Consider inflation when deciding when to begin CPP

Inflation has a significant bearing on when to start a CPP retirement pension. With inflation at its highest in 30 years, now is a good time to revisit the factors involved in deciding when to draw CPP.

Two inflation measures pertain to CPP

Two separate measures of inflation come into play when calculating CPP.

First, CPP payments are indexed to the consumer price index (CPI), as measured over the 12-month period ending in October of the previous year. The changes take effect on Jan. 1 of each year. For 2020 through 2022, CPP payments increased by 1.9%, 1.0% and 2.7% respectively.

Second, CPP performs certain calculations based on the year’s maximum pensionable earnings (YMPE), which is indexed for wage inflation. The maximum retirement pension (before taking into account the new tier introduced in 2019) for a given year is calculated by averaging the YMPE for the year the pension starts and the four prior years, then taking 25% of this amount.

The amount increases each Jan. 1 by the percentage increase in the 12-month average of the average weekly earnings in the industrial aggregate (as published by Statistics Canada, as of June 30 of the preceding year). It is then rounded down to the nearest $100.

The YMPE for 2020 was $58,700. It increased by 4.94% to $61,600 in 2021 and by another 5.36% to $64,900 for 2022. The increases to YMPE were so large because the bottom end of the labour market (e.g., service industries) suffered during the pandemic. Since the lower wages paid to these sectors were not taken into account, the aggregate rose.

Inflation affects age-based discounts and enhancements to CPP

People who begin drawing CPP before age 65 receive a discounted payment, while those who draw CPP after age 65 receive an enhanced payment. The discount and enhancement factors are shown in Table 1.

These factors may be adjusted every third triennial valuation, though the 0.6% per month discount has been in place since 2016 and the 0.7% per month enhancement since 2013. (Supplemental reports may be prepared where necessary.)

Source: Lea Koiv. Click on image to enlarge.

What we need to bear in mind is that that any upward or downward adjustment to the amount to be paid is calculated using the maximum retirement pension, which continues to grow to the year the pension starts to be drawn based on wage inflation. (The latest actuarial report assumes that there will be long-term real wage growth, that is the difference between nominal wage increases and CPI, of 1%. Hence, in my calculations I assumed CPI to be 2% and growth in the maximum retirement pension to be 3%.)

For the decade ending in 2018, the average age at pension take-up was 62.5. Inflation is now increasing rapidly, which could lead to a significant future increase for a deferred pension. Knowing that, does it make sense to first draw on alternate sources (e.g., RRSPs or RRIFs) and defer the start date?

Case study

Cynthia is retired and wanted to start her pension as soon as possible. She turned 60 and began drawing on her CPP pension in January 2020 (she did not want to access her other assets yet). As a result, she received 64% of the maximum (due to the 36% discount; $1,175.83 x 64% = $752.53 per month). This amount is indexed and increases each Jan. 1.

Had she waited to January 2021, she would have received $857.07 per month (71.2% x $1,203.75 = $857.07). Instead, her starting pension of $752.53 was indexed by 1.0% to $760.06. Had she waited the 12 months, her pension would have been 12.76% larger. (She did, however, draw 12 months of pension at the lesser amount.)

If she’d begun drawing her CPP in January 2022, the monthly amount would have been $982.81 (78.4% of $1,253.59). Meanwhile, the pension she began in 2020 would have grown by an additional 2.7% to $780.58 due to indexing. Had she waited to age 62 to start drawing the pension, the amount would have been 30.6% larger than the pension she began receiving at age 60.

Source: Lea Koiv. Click on image to enlarge.Note 1: Amount indexed each January 1 for CPI increases (actuals for 2021 and 2022 of 1.0% and 2.7%, respectively; 2% thereafterNote 2: Maximum CPP retirement pension based on actuals for 2020 through 2022 and 3% increases thereafter

For subsequent years, I assumed CPI increases equalled the Bank of Canada’s target inflation rate of 2%. The maximum retirement pension was assumed to increase by 3% based on existing actuarial assumptions.

As seen from Table 2, the results are dramatic. Delaying the CPP until age 65 would have resulted in a monthly retirement pension that was 82.03% larger. At age 70, it would have been 199.65% larger — essentially triple.

It’s worth noting that we don’t know whether the Bank of Canada will be able to tame inflation. The higher the inflation rate, the bigger the benefit of waiting.

To illustrate these differences another way, we can look at the present value (PV) of the retirement pension. Using a life expectancy of 96 and a 4% discount rate, the PVs are as follow:

• Age 60 start – $239,000
• Age 65 start – $318,000
• Age 70 start – $377,000

As the calculations show, Cynthia’s eagerness disadvantaged her. Assuming Cynthia had sufficient retirement assets to draw on until she began CPP, waiting would have been more beneficial.

There are, of course, situations in which waiting to start drawing the retirement pension may not be appropriate. Included here are when someone is receiving CPP survivor benefits, those facing the OAS clawback, and those in poor health.

Lea Koiv

Tax & Estate

Lea Koiv , CPA, CMA, CA, CFP, TEP, is a tax, pension and retirement expert who has held senior roles at a national insurer and international accounting firms. Reach her at info@leakoivassociates.ca.