When is it Optimal to Start Receiving Canada Pension Plan Benefits?

1. Executive Summary

The Canada Pension Plan (CPP) is a monthly pension that most Canadians receive (at least partially), designed to cover living expenses in retirement. The standard age to start the pension is 65. However, CPP payments can be taken any time between the ages of 60 and 70. There is an incentive for retirees to postpone the pension as much as possible as this results in a higher monthly benefit. In this paper we examine the trade-off between 1) taking CPP income before the age of 65 and postponing withdrawals from RRSPs and other investment accounts, and 2) postponing CPP benefits beyond 65 and triggering withdrawals from investment accounts immediately in retirement. 

Naturally, the optimal time to trigger the pension depends on the retiree’s personal circumstances. However, taking the CPP sometime between 60 and 65 would be most profitable for most Canadian seniors.

The variables that have the highest impact are the retiree’s life expectancy, rate of return on additional investments, and the annual inflation rate. The higher life expectancy results in more benefits received, which means that taking the CPP later is better. If personal investments have a high rate of return the retiree would prefer to let them grow as much as possible and take the CPP earlier. CPP payments are indexed to the consumer price index (CPI), as measured over the 12-month period ending in October of the previous year, so a higher inflation rate means postponing the CPP could provide for a bigger benefit.

A retiree in an excellent health, expecting to live a long life, and keeping low-return investments in a highly inflationary environment would postpone taking the CPP. Alternatively, an individual whose life expectancy is about the average for Canadians and holds a portfolio promising high returns in a low inflationary environment should take the CPP earlier.

Other factors like the amount of investments, the current age of the individual, and the contributions made towards the CPP will only have an impact on the amount of benefits and investment returns, but not on the optimal time to trigger the CPP.

Finding the optimal time to take the CPP could translate into an additional benefit of up to tens of thousands of dollars over the retiree’s lifetime. Therefore, it is crucial for individuals to consult with a financial planner prior to starting their CPP benefits.

 

2. Introduction

CPP, short for the Canadian Pension Plan, is a lifetime monthly taxable benefit received by Canadian pensioners starting between the ages of 60 and 70. The annual benefits depend mostly on the contributions made towards the CPP, as well as the length of the retiree’s employment history, and they are adjusted to the inflation annually. The choice when to start receiving the benefits is up to the individual, and they can do that at any time after the month they turn 60 years of age. The standard age to start receiving the pension is 65. Starting earlier results in more payments, but each payment would be smaller. For each month an individual decides to start receiving CPP before turning 65 there is a 0.6% decrease in the amount of the monthly benefit. Starting after turning 65 leads to an increase of 0.7% increase for every additional month that the pension is postponed up to age 70.

From a perspective to only maximize the total benefits received, one would choose to take out the CPP later to gain the higher benefit amount even of it is for fewer periods. In fact, when the life expectancy is at least about 85 years, the maximum possible benefit would be achieved if the CPP is taken at the age of 70.

However, individuals who retire before the age of 70 will have an important decision to make whether to meet their monthly retirement expenses with the CPP by taking it earlier thereby reducing the monthly pension amount, or by making withdrawals from an investment portfolio and giving up on the expected future returns on these investments.

Most Canadians start receiving the CPP either when they are 60 years old (the earliest possible age), or at the age of 65, which is the default start time (2018 statistics) [1]. However, according to a recent article by the Canadian Institute of Actuaries, “75-80% of Canadians […] would be better to delay their CPP payments”[2]. This result is achieved when comparing the CPP with an investment with a very low rate of return, meaning that the results will be biased towards an optimal decision of taking the CPP later (the impact of the rate of return is discussed below). This leaves us with the question whether and under what circumstances one should start taking the CPP earlier or when they should delay their benefits.

This white paper aims to examine the most important variables that would impact the choice of funding the retiree’s life expenses and what would be the optimal age to start taking out the CPP benefits.

 

3. Our Approach

To answer the question posed above, we developed an algorithm that calculates the optimal time to start receiving the CPP benefit given multiple variables like life expectancy, annual inflation, return on the individual’s investments, and monthly needs, among others. The output is the exact month at which one should start receiving the pension, and what life expectancy, given all other variables, would result in the optimal age being 70. Note that there is no economic benefit of postponing the CPP further after turning 70 because there would be no further increase in the pension amount).

Our algorithm compares the outcome of taking the CPP at all 120 different possible months between the ages of 60 and 70 and calculates the most optimal time to start receiving the benefits. We assume that the retiree will have a specific dollar amount of monthly needs, which annually with the rate of inflation. If they have started receiving the CPP and the benefit is higher than their expenses, the individual will invest the difference. If the benefit is not enough to cover the expenses, then we take the balance from the retiree’s investment portfolio.

 

4. Results and Explanation

We analyzed the impact of all major variables on the decision by taking a base case and making changes to any one variable without altering the rest of the variables. The chosen variables mostly align with the expected averages for Canadian retirees in recent years. A detailed explanation of the experiment, its variables, as well as its exact results could be found in Appendix 1.

In general, one would typically prefer to start receiving the CPP before the age of 65.

We will analyze how each variable affects the decision. The following list examines the cases in which taking the CPP before age 65 would be a better option.

• High Return on Investment

One of the major variables of interest is the expected rate of return on the retiree’s investment portfolio. In our comparison we consider the difference in growth between an investment portfolio and CPP payments to evaluate which one should be used to finance retirement expenses first. Intuitively, the higher the return on the investment portfolio, the earlier we would want to start receiving the CPP. This stems from the fact that a higher return on investment would mean that we would not want to take out our investments now to pay for our monthly expenses, but rather we would want to keep the investments grow in an investment account. Therefore, in order to pay for the everyday expenses, one would need to start receiving the CPP earlier.

Taking the CPP earlier, however, does not mean taking it too early. In our experiment, we used a case of a 12% return with 2% inflation and $3000 of monthly expenses with life expectancy of 82, and the optimal time to start receiving the CPP ended up being 61 years, compared to 63 when the return is 8%. In comparison, the optimal age is 67 when the investment portfolio return is 4%. Under the investigated circumstances, one would choose to start receiving the CPP a few years earlier if the return is significantly higher, but not too early.

A realistic and achievable annual rate of return for a conservative retirement portfolio will be below 8%. Therefore, according to our calculations, most retirees should aim to trigger their CPP payments between the ages of 62 and 67.

• Low Life Expectancy

Life expectancy is the other major variable affecting the optimal CPP age. All else equal, triggering the CPP earlier results in better outcomes if the retiree’s expected life expectancy is shorter. The reasoning stems from the fact that given a shorter horizon to receive the benefits, receiving more payments even if they are for a smaller amount would result in a higher aggregate pension amount.

Like the rate of return, life expectancy has a big impact on the decision when to take the CPP. In our experiment a 5-year increase in life expectancy translates in a 2-year increase in the optimal age to take the pension. Surprisingly, age 70 is almost never the optimal age even if life expectancy is increased dramatically. For a more detailed discussion why that is the case, please refer to subpoint 6 (When is it most optimal to take out at the age of 70?).

• Low Inflation

Inflation leads to an increase both in the monthly CPP benefits and the retiree’s lifestyle expenses. Higher inflation impacts monthly benefits on a continuous basis even after the retiree starts receiving CPP payments. Pension amounts are increased every January based on the average CPI from November to October of the previous year. For instance, if we compare the alternatives of taking the benefit earlier at $600 or later at $700, an inflation of 3% will increase the gap between the amount for the following period by $3 ($103 vs $100 at the start), while an inflation of 6% increases the next year’s gap by $6. The difference will become wider as we increase the number of years of compounding. Continuing with this example, in 10 years’ time the increase in benefits with 3% inflation will be $34 (or $413 annually) versus $79 (or $949 annually) with 6% inflation.

It becomes apparent that higher inflation brings an incentive to start receiving the CPP later as the individual payments will be much higher when delayed. In a case of high inflation but constant return on investment, we would want to postpone taking the CPP, and the retiree will prefer to cover monthly expenses with income from the less profitable investment portfolio.

• Investment Amount / Current Age / Contributions / Monthly Needs – no impact

The investment amount and the monthly needs are the only observed variables that never affected the CPP take-up decision. This conclusion seems logical since the exact amount of funds in investment accounts does not determine the profitability of these funds, and thus it has no effect on our decision. Rather, the profitability will be determined by the rate of return on the investment. A similar case could be made for the retiree’s monthly expenses. If the monthly needs are lower, there will be more surplus income from the CPP to re-invest in a retirement portfolio, which increases the overall investment. If the monthly needs are higher, additional income must be withdrawn from the investment portfolio. In both cases the expected rate of return will ultimately determine the optimal time to trigger CPP payments.

The current age and the dollar amount of contributions also did not impact the result. This is because both are only used to determine the base amount of the benefits, which, like the monthly expenses, does not matter in the CPP take-up decision. This only matters in determining the exact amount that one will earn in retirement. However, if we consider a case when the investment portfolio is not substantial enough to cover for the monthly expenses, a retiree might be forced to redeem the CPP earlier even if that is not the optimal decision.

• January Effect

The CPP pension is adjusted to the CPI (the inflation rate) each January. That is, if an individual has started receiving the CPP, the monthly benefit will be increasing each year. If they have not started receiving it, there will be a higher increase in the benefit if they wish to start receiving it in January. This stems from the fact that the monthly increase in the benefit, should one wish to postpone it, is either 0.6% or 0.7%, depending on whether they are younger or older than 65. However, the monthly increase from December to January would be slightly higher due to the increase from the inflation adjustment. If one chooses to start receiving the CPP in December, the amount will be adjusted up by the inflation rate in January. However, if they postpone one more month, the amount will increase by the 0.6% or the 0.7% plus inflation, making the total increase higher. While this additional increase will generally be relatively small, it translates in a higher base amount, which means higher compounding in later periods, which can potentially make a difference.

Our algorithm has a preference to take the CPP in January (even if the individual is not born in December), but it is not particularly pronounced. Investors have a small incentive to start receiving the benefit in January, but that does not mean January will always be the optimal choice.

 

5. Comparison to Taking the CPP at the Age of 65

After discussing how the variables affect the decision of when to start receiving the CPP, we should determine how much more one can earn according to our recommendation compared to the typical default start time at the age of 65. In our base case scenario, taking the CPP at the age of 62 and 11 months, only two years and a month earlier than turning 65, could translate in over $10,000 net additional income. In fact, in most of the cases we examined the difference between taking the CPP at the recommended time and taking it at 65 was up to $100,000 over the lifetime of the pension. This is why finding the optimal time to take the CPP is so important.

 

6. When is it most optimal to take CPP at age 70?

The CPP benefit is about two times larger if taken out at the age of 70 instead of the age of 60. This creates the impression that electing to postpone the pension as long as possible will always be the optimal choice. This makes sense if we only focus on maximizing the aggregate amount of payments over the lifetime of the pension.   All else equal, if life expectancy is 85 or higher, it will always be more beneficial to wait until the age of 70.

However, when we include the investments from an RRSP or other investment accounts, age 70 is rarely the optimal time to take the CPP. From a practical perspective, our tests indicate that in most cases the impact of taking the CPP a bit earlier (between the ages of 60 and 65) tends to outweigh the benefits of receiving the higher pension later as this allows additional investments to compound for a longer period.

One situation in which that is not the case is if the return on investments is low, or the inflation rate is high. In both scenarios (the exact parameters can be found in Appendix 1), we had to extend life expectancy to 90 years before 70 became the optimal CPP take-up age. However, if the retiree has a well-managed investment portfolio, it will rarely be most profitable to wait until the age of 70 to begin receiving CPP payments.

 

 

7. Appendix 1: Detailed Discussion of the Results

For the experiment, we chose a specific base case scenario and then we unilaterally changed all the variables to observe how the decision when to start taking the CPP pension would shift. The variables we chose for the base case are close to the averages for the typical Canadian pensioner. The base case was an individual aged 45 in 2022 and born in January, with an estimated life expectancy of 82 years, who has made 60% of the maximum contributions (they would be entitled to only 60% of the maximum possible CPP benefit)[3][4]. Once retired this person would have monthly needs of $3000. Currently they have an investment portfolio worth $200,000 that grows at 8% annually[5]. The inflation rate is assumed to be 2%. According to our algorithm, in these circumstances an individual should start receiving the CPP when they are 62 years and 11 months old, and, all else equal, it is never most profitable to start receiving it at 70, regardless of life expectancy.

The table below summarizes the results of the experiment. It shows the age to start taking the CPP and the required minimum life expectancy so that it is more optimal to start receiving the CPP at the age of 70 (result of a life expectancy higher than 120 years have been disregarded).

In only a few cases it would be best to start receiving the CPP at the age of 70 if the life expectancy is long enough (and reasonable).

In almost all cases the optimal time to take out the CPP is before the age of 65. In most cases, it is alays optimal to take out the investment 11 months after turning a certain age; this is due to the fact that the individual is born in January, and it is better to start receiving the CPP in January because of the higher increase in the pension amount.

Change Variable:	Increase to	Age to take CPP	Target life expectancy	Decrease to	Age to take CPP	Target life expectancy
Return	12%	60 y, 6 m	-	4%	66 y, 11 m	90
Life Exp.	87	64 y, 1 m	-	77	61 y, 9 m	-
Inflation	6%	66 y, 11 m	90	0%	61 y, 7 m	-
Investment Amount	$500,000	62 y, 11 m	-	$120,000	62 y, 11 m	-
Current Age	60	62 y, 11 m	-	30	62 y, 11 m	-
Contributions	90%	62 y, 11 m	-	30%	62 y, 11 m	-
Month After Birthday	8	63 y, 1 m	-	1	63 y	-
Monthly Needs	$5,000	62 y, 11 m	-	$1,000	62 y, 11 m	-

Table 1. Summary of the Results

 

8. Appendix 2: Algorithm Explanation

The algorithm takes ten different variables:

• The year an individual is planning to start taking the CPP. It is used for comparison purposes to determine how much more profitable our recommendation is.
• The age of the investor. It is used to calculate the base amount and the growth of the current investment.
• Current year. It is used to calculate the base amount.
• Percent of maximum contributions. It is used to calculate the base amount.
• Life expectancy.
• Inflation
• The month after the birthday of the individual. It is used to adjust for the difference between calendar years and the age of the individual.
• Monthly expenses.
• Return on investment.
• The dollar amount of investments in RRSP and other accounts.

 

First, the algorithm calculates the base amount which one will receive if they start getting the pension at age 65. It uses the base amount for 2022, which is $1253.59, and adjusts for inflation increases if the investor is younger than 65 and for the dollar amount of contributions made towards the CPP.

We start by calculating the investments in the accounts at the age of 60. The investment portfolio grows at the selected rate of return. Then, we calculate the end value of the investments in the account. We calculate it for each of the 120 months between the age of 60 and 70, and then we identify the highest of these amounts. In each calendar year the monthly CPP would be the same and it will increase at the end of the year, while lifestyle expenses are continuously adjusted for inflation. Finally, we take note of the year an individual is planning to start taking the CPP, and we compare the total ending investment at that time to the most optimal month to take the investment out.

 

Author: Alexander Natchev

 

[1] https://www.planeasy.ca/are-most-people-taking-cpp-early-or-late-some-real-numbers/#:~:text=In%20fact%2C%20over%209%20out,the%20way%20to%20age%2070.

[2] https://www.cia-ica.ca/docs/default-source/research/2020/rp220114e.pdf

[3] https://data.worldbank.org/indicator/SP.DYN.LE00.IN?locations=CA

[4] https://www.canadalife.com/investing-saving/retirement/pension-plans/canada-pension-plan-cpp.html#:~:text=Everyone%20gets%20a%20unique%20amount,at%20age%2065%20is%20%241%2C253.59.

[5] https://www.sofi.com/learn/content/typical-retirement-expenses/