Saturday, May 30, 2009

CPP Proposed Changes

Many people are hurting financially in this recession, and the government has decided to help out with changes to the Canada Pension Plan (CPP). This is the same kind of help you might get from a stranger who sees you need money badly and offers you ten bucks for your iPod.

For anyone planning to retire and draw from the Canada Pension Plan over the next 5-10 years, this will affect you and may ultimately make you decide to either retire early or later. There are several proposals on board but there are three that can/will dramatically affect your pension benefits.

Retirement pensions are paid monthly to all Canadians who have contributed to the Plan. The normal age of CPP take up is 65, but reduced pensions are available starting at age 60. For those who delay take up beyond age 65, pensions are increased up to the age of 70. In 2009, the maximum monthly pension amount payable at age 65 is $908.75.

Change #1

Currently, if you were to retire early, CPP reduces your monthly benefit by .5% per month for every month you retire before age 65. If you retire at age 60, you lose 30% of your benefit. If you wait until after 65, they add .5% for each year (up to 70). The plan now is the change the early "penalty" to .6% per month. If you take your CPP early, the reduction in pension amount is permanent. The pension will not go back up to the “normal” level at age 65. So, the extra .6% reduction will apply for the rest of your life.

Say someone is eligible for a CPP benefit of $900 per month. They are age 60 and want to retire now. With the current rules, they would receive monthly income of $630 per month. ($900 - 30% or $270). Under the proposed changes, that income would be reduced to $576 per month. This would mean a loss of $54 per month. For a person living to age 85, they lose $16,200 and that doesn't take into account inflation related increases. That moves the figure closer to $25,000.

On the other hand, with the proposed changes, if you wait to collect after age 65, you will receive a bonus of .7% per month. The same person retiring at age 70 would see their benefits increase to $1215 per month. The trade off is that they would only receive benefits until they die. If they were to live to age 85 (as above and ignoring inflation related pay increases), the 60 year old receives $172,800 and the 70 year old receives $218,700. If you were to factor in inflation of 3%, the numbers change. The 60 year old gets roughly $250,000 and the 70 year old gets roughly $271,000.

The combination of allowing people still working to draw early CPP along with being in a recession may cause many people to make the short-term decision to draw CPP early. The government is right there to help them out with a low ball offer of 36% reduced CPP payments. From an actuarial point of view, this increased early penalty makes little sense because people are living longer. The longer you live, the less enticing a reduced early pension becomes. From the point of view of taxpayers, this is a good move by the government. CPP payouts will increase somewhat in the short term, but over the long run, the total benefits paid out will be lower.

Change #2

The CPP retirement pension amount is based on the number of years a person has worked and contributed to the Plan, as well as the salary or wages he or she earned. Specifically, it is calculated as 25 percent of an individual’s “average career earnings”, starting at age 18 and ending at the age of CPP take-up. If, for example, an individual takes the CPP at age 65, the span of the career is considered to be 47 years. If, for example, the CPP is taken at age 60, the span of the career is 42 years.

The average of earnings over the span of the career is calculated allowing for 15 percent of the years where earnings are low or nil for whatever reason (e.g., full-time post-secondary education attendance or spells of unemployment) to be dropped. This provision is called the “general low earnings drop-out”. The 15 percent gives individuals who take their CPP at age 65 almost 7 years of low or zero earnings years that can be dropped from the calculation of their average career earnings. In addition, there are drop-out provisions specifically for child rearing and periods spent receiving a CPP disability benefit.

These drop-out provisions are intended to ensure that an individual’s average career earnings are not affected by a certain number of years of unusually low earnings that occur in most people’s career for various reasons. Virtually everyone benefits from the CPP’s drop-out provisions. Without these provisions, virtually everyone’s “basic” pension amounts – that is, the pension amount if the CPP is taken-up at age 65 without any adjustments for early or late take-up – would be lower.

Under the proposed changes, the 15 percent figure would increase to 16% then to 17%. This change would benefit virtually all CPP contributors and improve their basic retirement pensions. It would also increase the average CPP disability and survivor pensions, as the calculation of these benefits is based on the retirement benefit calculation. While the change would increase the average retirement benefit of virtually all contributors, it would be particularly helpful to those whose careers suffer more work interruptions for a variety of reasons. For instance, those who pursue post-secondary studies or other educational opportunities, those who reduce their participation in the labour force to provide care to a family member, or those who immigrate to Canada as adults are all more likely to find this measure especially helpful.

Change #3

You will be able to draw CPP at age 60 while still working without taking two months off. This is welcome news for older workers who have been laid off and are having a hard time getting by on half as much pay at a new job. In other words, you don't have to "retire" and then go back to work later. This may be an attractive thing to someone forced out of an old job, who resumes one at a lower income.

Jonathan Chevreau of the Financial Post had 3 actuaries discuss the situation in greater detail. Don’t blame people who choose to take early CPP despite the extra reduction. It’s possible that a person’s unique circumstances make this a wise choice. For years I have been telling single people that they should almost always take it as early as possible. Unlike someone with a spouse, if they die, their estate receives a cheque for $2500 AND THAT IS IT. At least with a couple, their is a monthly benefit paid to a surviving spouse. Unfortunately, people will often make choices based on their immediate needs. The one good thing about these proposals is that the changes will allow the government to maintain current funding levels. At least this means you don't need to pay more to get less.

It’s good to know that when people are hurting, the government is right there to say “I’ll give you a hundred bucks for your car.”

Stay Well and Pay It Forward.

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