I just found out something new about CPP, something that is important for anyone considering retirement before age 60.
For each year one retires early, that is prior to age 60, one accumulates a $0 CPP contribution year. Your not working so you don't contribute to the CPP and you qualify for a smaller Canada Pension Plan.
Depending upon your work history this fact can have the effect of reducing the CPP that you will receive. In my case, dumb luck saved me once again, and although I retired a few years ago, at age 60 I will still qualify for just a hair under the maximum amount. However, if I delay taking it past age 60 - the $0 contribution years continue to accumulate and I start to get further away from the maximum I might otherwise have qualified for.
It occurred to me that anyone who plans on retiring really early such as at age 45 should be aware of this fact.
Showing posts with label Canada Pension Plan. Show all posts
Showing posts with label Canada Pension Plan. Show all posts
Thursday, November 1, 2007
Thursday, April 19, 2007
Canada Pension Plan #3
Continuing on from my first two posts about CPP.
The CPP rules allow a lot of flexibility. So I must decide if I want to accept a lower amount, for life, starting as early as age 60, or wait until age 65 and receive the maximum I qualify for, for life. For me, the age 70 option is a non-starter. My original retirement plan was based on the assumption that I would take it at age 60.
Now its time to ask myself...Is that best? What difference would it make?
Summary
My calculations below show, that if one lives to age 80 it doesn't matter what choice is made, the total dollars received are the same. The break-even point is near age 80. Therefore, taking the pension at age 60 appears more attractive on the basis that age 80 is an average life estimate and one would enjoy the benefits of extra income between age 60 and 65. Even if one lives until they are 100 years old they only receive about 13 percent more money overall. An important consideration is the intangible benefit of receiving more money when you are younger compared to receiving more money later in life.
Calculations
Let's consider an average pension amount to get a feel for the numbers. The average CP at age 65, is $473 per month or $5,677 per year. The age 60 average pension, reduced by 30 percent (0.5 % per month) is reduced down to $3,974 per year. The penalty for taking it 5 years early is $142 per month or $1,703 per year.
From a simple cold blooded accounting viewpoint...at some point in time, if one takes the reduced pension amount at age 60 and they live enough, there will be a break even point. At the break even point it does not matter which option one takes, the total money received is the same. My question is - what age does that happen?
I am aware of two possible ways to compare the options. One is to compare two cash flows brought backward in time into present day dollars. Another approach I have seen is to view the early pension option from age 60 to 65 as a loan that must be paid back.
The big "unknown" in this decision is life expectancy. For these calculations lets "guess" that the pensioner lives until age 80. This puts an upper limit on how much money is received depending upon the choice.
The pension is indexed to the Consumer Price Index to make up for inflation.
So the boundaries are; one cash flow stream at a lower amount starting at age 60 and ending at age 80, and the other stream is a higher amount that starts 5 years later, at age 65 and ending at age 80. So we are comparing apples to apples, we can bring both cash flows to equivalent sums at age 60.
The indexing to the Canadian Price Index (CPI) means, that inflation is accounted for, so a future amount will always have the same value at age 60. If we assume that the money is spent in the year it is received, then any investment benefit can also be ignored.
Age 60 Option
30 percent less for life, from age 60 to age 80 (20 years).
Reduced pension comes to $5,677 (0.70) = $3,974/year
20 years ($3,974/year) = $79,478.00 present value at age 60.
Age 65 Option
In this case, present value must be calculated in two steps. First to age 65, followed by taking the lump sum back in time from age 65 to age 60.
100 percent for life, from age 65 to age 80.
Pension amount is $5,677 per year
15 years ($5,677/year) = $85,155.00 present value of at age 65.
This sum must then be discounted for 5 years, assuming a 2 % inflation rate, to find the equivalent sum at age 60 for comparison. This step is like asking... What lump sum would I have to have on deposit, compounded at 2% per year for 5 years, so it grows into $85,155.00?
From the table, the discount rate is 0.906 for 2 % for 5 years. You can check this answer with a calculator by multiplying (compounding) $77,150 by 1.02 a total of 5 times.
$85,155 (0.906)= $77,150 present value at age 60.
Because the numbers are about the same, $79,000 versus $77,000, these calculations suggest that the break-even point is somewhere near age 80. After age 80 the winner will be the wait until age 65 option.
But how much is the pensioner losing if they take the lesser pension at age 60 then live past age 80? Someone else may ask...what does it matter after age 80?
Lets consider the average pensioner living until age 100;
Age 60
$3,974 (100-60 years) = $158,960.
Age 65
$5,677 (100-65) =$198,695
$198,695 (0.906) = $180,018
So, if the average pensioner lives to be 100, this means an extra $21,000 or 13 percent by waiting for the larger pension to start at age 65.
The Loan Point of View Type of Analysis
Lets look at this from a slightly different viewpoint and call the early pension between age 60 and 65 a loan, one that must be paid back from age 60 to age 80. The loan payments are deducted from the pension.
In this case, the amount of the loan (the principal) is $3,974 (5 years) =$19,870. The payments come to $142 per month or $1,703 per year. If we simplify this, by assuming the entire amount is received at age 65, then $19,870 /$1,703 = 11.7 years. 65 + 11.7 = 76.7. This suggests that the break even point occurs in the vicinity of age 77. A similar result to the cash flow view point.
Is it better to get $20,000 between age 60 and 65, or take nothing during that period, and receive $21,000 more between age 80 and age 100?
I think I could make better use of the money at a younger age. Based on this rationale, the age 60 option looks pretty good to me.
The CPP rules allow a lot of flexibility. So I must decide if I want to accept a lower amount, for life, starting as early as age 60, or wait until age 65 and receive the maximum I qualify for, for life. For me, the age 70 option is a non-starter. My original retirement plan was based on the assumption that I would take it at age 60.
Now its time to ask myself...Is that best? What difference would it make?
Summary
My calculations below show, that if one lives to age 80 it doesn't matter what choice is made, the total dollars received are the same. The break-even point is near age 80. Therefore, taking the pension at age 60 appears more attractive on the basis that age 80 is an average life estimate and one would enjoy the benefits of extra income between age 60 and 65. Even if one lives until they are 100 years old they only receive about 13 percent more money overall. An important consideration is the intangible benefit of receiving more money when you are younger compared to receiving more money later in life.
Calculations
Let's consider an average pension amount to get a feel for the numbers. The average CP at age 65, is $473 per month or $5,677 per year. The age 60 average pension, reduced by 30 percent (0.5 % per month) is reduced down to $3,974 per year. The penalty for taking it 5 years early is $142 per month or $1,703 per year.
From a simple cold blooded accounting viewpoint...at some point in time, if one takes the reduced pension amount at age 60 and they live enough, there will be a break even point. At the break even point it does not matter which option one takes, the total money received is the same. My question is - what age does that happen?
I am aware of two possible ways to compare the options. One is to compare two cash flows brought backward in time into present day dollars. Another approach I have seen is to view the early pension option from age 60 to 65 as a loan that must be paid back.
The big "unknown" in this decision is life expectancy. For these calculations lets "guess" that the pensioner lives until age 80. This puts an upper limit on how much money is received depending upon the choice.
The pension is indexed to the Consumer Price Index to make up for inflation.
So the boundaries are; one cash flow stream at a lower amount starting at age 60 and ending at age 80, and the other stream is a higher amount that starts 5 years later, at age 65 and ending at age 80. So we are comparing apples to apples, we can bring both cash flows to equivalent sums at age 60.
The indexing to the Canadian Price Index (CPI) means, that inflation is accounted for, so a future amount will always have the same value at age 60. If we assume that the money is spent in the year it is received, then any investment benefit can also be ignored.
Age 60 Option
30 percent less for life, from age 60 to age 80 (20 years).
Reduced pension comes to $5,677 (0.70) = $3,974/year
20 years ($3,974/year) = $79,478.00 present value at age 60.
Age 65 Option
In this case, present value must be calculated in two steps. First to age 65, followed by taking the lump sum back in time from age 65 to age 60.
100 percent for life, from age 65 to age 80.
Pension amount is $5,677 per year
15 years ($5,677/year) = $85,155.00 present value of at age 65.
This sum must then be discounted for 5 years, assuming a 2 % inflation rate, to find the equivalent sum at age 60 for comparison. This step is like asking... What lump sum would I have to have on deposit, compounded at 2% per year for 5 years, so it grows into $85,155.00?
From the table, the discount rate is 0.906 for 2 % for 5 years. You can check this answer with a calculator by multiplying (compounding) $77,150 by 1.02 a total of 5 times.
$85,155 (0.906)= $77,150 present value at age 60.
Because the numbers are about the same, $79,000 versus $77,000, these calculations suggest that the break-even point is somewhere near age 80. After age 80 the winner will be the wait until age 65 option.
But how much is the pensioner losing if they take the lesser pension at age 60 then live past age 80? Someone else may ask...what does it matter after age 80?
Lets consider the average pensioner living until age 100;
Age 60
$3,974 (100-60 years) = $158,960.
Age 65
$5,677 (100-65) =$198,695
$198,695 (0.906) = $180,018
So, if the average pensioner lives to be 100, this means an extra $21,000 or 13 percent by waiting for the larger pension to start at age 65.
The Loan Point of View Type of Analysis
Lets look at this from a slightly different viewpoint and call the early pension between age 60 and 65 a loan, one that must be paid back from age 60 to age 80. The loan payments are deducted from the pension.
In this case, the amount of the loan (the principal) is $3,974 (5 years) =$19,870. The payments come to $142 per month or $1,703 per year. If we simplify this, by assuming the entire amount is received at age 65, then $19,870 /$1,703 = 11.7 years. 65 + 11.7 = 76.7. This suggests that the break even point occurs in the vicinity of age 77. A similar result to the cash flow view point.
Is it better to get $20,000 between age 60 and 65, or take nothing during that period, and receive $21,000 more between age 80 and age 100?
I think I could make better use of the money at a younger age. Based on this rationale, the age 60 option looks pretty good to me.
Sunday, April 15, 2007
Canada Pension Plan #2
In the not to distant future- I will decide when to start receiving my Canada Pension Plan (CPP).
The Canadian Human Resources...website states,
"The age you start your pension makes a difference... forever.
The normal age that you start receiving a CPP retirement pension is 65. However, you can start receiving your pension as early as 60 or as late as 70. If you start your pension before 65, you must stop working or earn less than a maximum amount for a required period of time.If you start your pension early, it is permanently reduced by 0.5 percent for each month that you are under 65. If you start your pension later, it is increased by 0.5 percent for each month that you are over 65, up to the age of 70. "
The benefit rates, at age 65, range from a maximum of $864/month or $10,365/year (2007) to an average of $473/month or $5,677/year (Oct. 2006). The payments are not automatic, one must apply for this pension. and they recommend applying at least 6 months in advance of one's start date.The rules allow some flexibility. So one must decide to accept a lower amount, for life, starting as early as age 60, or wait until later and receive a larger pension, for life.
The "for life"part part is important. I guess pension plans in general are a crap shoot, in that those who live longer get more and those who die at an early age receive less. Death benefits and survivor benefits offset this fact to some degree. I believe Canada requires that a surviving spouse receive at least 50 percent.
When it comes to life expectancy...its a little bit like a roulette wheel picking an age. I recall a number of guys that never even made it to retirement. Some only lived a short time after retirement and others lived past age 80.
If one enjoys a physical activity, then one of the realities is that as we age we get less bang for our buck . For many people, if not for most, they can expect to have less energy and less enthusiasm. It doesn't mean that extra money cannot be spent on other things one thinks are worthwhile. Maybe you want to leave a larger estate to relatives or more to a charity.
I'm crunching some numbers for comparsion and will post them in the future.
The Canadian Human Resources...website states,
"The age you start your pension makes a difference... forever.
The normal age that you start receiving a CPP retirement pension is 65. However, you can start receiving your pension as early as 60 or as late as 70. If you start your pension before 65, you must stop working or earn less than a maximum amount for a required period of time.If you start your pension early, it is permanently reduced by 0.5 percent for each month that you are under 65. If you start your pension later, it is increased by 0.5 percent for each month that you are over 65, up to the age of 70. "
The benefit rates, at age 65, range from a maximum of $864/month or $10,365/year (2007) to an average of $473/month or $5,677/year (Oct. 2006). The payments are not automatic, one must apply for this pension. and they recommend applying at least 6 months in advance of one's start date.The rules allow some flexibility. So one must decide to accept a lower amount, for life, starting as early as age 60, or wait until later and receive a larger pension, for life.
The "for life"part part is important. I guess pension plans in general are a crap shoot, in that those who live longer get more and those who die at an early age receive less. Death benefits and survivor benefits offset this fact to some degree. I believe Canada requires that a surviving spouse receive at least 50 percent.
When it comes to life expectancy...its a little bit like a roulette wheel picking an age. I recall a number of guys that never even made it to retirement. Some only lived a short time after retirement and others lived past age 80.
If one enjoys a physical activity, then one of the realities is that as we age we get less bang for our buck . For many people, if not for most, they can expect to have less energy and less enthusiasm. It doesn't mean that extra money cannot be spent on other things one thinks are worthwhile. Maybe you want to leave a larger estate to relatives or more to a charity.
I'm crunching some numbers for comparsion and will post them in the future.
Tuesday, April 10, 2007
Canada Pension Plan #1
The Canada Pension Plan (CPP) has an interesting story behind it. Started back in the 1960s, the intention was to ensure that all working Canadians put away something for retirement. It is funded by pay check deductions at the workplace. Over time, Canadians became concerned that the pension plan would not be sufficient to meet all the pension payments due to the aging population and growth in the number of pensioners. The contribution rates were increased, and extra money was invested with the goal of making ends meet in the future. In recent years, the concern about the sustainability of CPP seems to have diminished due to increased pay check deduction rates imposed on those who earn income, and a move toward building up the plan assets and investing the extra cash. Plan assets are growing.
The average CPP received by retirees in 2006 was $5,677 per year ($473 per month). The maximum CPP received in 2007 was $10,365 per year ($864 per month). These amounts are indexed for inflation. In 2007, CPP pensions were increased by 2.1 % to match the Canadian Price Index. The annual increase for inflation is a nice feature. CPP income is taxable.
When I decided to take early retirement at age 55, I "guessed" that my CPP would only be paid out at 50 percent of my starting rate. This was part of my safety factor. In addition, I expected to use CPP income for non-essentials such as owning a boat, an expense we did not have prior to retirement.
The average CPP received by retirees in 2006 was $5,677 per year ($473 per month). The maximum CPP received in 2007 was $10,365 per year ($864 per month). These amounts are indexed for inflation. In 2007, CPP pensions were increased by 2.1 % to match the Canadian Price Index. The annual increase for inflation is a nice feature. CPP income is taxable.
When I decided to take early retirement at age 55, I "guessed" that my CPP would only be paid out at 50 percent of my starting rate. This was part of my safety factor. In addition, I expected to use CPP income for non-essentials such as owning a boat, an expense we did not have prior to retirement.
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