Why and how advisors can help
[A version of this article appeared in Advocis Forum February 2021]
While playing charades over the holidays, my youngest son stumbled with “a bird in the hand is worth two in the bush”. Eventually we guessed it, and I explained to him that it means accepting a sure thing now rather than holding out for something potentially bigger later.
Coincidentally, that adage also featured prominently in an item on my holiday reading list. It’s a research paper[1] about delaying Canada Pension Plan retirement benefits, released in late 2020 by the National Institute on Ageing and the FP Canada Foundation.
My long-held opinion has been to take at 65, unless there are compelling reasons to start earlier. After reading this paper, I’m now leaning toward 70 as the default position.
When we’re starting CPP, and why
The majority of Canadians – 7 out of 10 – take their CPP retirement pension at either 60 or 65. Less than 5% take after age 65, and only 1% wait until 70. The study’s author, Bonnie-Jeanne MacDonald, attributes this pattern of early uptake to a combination of lack of advice, bad advice and ‘bad “good” advice’.
The bad advice includes the emotional pull of the bird-in-the-hand: ‘If you die early (so the argument goes), you’ll leave money on the table, so take CPP as soon as you can’. However, the only guarantee is that your payments start sooner, not that you’ll receive more. And ironically, the early uptake may in fact increase the likelihood that you will receive less, as we’ll see following.
The ‘bad “good” advice’ is the mainstream practice of using a breakeven age. It compares two starting ages, say 60 and 65, focusing attention on whether you will reach the age when the cumulative receipts are the same. This plays to our behavioural tendency to favour the near-term (from first age to second age to breakeven age), thereby undervaluing the lifetime income security that CPP offers. On top of that, academic research shows we tend to underestimate our life expectancy, making it even more likely to choose the earlier start.
According to Canada’s Chief Actuary, life expectancy at age 60 is 85.9 for men and 88.5 for women. In my own experience, I’ve never seen a suggested breakeven/crossover age much over 80. This has long been my discomfort with this approach, as you are betting on being in the ‘dies-before’ half of the cohort population. You lose (statistically) simply by being average, and it gets worse the longer you live.
Measuring the dollar difference
Early uptake would not be a concern if it in fact leads to a better financial outcome. To test this, MacDonald departs from the breakeven approach, favouring a calculation of the current dollar value of the expected loss, or “Lifetime Loss”.
For someone with average life expectancy entitled to the median CPP income who takes at 60 rather than delaying to 70, the Lifetime Loss in current dollars is over $100,000.
The model factors-in the drawdown of RRSP/RRIF savings until the CPP begins. Including this component, it finds that most people will still be much better off by bridging this way, than by taking CPP early and stretching their RRSP/RRIF money over the expected retirement years.
Notably among the scenarios canvassed in the paper, someone entitled to the maximum CPP pension who lives close to age 100 (a 25% probability from age 60 according to the dataset used), the current dollar loss can exceed a quarter of a million dollars.
Advisors have a key role
To be clear, Lifetime Loss is not intended to be applied without consideration of individual circumstances. There are many situations where it would make sense to begin early, such as when there is a known life-limiting health condition, or when someone is trying to preserve income-tested benefits or shield against the Old Age Security clawback.
For most people, it’s a challenge just to identify all the contributing factors in making such a decision, let alone evaluate the trade-offs among them. It’s both technically complicated and emotionally charged, which together can be overwhelming.
In addition to being a dependable information source, financial advisors can guide their clients by applying some of the lessons of behavioural finance:
- Loss aversion holds that we feel the pain of loss twice as much as the joy of gain, which is what Lifetime Loss illustrates in concrete terms.
- It also frames the discussion on the more likely scenario of longevity, as opposed to early death.
- Lastly, it anchors at the later age of 70, to be lowered as the analysis warrants rather than having to make the uphill battle from age 60.
Ultimately the decision should be informed by individual particulars and reliable evidence. In the latter respect, I recommend this paper as a helpful resource for all financial advisors.
1 https://www.fpcanadaresearchfoundation.ca/media/5fpda5zw/cpp_qpp-reseach-paper.pdf