Posted by Tim Stobbs on March 25, 2008
In Part I I walked you through how to come up with a yearly income requirement for retirement in today’s dollars. Now today we are going to look at government benefits.
In Canada there are a few different programs you can tap into during your retirement. The most common programs people have to account for is Old Age Security (OAS) (which is vaguely similar to Social Security in the US) and the Canada Pension Plan (CPP).
Both are important to account for in your plans in some form or another. Some people don’t believe the programs will continue when the baby boomers hit retirement. I think you can’t estimate inflation for twenty years either or even tax code changes for next year, but we still try. So for now let’s assume everything is the same and keep them in and we will add some buffer to our calculation later. Also if you really have problems with the OAS program you can drop it out of your calculations entirely, but I would suggest leaving the CPP in as it is a pension plan run by a government. Let’s face it you’ve got a higher risk of your work pension going belly up that the CPP running out of money (after all does anyone recall a company called Enron and their pension plan?).
1) Canada Pension Plan
You’ve seen the deduction on every pay cheque for years and now here is the good news. You get to cash in on some of that forced savings. The earliest you can collect is age 60. Since you don’t know when your going to die I suggest that most people just take the cash and accept that your going to have a pension reduction of 30%. The 30% reduction is worth it when you consider you are being paid for any addition five years. Even if you don’t need it you can always bank it up in a Tax Free Saving Account (TFSA) and pull it out later.
Now normally I don’t suggest people get too involved with understanding how the government calculates your benefits from these programs. All you typically need to know is your benefit amount. Yet in the case of the CPP program and early retirement it is down right critical to understand a few points.
You see your CPP benefit depends on your income from age 18 to 60 (or 65 if you taking it later). The government takes the average over that period and determines your benefits from that (up to the maximum of about $40,000/year). Yet they do give you a break in deducting your lowest 15% of your working years as long as you have contributed for at least 10 years (more if you were raising your children under age 7 and that caused you a lower income for a number of years). So in the typical case (18 to 60) that means you will remove 6.3 years of your lowest earnings using just the 15%. You might notice that if you plan a retirement earlier than 55 you will be adding a several years of potential zero income which will drag down your CPP benefits. So in my case when I retire at 45, I will be adding 15 years of zeros to my average income. I can only offset 6.3 of those, so in total I will be adding 8.7 year of zeros to my average (or about 24% of my calculated earning years). There really isn’t anything you can do about this. If you choose the early retirement path you have to give up some of your CPP benefits. It’s the price of freedom. (With the expection that you want to work in retirement, then you will replace a few zero years with a little work income which will raise your benefit slightly.)
So with that all in mind you have to use the following method to determine you CPP benefits, otherwise it is highly likely you will get a wrong estimate. First you must request a statement of your CPP contributions to date to determine where you currently are. If you take that you can plug it in to this online calculator and get an estimate of what you are going to earn. Also you have the option of adding an age where you stop contribution to simulate early retirement. In my case I got $5460/year for me if I start at age 60 and retire at age 45 and I’ll assume $1200/year for my wife. The reason my wife’s is so low is I’m unsure where she will fall out after the child care drop out so I’m going to play it safe and assume a low number.
I know that doesn’t look like a lot but combined, the $6660/year is still a useful base for your retirement income. The added tax benefit of a CPP pension is income splitting is allowed. Please note that if your from Quebec you fall under the Quebec Pension Plan (see here for information).
2) Old Age Security
Just about everyone qualifies for the OAS. All you have to do is live in Canada for 10 years prior to your retirement but after you turn 18 (and be a Canadian citizen or legal resident). If you’ve lived in Canada for 40 years or more after you turned 18 you will qualify for the full pension. If you are not there I suggest you go read the fine print to find out if you can expect anything or if you qualify for other benefits such as the Guaranteed Income Supplement or the Allowance. Based on the current rates, I expect my wife and I will collect an additional $6027/year each after we turn 65. So that would add another $12,054 to our retirement income.
Therefore in total OAS and CPP will pay me and my wife $18,714/year of inflated indexed money in today’s dollars. Depending on if required retirement income is fairly modest you might find yourself most of the way towards your goal after you turn 65.
Tomorrow we will continue this series and see how a work place pension and RRSP’s fit into the mix and this is where some of big changes have happened to my plan.