Best of 2010: Deciphering the CPP crossover

Given the importance of the Canada Pension Plan to most retirement plans, any tinkering with it must be understood. Doug Carroll explained the changes that went into effect in 2010.

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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 dropout years: 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 if 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 pretax dollars are maximized for each commencement year .

Commencement age	60	61	62	63	64	65	66	67	68	69	70
Death by – Old rules	70	72	73	75	77	79	81	82	84	86	87
Death by – New rules	68	69	71	73	75	76	77	79	80	82	83

Once the new rules are fully implemented in 2016, we can see 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. .

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Doug Carroll, JD, LLM (Tax), CFP, TEP, is vice-president of tax and estate planning at Invesco Trimark Ltd.

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