COVID has invaded nearly every aspect of our lives over the past two years so it shouldn’t come as a surprise that it will also affect our pensions. Strangely, the impact of the pandemic on your Canada Pension Plan (CPP) is beneficial, especially for people who will start receiving their benefits in the next few years.
By now, most Canadians know they can delay the start of their CPP benefits beyond the age of 65 in return for a bigger pension. For each year that one waits after 65, CPP payments are boosted by 8.4 per cent. So the pension starting at the age of 70 is 42 per cent larger than at 65.
Less well known is the CPP pension adjustment at 70 is not really 42 per cent – it’s more than that, or at least it will be for the next several years. That’s because the actual bonus for deferring CPP depends on what happens to average wages in Canada. If wages rise faster than price inflation, the pension payable from 70 will exceed the amount at 65 by more than 42 per cent.
This is where COVID comes in. The pandemic has caused many lower-paying jobs to disappear and has also prompted employers to give bigger pay increases to retain employees. As a result, average wages in Canada for CPP purposes have been rising more quickly than we have seen in decades. Wages rose 4.9 per cent in 2020 and 5.4 per cent in 2021.
By contrast, CPP pensions that had already started before 2020 rose by a mere 0.9 per cent in 2020 and 2.7 per cent in 2021. That is because once CPP benefits start, the amount payable rises only with price inflation, not wage inflation.
The large wage increases in 2020 and 2021 will translate into higher CPP pensions for people retiring after 2020. Because the CPP pension formula uses a five-year rolling average for wages, the bump was minimal for people starting their CPP in 2021 and only slightly greater for those starting CPP in 2022.
It is only those starting CPP in 2025 or later who will enjoy the full impact. Assuming the COVID effect is over (it may not be), someone starting CPP at the age of 70 in 2025 will have a pension about 50 per cent greater than if they had started it in 2020 at the age of 65.
All this means the case for deferring CPP is stronger than ever. To clinch the argument, we need to know whether deferring CPP still makes sense once you take income tax into account. Those who are skeptical will point out that deferring CPP until 70 forces you to dismantle a cherished tax shelter: your registered retirement savings plan. In the years that you don’t receive CPP, you will be drawing down your RRSP assets faster and earlier than you would otherwise. That hardly sounds optimal from a tax perspective.
To come to a definitive conclusion, we need to project after-tax income in all future years and then determine the actuarial present value. That will tell us which strategy is better.
Here’s an example: Let’s say Roger is 64, single and about to retire with $600,000 in RRSP assets. To determine the retirement income that Roger can receive over his lifetime, I used a special version of PERC, or personal enhanced retirement calculator (available for free at PERC.ecm.lifeworks.com).
I modified PERC to calculate after-tax retirement income in all future years from all sources – including CPP and Old Age Security – and then took the present value of that income stream; this was done under two scenarios:
- Scenario 1: Start CPP immediately.
- Scenario 2: Defer starting CPP until the age of 70.
It turns out Scenario 2 is better by about 4 per cent if Roger’s RRSP/registered retirement income fund earns median returns in all years (about 5 per cent a year). If future returns are especially poor (say at the fifth percentile of all outcomes), then Scenario 2 is 9 per cent better. Part of the reason it is better for Roger to defer his CPP is the COVID effect described above, but it would have been better regardless.
The advantage gained by starting CPP at 70 may seem modest, but remember that deferring CPP increases the amount of pension that Roger can rely on no matter what. This is valuable even if the present value of Scenario 2 was the same as under Scenario 1.
Not everyone is better off taking CPP at 70, though. As I describe in my book, people with shorter life expectancies, insufficient savings or continued employment income after 65 might well be better off starting CPP earlier.
Frederick Vettese is former chief actuary of Morneau Shepell (now LifeWorks) and is also the author of Retirement Income for Life.