Tag: CPP

January 2012 CPP changes – Watershed moment or slippery slope?

We are well on the way to the implementation of the latest round of revisions to the Canada Pension Plan, with a host of revised rules and rates being phased in between 2011 and 2016.

Next month will be a particularly important juncture with the elimination of the work cessation test and the beginning of increased penalties for early pension take-up.  Taken together, these changes should have would-be CPP pensioners conscientiously reflecting on their newfound flexibility.

Recap of the CPP changes 

A more detailed rundown of the changes appeared in the March 2010 Tax & Estate Matters article, but they are in brief:

  • Increased monthly penalties/premiums for early/late pension commencement
  • Elimination of the work cessation test
  • Premium payment obligations and opportunities for working CPP pensioners
  • Improved pensions overall, due to an increase in the low earnings dropout years

Early and late take-up schedule

It is important to note first that one must apply for a CPP pension; it does not automatically start paying.  A pensioner may elect to begin as early as age 60, with full CPP pension entitlement in the birthday month at age 65.  A delay beyond that date to as far as age 70 will result in a premium top-up to the pension.

The exact amount of the pension will depend on premiums paid (and thus credits earned) by the person during working years.  The 2011 monthly maximum at 65 is $960, with the average of all pensions actually being $512 as of June 2011. 

Until these most recent revisions, the monthly penalty/premium for early/late take-up was 0.5% per month.  These will both increase on the following schedule*:

                                  <2011      2011        2012       2013        2014        2015        2016

Early penalty    0.50%     0.50%    0.52%    0.54%    0.56%    0.58%    0.50%

Late premium   0.50%    0.57%    0.64%    0.70%    0.70%    0.70%    0.70%

*Footnote: The Quebec Pension Plan will also adjust its early take-up penalties (2014 0.53%, 2015 0.56%, 2016 0.60%) and late take-up premium (2013 0.70%), but at present the work cessation test remains in place. 

Work cessation test – A closer look

The work cessation test requires/ed that an individual earn less than the current monthly maximum CPP retirement pension payment (again, $960 in 2011) for the month prior to and the month of pension commencement.  By the time you are reading this, that test will effectively be an historical footnote.

As of January 2012, one may apply for the CPP pension irrespective of current or future income.  To allow for processing time, the government recommends that the application be submitted six months prior to the month that the pension is to commence.

Tempered flexibility

There is no question that the elimination of the work cessation test opens accessibility and paves the way for flexibility as to when and how a CPP pension may be taken.  Still, pensioners must consider their options carefully.

As we look in the rearview mirror at the old penalty provisions, early take-up at age 60 meant a (lifetime) pension at 70% of what would otherwise have been available from age 65.  By 2016, the per-month penalty of 0.6% will push that down to 64% of the full entitlement.  That’s a haircut in excess of a third of full entitlement.  For those in ill health, early take-up may indeed make the best sense, but for those with long genes it could be a recipe for later life financial distress.

Ultimately, it remains a very personal decision, not one that is dictated by spreadsheet figures alone.  No doubt the easy availability of that cash supplement will be very hard to resist for many, and accordingly this is one of those times when a good financial advisor can earn his or her stripes by fairly presenting the options and implications, so that an informed decision may be made. 

Do recent changes to the CPP have a systemic and regressive punitive aspect?

I speak regularly at a variety of industry events, often providing a tax and estate snapshot of recent developments affecting personal wealth. One current item of interest is the slew of Canada Pension Plan (CPP) changes that has just passed into law.

The common theme that keeps coming up in comments and questions on these sessions is what effect these changes might have on the CPP ‘crossover’ point.  The response depends on how you interpret this concept and what you use it for. 

Recent CPP changes

The Canada Pension Plan comes up for formal review on a triennial basis, with the 2009 recommendations having made their way into law with Royal Assent granted to Bill C-51 on December 15, 2009.  The changes will be phased in over the next six years, and generally will not affect existing CPP beneficiaries or those who take their benefits before the changes come into effect.  

Work cessation test – Until now, a person under age 65 had to ‘retire’ (cease work or at least reduce income) before commencing a CPP pension, but could then return to work after two months.  The work cessation test will be eliminated in 2012. 

Working beneficiaries participating in the CPP – In the past, once a pension had begun, there would be no further CPP premiums paid.  Beginning in 2011, premiums will be mandatory for those under age 65, and voluntary from age 65 to 70. Ongoing retirement benefits will increase based on those premiums paid.  

General low earnings drop-out years – In the calculation of pension entitlement, the drop-out of low or nil earnings years will increase from seven years to eight years by 2014, leading to improved pensions for many people. 

Adjustments for early and late CPP take-up – The current adjustments reduce a pension by 0.5% per month the pension begins before the normal age of 65, or increase it by 0.5% for each month after the 65th birthday month. The early pension reduction will gradually increase to 0.6% by 2016, and the late pension augmentation will gradually increase to 0.7% by 2013.

As stated in the information paper issued by the Department of Finance, the package is “expected to improve the long-term financial sustainability of the CPP.”  With respect to the early and late take-up adjustments, it notes that these “have been left unchanged since 1987 despite significant shifts in the economic and demographic factors that affect their “actuarially fair” levels.”

The notional crossover

I use the word “notional” in reference to the crossover because it is an elusive figure to calculate. The idea is that for a given month after age 60, should the CPP retirement pension be triggered or should it be delayed until age 65, or perhaps even later?  There are so many variables, some subjective or elective, that arguably the exercise amounts to mere guesswork. Among the issues:

What is the person’s marginal tax rate at commencement and each year in future?  Is clawback of the age credit or OAS in play?

Will early receipts be spent or invested, and if invested, what level and type of returns are generated?  Is TFSA room available?

Will continuing premiums be required or desired if work continues?  If self-employed, what is the impact of paying both employer and employee premiums?

This is all apart from the fairly obvious unknown (for most of us) of the intervening time until death occurs. As a predictor for an individual pensioner, in my opinion, the crossover discussion verges on dangerous territory if recommending a selected date as optimal.  

Across the population however, we may find some interesting observations, especially in comparing expected outcomes under the old rules versus the new rules.  To facilitate the comparison, we can keep the variables constant, except to index the pension amount, in this case using a smoothed 2% annual factor.  

While the pension is actually calculated from commencement month, in this simplistic model we use commencement year. The grid shows the rolling year-of-death crossover points when accumulated pre-tax dollars are maximized for each commencement year.  

Once the new rules are fully implemented in 2016, we can see that the entire series shifts down, by two to three years under age 65, and by three to four years leading up to age 70. Not surprisingly, it appears that structurally the move to the new rules encourages the coming generation of retirees to think twice before triggering their pensions at early ages.  

To put on the cynic’s hat, however, if a pensioner’s economic circumstances are such that delaying triggering is not an option, one might surmise that there is a systemic and regressive punitive aspect to the new rules.  

Practical value to advisors

The changes — particularly these take-up adjustments — present financial planners with an opportunity to provide insight and guidance to clients in determining how best to manage their CPP pensions.

And given the ease of opting-in, presented by the elimination of the work cessation test, advisors may be having many more of these discussions as the next few years unfold.

Recent CPP changes: Your clients will be seeking your guidance in the coming years

The Canada Pension Plan (CPP) comes up for formal review on a triennial basis, with the 2009 recommendations having made their way into law with Royal Assent granted to Bill C-51 on December 15, 2009.  

It appears that structurally the new rules encourage the coming generation of retirees to think twice before triggering their pensions at early ages, which will likely influence the course of advisor conversations with clients and, potentially, the recommendations made.

The changes

Work cessation test – Until now, a person under age 65 had to “retire” (cease work or at least reduce income) before commencing with CPP payouts, but could then return to work after two months. The work cessation test will be eliminated in 2012. 

Working beneficiaries participating in the CPP – In the past, once a pension had begun, there would be no further CPP premiums paid. Beginning in 2011, premiums will be mandatory for those under age 65 and voluntary from age 65 to 70. Ongoing retirement benefits will increase based on those premiums paid.  

General low earnings dropout – In the calculation of pension entitlement, the dropout of low- or nil-earnings years will increase from seven years to eight years by 2014, leading to improved pensions for many people. 

Adjustments for early and late CPP take-up – The current adjustments reduce a pension by 0.5% per month that the pension begins before the age of 65, or increase it by 0.5% for each month after the month of a person’s 65th birthday. The early pension reduction will gradually increase to 0.6% by 2016, and the late pension augmentation will gradually increase to 0.7% by 2013.

Impact on pensioners and the system

As indicated above, the changes will be phased in over the next six years and generally will not affect existing CPP beneficiaries or those who take their benefits before the changes come into effect.  

As stated in an information paper issued by the federal Department of Finance, the package is “expected to improve the long-term financial sustainability of the CPP.” With respect to the early and late take-up adjustments, it notes that these “have been left unchanged since 1987 despite significant shifts in the economic and demographic factors that affect their ‘actuarially fair’ levels.”

Practical value to advisors

The changes – particularly these take-up adjustments – present financial advisors with an opportunity to provide insight and guidance to clients in determining how best to manage their CPPs.

And given the ease of opting in presented by the elimination of the work cessation test, advisors may be having many more of these discussions over the next few years.