined: 10 Feb 2015 11:39

Re: CPP Deferral debate - Fred Vettese article discussion

Post by gaspr »

@longinvest Well done. Appreciate that you used 2017 dollars for all calculations as it makes comparisons over time much more meaningful. I wish Fred Vettese had done the same in his articles.

Given the 1% participation rate to date, how likely is it that benefit deferral incentives might be increased?
User avatar
AltaRed
Veteran Contributor
Veteran Contributor
Posts: 33398
Joined: 05 Mar 2005 20:04
Location: Ogopogo Land

Re: CPP Deferral debate - Fred Vettese article discussion

Post by AltaRed »

gaspr wrote: 26 Mar 2017 11:53 Given the 1% participation rate to date, how likely is it that benefit deferral incentives might be increased?
If the 2012 change was done to make CPP more actuarially sound, then I'd suggest the deferral incentives have a reasonable probability of being increased yet again in another 5-10 years. Nothing moves quickly in these areas. Besides there is a policy incentive to keep skilled people in the work force longer given the looming shortage in the workforce AND it benefits the gov't to keep more people off OAS/GIS longer too.
Imagefiniki, the Canadian financial wiki The go-to place to bolster your financial freedom
longinvest
Veteran Contributor
Veteran Contributor
Posts: 3956
Joined: 10 Sep 2012 17:26
Location: QC

Re: CPP Deferral debate - Fred Vettese article discussion

Post by longinvest »

gaspr wrote: 26 Mar 2017 11:53 Given the 1% participation rate to date, how likely is it that benefit deferral incentives might be increased?
I don't think that the deferral is likely to be increased; it is already pretty generous. The problem is that almost nobody explains how to take advantage of the benefit early, as I did above, using a GIC ladder and cash during the deferral period.

There's also the fact that financial advisers* have a major incentive to promote taking CPP and OAS as early as possible; they are paid on a percentage of the retiree's liquid assets. Unfortunately, the portfolio is depleted faster when these pensions are delayed. Financial advisers also tend to promote transferring the commuted value of a pension to a LIRA, when possible. I wonder why.

Edited to add:

* I admit that my view of financial advisers is negatively biased. I've had financial advisers twice, for very short times, in my life. The first one put my small nest egg into expensive mutual funds. The second one put the amount of money I gave him to prudently manage into a newly issued single stock pushed by his brokerage. Luckily, I got out within a month or two, and I quit him. The stock went into bankruptcy within the following two years, if I remember correctly.

So, I apologize to all honest financial advisers who put the interest of their clients before their own and don't try to artificially inflate assets under management (AUM) through recommending early CPP/OAS, commuting pensions, and leveraged investing.
Last edited by longinvest on 26 Mar 2017 16:23, edited 5 times in total.
Variable Percentage Withdrawal (finiki.org/wiki/VPW) | One-Fund Portfolio (VBAL in all accounts)
gaspr
Contributor
Contributor
Posts: 287
Joined: 10 Feb 2015 11:39

Re: CPP Deferral debate - Fred Vettese article discussion

Post by gaspr »

longinvest wrote: 26 Mar 2017 11:18
By delaying the pension to age 70, the retiree is able to increase his annual CPP+RRSP income from $22,769.96 to $25,000.87 starting at age 60! This is ($25,000.87 - $22,769.96) / 12 = $185.91 per month. That represent 42% of the age 60 CPP pension.

In other words: Delay CPP until age 70 and safely spend 42% more starting at age 60 while also increasing the lifelong inflation-indexed CPP pension by 119%!
I see this as a roughly 10% increase in safe spending. $25000/$22769=1.0979
longinvest
Veteran Contributor
Veteran Contributor
Posts: 3956
Joined: 10 Sep 2012 17:26
Location: QC

Re: CPP Deferral debate - Fred Vettese article discussion

Post by longinvest »

gaspr wrote: 26 Mar 2017 12:08
longinvest wrote: 26 Mar 2017 11:18
By delaying the pension to age 70, the retiree is able to increase his annual CPP+RRSP income from $22,769.96 to $25,000.87 starting at age 60! This is ($25,000.87 - $22,769.96) / 12 = $185.91 per month. That represent 42% of the age 60 CPP pension.

In other words: Delay CPP until age 70 and safely spend 42% more starting at age 60 while also increasing the lifelong inflation-indexed CPP pension by 119%!
I see this as a roughly 10% increase in safe spending. $25000/$22769=1.0979
It is 42% in additional income, when compared to the age 60 CPP pension. It would be unfair to use the entire $500,000 portfolio as reference. Why not use a $2M portfolio and make the percentage even lower? Makes no sense to me. We want to measure the increase above what we can get in pension at age 60.
Variable Percentage Withdrawal (finiki.org/wiki/VPW) | One-Fund Portfolio (VBAL in all accounts)
gaspr
Contributor
Contributor
Posts: 287
Joined: 10 Feb 2015 11:39

Re: CPP Deferral debate - Fred Vettese article discussion

Post by gaspr »

In your "Delay OAS to 70" post you came up with an 8.8% increase...a methodology I agree with. I still see this as a 10% increase in safe spending which has to include RRSP spending as well...
longinvest
Veteran Contributor
Veteran Contributor
Posts: 3956
Joined: 10 Sep 2012 17:26
Location: QC

Re: CPP Deferral debate - Fred Vettese article discussion

Post by longinvest »

gaspr wrote: 26 Mar 2017 12:27 In your "Delay OAS to 70" post you came up with an 8.8% increase...a methodology I agree with. I still see this as a 10% increase in safe spending which has to include RRSP spending as well...
The 42% is calculated similarly to the 8.8%.

I look at it this way: By delaying CPP until age 70 (and increasing it by 119%), I get a similar result to increasing the CPP payment immediately by 42% at age 60. This works regardless of portfolio size (as long as the portfolio is big enough to cover the 10-year gap).
Last edited by longinvest on 26 Mar 2017 12:42, edited 1 time in total.
Variable Percentage Withdrawal (finiki.org/wiki/VPW) | One-Fund Portfolio (VBAL in all accounts)
longinvest
Veteran Contributor
Veteran Contributor
Posts: 3956
Joined: 10 Sep 2012 17:26
Location: QC

Re: CPP Deferral debate - Fred Vettese article discussion

Post by longinvest »

Let me just to put things into perspective, though.

We're talking, for the illustrated scenario, about a monthly increase of $185.91 per month. That's an annual $2,240.92 in taxable income. For some multi-millionaires of this forum, this is probably mere pocket change.

But, for some of us, it can still represent an interesting amount, as it is the marginal amount of available after-tax money, after paying for basic expenses (food, shelter, utilities, transportation, and basic clothing), that makes most of the difference in one's comfort.
Variable Percentage Withdrawal (finiki.org/wiki/VPW) | One-Fund Portfolio (VBAL in all accounts)
SQRT
Veteran Contributor
Veteran Contributor
Posts: 5441
Joined: 01 Nov 2012 11:33
Location: Ontario/Arizona

Re: CPP Deferral debate - Fred Vettese article discussion

Post by SQRT »

longinvest wrote: 26 Mar 2017 12:36 Let me just to put things into perspective, though.

We're talking, for the illustrated scenario, about a monthly increase of $185.91 per month. That's an annual $2,240.92 in taxable income. For some multi-millionaires of this forum, this is probably mere pocket change.

But, for some of us, it can still represent an interesting amount, as it is the marginal amount of available after-tax money, after paying for basic expenses (food, shelter, utilities, transportation, and basic clothing), that makes most of the difference in one's comfort.
Agree. Not material to me but still, why wouldn't I defer? Presumably OAS deferral would have the same analysis.
User avatar
ghariton
Veteran Contributor
Veteran Contributor
Posts: 15954
Joined: 18 Feb 2005 18:59
Location: Ottawa

Re: CPP Deferral debate - Fred Vettese article discussion

Post by ghariton »

Longinvest,

I'm not sure, but I think that you are implicitly assuming a real discount rate of zero. As the real discount rate increases, the benefits of delay will decrease. It would be interesting to see the sensitivities to the discount rate.

I am agnostic about future interest rates, but as you said in another post, there is a good chance of their increasing. Increasing interest rates (or rates of return) will lower the value of an annuity paying out a fixed yearly amount. The longer the life expectancy, the longer the duration, so the greater this market risk. Hence the greater the opportunity cost of surrendering the possibility to invest at higher real rates of return.

Put another way, delaying CPP or OAS is just a way of purchasing an (additional) life annuity, one with a fairly long duration. That's fine, as long as the purchaser understands the risks and likes the risk profile.

The other aspect is that you modelled this assuming fixed income only portfolio. That's appropriate so as to compare apples to apples. After all, government securities (including legislatively based pensions) are about as safe as one can get. But what about investors who are willing to accept a bit more risk? Perhaps the extra return from having some equities in the portfolio is acceptable. Unfortunately, delaying CPP and OAS does tilt the entire portfolio (including present worth of pensions) toward the very safe end of the spectrum. Perhaps the investor can compensate for this by increasing the allocation to equities, etc., in the rest of his holdings. But that assumes enough other assets.

You also assume, for simplicity, that other assets are held in a RRSP/RRIF. That's fine for most people. But for some, the gap will have to be funded via savings in a non-registered account. At this point, tax complications arise, and can lead to some complicated scenarios.

Notwithstanding these little points, I think that your exercise is very clear and very informative. Thank you.

George
The juice is worth the squeeze
User avatar
adrian2
Veteran Contributor
Veteran Contributor
Posts: 13333
Joined: 19 Feb 2005 08:42
Location: Greater Toronto Area

Re: CPP Deferral debate - Fred Vettese article discussion

Post by adrian2 »

ghariton wrote: 26 Mar 2017 13:01I think that your exercise is very clear and very informative. Thank you.
+1!
Imagefiniki, the Canadian financial wiki
“It doesn't matter how beautiful your theory is, it doesn't matter how smart you are. If it doesn't agree with experiment, it's wrong.” [Richard P. Feynman, Nobel prize winner]
gaspr
Contributor
Contributor
Posts: 287
Joined: 10 Feb 2015 11:39

Re: CPP Deferral debate - Fred Vettese article discussion

Post by gaspr »

longinvest wrote: 26 Mar 2017 12:35
gaspr wrote: 26 Mar 2017 12:27 In your "Delay OAS to 70" post you came up with an 8.8% increase...a methodology I agree with. I still see this as a 10% increase in safe spending which has to include RRSP spending as well...
The 42% is calculated similarly to the 8.8%.

I look at it this way: By delaying CPP until age 70 (and increasing it by 119%), I get a similar result to increasing the CPP payment immediately by 42% at age 60. This works regardless of portfolio size (as long as the portfolio is big enough to cover the 10-year gap).
"Safe spending" to me means my total annual spending. I guess we agree to disagree. :?
longinvest
Veteran Contributor
Veteran Contributor
Posts: 3956
Joined: 10 Sep 2012 17:26
Location: QC

Re: CPP Deferral debate - Fred Vettese article discussion

Post by longinvest »

ghariton wrote: 26 Mar 2017 13:01 I'm not sure, but I think that you are implicitly assuming a real discount rate of zero. As the real discount rate increases, the benefits of delay will decrease. It would be interesting to see the sensitivities to the discount rate.
I effectively assumed a real discount rate of 0% for the gap money (GIC ladder + cash).

But, had I assumed a higher discount rate, the benefit of delaying the CPP pension would have been higher than what I calculated. Let me illustrate:

If he chooses to defer until age 70, and he is willing to assume a little risk, he could put aside enough money into a short-term corporate bond ETF to fill the gap. Let's assume the he is able to get an annual return that is 1% above inflation, with his short-term corporate bond ETF. In order to fill the gap between age 60 and age 70, he needs to put aside:
  • Using a financial calculator: n=10, i=1, FV=0, PMT=11539.8, BGN=true (payment at start of year)
    => PV=-110389.93
So, with a real 1% discount rate, he would only need to put aside $110,389.93 into his short-term corporate bond ETF (and cash for early payments).

As a result, his RRSP is now composed of $110,389.93 in a short-term corporate bond ETF, and ($500,000 - $110,389.93) = $389,610.07 in a 50/50 portfolio. Applying 3.5% on the portfolio part yields an annual $13,636.35 withdrawal target in addition to the pension gap withdrawals.

So, if he claims his CPP pension at age 70, he will get a total of:
12 X $961.65 + $13,636.35 = $25,176.15

That's $175.28 more, per year, than using a real 0% discount rate.

So, effectively, one could increase the bonus of deferring the CPP pension by taking some risk with the money used to cover the 10-year gap.
Last edited by longinvest on 26 Mar 2017 14:21, edited 3 times in total.
Variable Percentage Withdrawal (finiki.org/wiki/VPW) | One-Fund Portfolio (VBAL in all accounts)
User avatar
AltaRed
Veteran Contributor
Veteran Contributor
Posts: 33398
Joined: 05 Mar 2005 20:04
Location: Ogopogo Land

Re: CPP Deferral debate - Fred Vettese article discussion

Post by AltaRed »

adrian2 wrote: 26 Mar 2017 13:09
ghariton wrote: 26 Mar 2017 13:01I think that your exercise is very clear and very informative. Thank you.
+1!
While I don't see all that much practical application of this in real life for most people reaching retirement age, I also find longinvest's effort informative. Thank you.
Imagefiniki, the Canadian financial wiki The go-to place to bolster your financial freedom
longinvest
Veteran Contributor
Veteran Contributor
Posts: 3956
Joined: 10 Sep 2012 17:26
Location: QC

Re: CPP Deferral debate - Fred Vettese article discussion

Post by longinvest »

gaspr wrote: 26 Mar 2017 13:10
longinvest wrote: 26 Mar 2017 12:35
gaspr wrote: 26 Mar 2017 12:27 In your "Delay OAS to 70" post you came up with an 8.8% increase...a methodology I agree with. I still see this as a 10% increase in safe spending which has to include RRSP spending as well...
The 42% is calculated similarly to the 8.8%.

I look at it this way: By delaying CPP until age 70 (and increasing it by 119%), I get a similar result to increasing the CPP payment immediately by 42% at age 60. This works regardless of portfolio size (as long as the portfolio is big enough to cover the 10-year gap).
"Safe spending" to me means my total annual spending. I guess we agree to disagree. :?
I admit, the "delay to 70, spend x% more at age xx" catch phrase is a form of marketing, not completely false nor completely true.

When you think 2 seconds about it, you see that it is impossible to describe the additional spending as a relative ratio to total income, including portfolio withdrawals, as different investors usually have different portfolio sizes.

If I wanted to be exact, I would have to write: "Assuming you could get a $439.08 monthly CPP pension at 60 in 2017 dollars along with a bunch of other assumptions about your work record, delay your pension to age 70 and safely get an additional $185.91 in monthly taxable income to spend starting at age 60 assuming a real 0% discount rate on money put aside to cover the gap; get even more if you use a higher discount rate...". (Just to get it right, I had to fix the sentence at least 3 times!)

I prefer the shorter, yet less precise version. Don't you? :wink:
Variable Percentage Withdrawal (finiki.org/wiki/VPW) | One-Fund Portfolio (VBAL in all accounts)
longinvest
Veteran Contributor
Veteran Contributor
Posts: 3956
Joined: 10 Sep 2012 17:26
Location: QC

Re: CPP Deferral debate - Fred Vettese article discussion

Post by longinvest »

For the record, I credit the entire idea of increasing spending by delaying CPP/OAS and filling the gap using cash investments to Bogleheads member Cut-Throat in this remarkable 2012 post:

Delay Social Security to age 70 and Spend more money at 62
Variable Percentage Withdrawal (finiki.org/wiki/VPW) | One-Fund Portfolio (VBAL in all accounts)
User avatar
GreatLaker
Contributor
Contributor
Posts: 662
Joined: 16 Dec 2014 13:02
Location: Toronto

Re: CPP Deferral debate - Fred Vettese article discussion

Post by GreatLaker »

When people say you should take CPP early because it's a bird in the hand, my response is I prefer to ensure my nest has enough eggs if I am fortunate to live a very long time.

I find it interesting that people say CPP should be taken early for risk mitigation because the government may change the rules and lower payments, or it may become underfunded and therefore cut back. But many of the same people still complain about how badly their finances and retirement were hurt by the financial crisis in 2008. Has the government ever dealt a financial setback as bad as the great depression, the great recession, the lost decade of the 2000s or the horrible investing environment of the 1970s where a bear market massacred stocks, high interest rates crushed bonds and inflation robbed purchasing power from people on fixed incomes? Yet people are more skeptical of government pensions.

One thing I have not seen factored into these discussions is the retiree's need for guaranteed, inflation indexed retirement funding. A low-income person whose retirement will be funded almost exclusively by CPP/OAS/GIS with savings providing only a small slice of discretionary income may as well take CPP & OAS as soon as they retire (hopefully making it to 65 before retiring to maximize CPP). For a retiree with a well funded indexed DB pension (typically government or union) that will easily cover all their non-discretionary expenses, I don't think it makes much difference when they take CPP/OAS. But for a large number of retirees without DB pensions and that are at risk of outliving their own savings, delaying CPP and/or OAS is a good opportunity to lower that risk.
When I was young, I was poor. Now, after years of hard work, I am no longer young.
gaspr
Contributor
Contributor
Posts: 287
Joined: 10 Feb 2015 11:39

Re: CPP Deferral debate - Fred Vettese article discussion

Post by gaspr »

GreatLaker wrote: 26 Mar 2017 19:01
One thing I have not seen factored into these discussions is the retiree's need for guaranteed, inflation indexed retirement funding. A low-income person whose retirement will be funded almost exclusively by CPP/OAS/GIS with savings providing only a small slice of discretionary income may as well take CPP & OAS as soon as they retire (hopefully making it to 65 before retiring to maximize CPP). For a retiree with a well funded indexed DB pension (typically government or union) that will easily cover all their non-discretionary expenses, I don't think it makes much difference when they take CPP/OAS. But for a large number of retirees without DB pensions and that are at risk of outliving their own savings, delaying CPP and/or OAS is a good opportunity to lower that risk.
Well said. My answer to those who use the bird in the hand example, is this...But what if you fail to die in a timely manner? Or this...All those who intend to die young in retirement should take benefits early. :)
gaspr
Contributor
Contributor
Posts: 287
Joined: 10 Feb 2015 11:39

Re: CPP Deferral debate - Fred Vettese article discussion

Post by gaspr »

longinvest wrote: 26 Mar 2017 11:18 OK. Let me do the calculation for the average Canadian. The average monthly CPP pension, at age 65, is $644.35. That's approximately half of the maximum monthly pension of $1,114.17 corresponding to a $53,480 YMPE (Year's Maximum Pensionable Earnings).* We can check this: $53,480 X 25% / 12 months = $1,114.17.

* Canada Pension Plan – How much could you receive.

ASSUMPTIONS

Let me make some additional assumptions: (1) This worker had a well-paid but spotty work record. (2) He stopped working at 60 and he would get $644.35 monthly in inflation-adjusted (2017) dollars if he waited until age 65 to claim his pension. (3) He has accumulated a big-enough portfolio in his RRSP to draw money during the deferral period, should he choose to wait before claiming his pension. (4) He is single (to keep things simple). (5) He has no bequest motives (in other words, he is not trying to maximize the size his after-death portfolio); he would rather spend more while alive.

SCENARIOS

Let me analyze two scenarios.
  1. He claims his CPP pension early at age 60.
  2. He claims his CPP late at age 70.
We (and he) have no idea at what age he will die.

We will do all calculations in inflation-adjusted dollars (or, if you prefer, in 2017 dollars).

PENSION AMOUNTS

First, let's calculate the amounts he would get at age 60 and at age 70. I will assume that wage inflation is 1% higher than inflation (as measured by the CPI).

As he would get $644.35 at age 65, we can assume that he has accumulated $644.35 X 12 X 4 X (65 - 18) X (1 - 17%) = $1,206,532.49 in pensionable earnings between ages 18 and 60. As he had a spotty work record, his $0 earning years already exceeded the 17% drop out provision at age 60.

So, at age 60 he would get**:
$1,206,532.49 / ((60 - 18) X (1 - 17%)) X (1 - 5 X 12 X 0.6%) X 25% / 12 / (1.01^5) = $439.08

** In other words, he worked for 34 years with an annual salary of $35,486.25 between ages 18 and 60.

Similarly, at age 70 he would get:

$1,206,532.49 / ((65 - 18) X (1 - 17%)) X (1 + 5 X 12 X 0.7%) X 25% / 12 X (1.01^5) = $961.65

Remember that these are inflation-adjusted amounts. In a 2% inflation world, he could have drawn a $397.69 pension at age 60 which would have grown to a $484.78 pension at age 70, or he could have waited until 70 to get an initial $1,061.74 payment, if we expressed these amounts in nominal dollars.

RESULTS

OK, now that we have the pension amounts, let's look at the two chosen scenarios.

For simplicity, let's assume that the retiree has a $500,000 portfolio in his RRSP. At age 60, his target portfolio withdrawal is 3.5% of this amount (his assumed SWR). That's $17,500 per year.

Of course, in real life, he is likely to use the much safer VPW approach, which would give him an initial 4.5% of current portfolio at age 60 for a 50/50 portfolio***. But, remember that the VPW amount is variable; it goes up and down, from year to year, based on market returns. So, it is safe enough to consider that in most years, he well get an inflation-adjusted withdrawal of $17,500 or more.

*** The portfolio allocation does not need to be 50/50. I needed to choose an allocation to extract a percentage from the VPW table at age 60. Note that usually the SWR doesn't change with allocation, except when the stock allocation is too low or too high. For simplicity, I'll use the 50/50 allocation for the rest of this example.

Choice #1: pension at 60

If he claims his CPP pension at age 60, he will get a total of:
12 X $439.08 + $17,500 = $22,769.96

That's in addition to any other pension and withdrawals from his taxable account and TFSA.

Choice #2: pension at 70

If he chooses to defer until age 70, and he doesn't want to increase risk, he has to put aside enough money into a GIC ladder to fill the gap. Let's assume the he is able to get an annual return that matches inflation, with his ladder. In order to fill the gap between age 60 and age 70, he needs to put aside:
10 X 12 X $961.65 = $115,398 into a GIC ladder (and cash for the early payments)

As a result, his RRSP is now composed of $115,398 in a GIC ladder and cash, and ($500,000 - $115,398) = $384,602 in a 50/50 portfolio. Applying 3.5% on the portfolio part yields an annual $13,461.07 withdrawal target in addition to the GIC/cash gap withdrawals.

So, if he claims his CPP pension at age 70, he will get a total of:
12 X $961.65 + $13,461.07 = $25,000.87

That's in addition to any other pension and withdrawals from his taxable account and TFSA.

ANALYSIS

As you can see in the RESULTS section, the calculations are very simple (as long as one knows the CPP pension amounts at 60 and 70).

By setting aside the gap money into cash and a GIC ladder (within the RRSP), when delaying until age 70, this money is not exposed to market risk. It is exposed to very little inflation risk, as it is usually possible to find 5-year GICs with a higher interest rate than the Bank of Canada's 2% inflation target.

By delaying the pension to age 70, the retiree has insured himself an additional $6,270.84, annually, that is not subject to market risk or longevity risk, and that increases with inflation every year.

By delaying the pension to age 70, the retiree is able to increase his annual CPP+RRSP income from $22,769.96 to $25,000.87 starting at age 60! This is ($25,000.87 - $22,769.96) / 12 = $185.91 per month. That represent 42% of the age 60 CPP pension.

In other words: Delay CPP until age 70 and safely spend 42% more starting at age 60 while also increasing the lifelong inflation-indexed CPP pension by 119%!

This is pretty simple, folks. In absence of bequest motives, there's little justification not to allow oneself to safely increase spending by 42% at age 60 by delaying CPP until age 70 and filling the gap with a GIC laddder and cash, as long as one has a big-enough portfolio to do so. But, emotionally, it's a difficult thing to do; one has to keep his hands off the available pension for a long 10-year period.

I hope my explanations were simple and clear enough. But, don't hesitate to help me clarify further, if needed.
Just wanted to add that although it would be difficult to quantify, there would definitely be some tax efficiencies to using this approach as well. Spending down the RRSP before triggering pensions etc...
longinvest
Veteran Contributor
Veteran Contributor
Posts: 3956
Joined: 10 Sep 2012 17:26
Location: QC

Re: CPP Deferral debate - Fred Vettese article discussion

Post by longinvest »

gaspr wrote: 27 Mar 2017 16:47 Just wanted to add that although it would be difficult to quantify, there would definitely be some tax efficiencies to using this approach as well. Spending down the RRSP before triggering pensions etc...
I have no illusions: higher income usually leads to higher taxes. The additional annual $2,230.92 in taxable income will attract taxes. But, more importantly, net income will also be higher.

I've specifically used RRSP money in my example, for filling the 10-year gap, so that there wouldn't be surprising fiscal impacts. Both RRSP withdrawals and CPP payments attract the same taxes. (Let's ignore any pension tax credit which might be used, at the same time, to shift additional money from RRSP to TFSA free of tax).
Variable Percentage Withdrawal (finiki.org/wiki/VPW) | One-Fund Portfolio (VBAL in all accounts)
Chuck
Veteran Contributor
Veteran Contributor
Posts: 2048
Joined: 21 Feb 2005 11:48
Location: Manitoba

Re: CPP Deferral debate - Fred Vettese article discussion

Post by Chuck »

longinvest wrote: 26 Mar 2017 11:18 As he had a spotty work record, his $0 earning years already exceeded the 17% drop out provision at age 60.
Hi longinvest, I just wanted to ask a question to get your thoughts since I have seen a few posters say they did not want to defer past age 60 due to fear of adding more zero earning years which they would not be able to drop out.

However, your example seems to indicate, even if you have exceeded the 17% drop out max, it does no real harm to exceed it by 5 more years. Would you say this is because the 7.2%/year (36% over 5 years) actuarial reduction in CPP does much more to reduce your payout than adding 5 more zero earnings years into the calculation? It would also seem that if you are under the 17% dropout limit at age 60, it would be even more beneficial to defer to at least 65 as some of your zero earnings years would not even hurt.

And then, of course, it becomes again more beneficial to add another 5 years to age 70, as those zero earnings years are not even a factor.

Am I understanding this correctly?
Post Reply