Blessed by the Potato

A reader asks whether or not he should start taking CPP early. There are hundreds of articles out there asking this very question, but that’s not going to stop me from giving you my take on it, too! [Edit: can’t believe I forgot to link to Michael James’ post on the matter, which has a graph!]

For those who are unaware, CPP stands for Canada Pension Plan: you pay into the plan in your working years, and in return in your sunset years the plan pays you a small pension. The normal age for that to happen is 65, but you can start taking payments as early as 60 if you like, or put off withdrawing until age 70. Taking it early incurs a penalty (you get 36% less if you start at 60), while you get a bonus to your payments if you defer taking it. My impression from reading all the articles along the way was that the system was set up to be pretty close to break-even, so you should just start taking payments early if you needed them, and defer if you didn’t (e.g., if you were still working at age 60).

But the question has been posed, so let’s answer it!

First up, the very simple case of not giving any value to having the payments early (i.e.: not investing). In that case there’s a break-even point around age 74 in terms of how much total money you can pull from the plan: if you die before age 74, you’ll have squeezed the most out of the plan by taking CPP right at 60. If you live longer, you’ll be glad for having put off withdrawing until age 65 to get that bigger benefit, and it’ll add up to getting more out of the plan in the end. This agrees with most of the articles I’ve found.

If you invest the money you start taking right away (or equivalently, keep more money in your investments because you’re spending the CPP money), then that gives more benefit to having money early on (it compounds). With a 3% real return, that pushes the break-even point back to age 76, and with a 6% return, it pushes the break-even back to age 80.

One non-financial reason for taking it early was given somewhere (and unfortunately I’ve closed the tab, or I’d give credit): even if you get less total payout, you should still take it early because you’ll enjoy a bit of money more at age 60 than you will more money at age 70. Your lifestyle expenses may be higher when you’re a young retiree in good health than when you’re older, so even a reduced pension will be put to better use. On the flip side, your medical bills may be higher in later life, and the higher payout of a deferred CPP payment may come in handy then.

Update: years after this, I’ve had more time to think about this, and the case for deferring is much stronger. That’s because I wasn’t properly considering the importance of longevity insurance — it’s not just about some break-even age. If you can defer, then defer — if you have no savings, then you may have no choice but to take it as soon as you stop working. As for the last point about enjoying it more when you’re younger, when you factor it all in that’s rubbish too — if you have the savings, then you can spend your savings while you’re younger to enjoy the spending at a younger age, which you can do with confidence because the higher CPP payments later in life will be guaranteed and inflation-adjusted. If you want to instead take CPP early to spend when you’ll enjoy it, you’ll end up having to hold back more of your own savings, as you have to be more conservative with your longevity and return assumptions. It feels different to spend the government cheque than your own savings, but you can safely spend more earlier in retirement (out of your own savings) by deferring!

So my final answer is a little wishy-washy: most people will expect to live beyond the break-even point, so waiting until the “normal” age of 65 to take CPP should make sense. However, it’s not by a huge margin, so if you need the money starting at age 60, then take it starting at that point.