The Canada Pension Plan and Old Age Security are often the backbone of retirement income for many Canadians.
The fact these government pensions can provide a maximum-annual benefit of almost $19,000 for the rest of a retiree's life -- and these programs are sustainable for the long-term -- make them the envy of the developed world.
In the last few years, the federal government has made a number of changes to increase the long-term solvency of these plans as well as their flexibility for retirement planning.
But this somewhat long list of changes has also made figuring out how best to use these pensions as part of a retirement plan more complicated.
Even a retirement expert like Evelyn Jacks, author of multiple books on our tax system (can it get any more complex?) can admit to that.
"It's not easy to understand this stuff," said Jacks, who is president and founder of the Knowledge Bureau, a Winnipeg-based financial-education institution.
"That's why working with a retirement income planner who is really up to date on his or her tax knowledge is very important."
Of course, who could be more up-to-date than Jacks herself?
So, if you find yourself out of the loop on recent changes to CPP and OAS, consider this a mini-crash course -- courtesy of Jacks, one of the leading tax experts in the country.
OAS payment pushed back
By now, many Canadians are already aware those of us born in 1958 or later (age 55 this year) are going to have to wait longer to get our first Old Age Security cheque. To fretful fanfare, the federal government announced in 2012 that OAS eligibility will move from 65 to 67 starting a decade from now.
"If you're under 55, this essentially means you're going to have to save about $13,000 more for retirement because OAS is worth around $6,500 a year now," she said. Adjusted for inflation, it's likely more in the range of $16,000.
"Given the time value of money, the younger you are the easier that's going to be, but if you're in your early 50s, then you really do need to think seriously about how to make up for that shortfall."
The change will be phased in gradually between 2023 and 2029, so people born between April 1, 1958, and Jan. 31, 1962, will have an age of eligibility between 65 and 67.
For example, someone born in April, 1959 will have to wait one year and one month after they turn 65 to become eligible.
The same change will also apply to the Guaranteed Income Supplement (GIS), and the Spouse's Allowance and Allowance for Survivors benefits. Except instead of changing from 65 to 67, this benefit will start at 62 rather than its current eligibility age of 60.
"These changes can be really a big concern for people at the lowest income levels who will quite likely have to cope by working a little bit longer if they can," Jacks said.
While most of us know that we'll have to wait longer for OAS, we may not know that starting this month we can defer receipt of OAS as far as age 70. "The primary benefit of doing so is you'll have a larger pension when you do start to receive it," Jacks said. "It will increase by 0.6 per cent for each month of deferral, and the maximum pension deferral after the full five-year period will result in an increase of 36 per cent of the OAS benefit that you will eventually receive."
Bear in mind, however, that those five years will represent 37 per cent of the life expectancy of a male after age 65 and 28 per cent of the life expectancy of a female. "If you beat the odds and live beyond your 79th birthday, you will likely receive a larger lifetime OAS benefit if you have deferred one year for each year you live beyond 79."
For many people, therefore, deferring OAS will come down to a question of longevity. If you've got a family history of longevity, it's worth considering deferring because it can provide some tax-efficient advantages to retirees with RRSPs.
"It certainly will provide an extra five years of tax room to melt down other taxable sources such as your RRSP, for example," she said. "You might draw $6,500 more each year -- the equivalent of the OAS -- from those sources to avoid a bigger tax bite on your RRSP savings after age 71 when you have to convert to a RRIF and draw a mandatory amount as income and also receive the OAS benefit." Married couples can also mitigate some of the tax risk through pension-income splitting, she added.
Deferring OAS also gives retirees who are in the OAS clawback zone -- in which net income exceeds $70,954 annually -- the opportunity to structure their income so their future OAS monthly cheques may not be reduced as much, or maybe even at all.
"If because of your high net income the clawback eliminates your OAS benefits, there's absolutely no reason not to consider deferring your OAS pension," she said. "However, it's best to confer with a qualified retirement-income specialist to be sure."
CPP... the later the better for some
Deferring Canada Pension Plan benefits will also put more pension money in your pocket than ever before. As of this year, delaying taking the benefit after age 65 will increase the benefit by 0.7 per cent per month. That's 8.4 per cent per year and if you delay until age 70 -- the longest you can defer -- your benefit will increase by 42 per cent. Again, Jacks said deferring CPP may be useful for individuals with RRSPs, who are in or nearing the OAS clawback zone, because they can choose to unwind RRSP assets for income early in retirement, for example, and then take larger government pensions at age 70.
CPP... the early bird gets a smaller worm
Retirees can still take CPP starting at age 60, but the reduction in benefit is gradually increasing from 0.5 per cent a month in 2011 to 0.6 per cent a month in 2016. Because the decrease will be phased in over five years, retirees starting CCP early each year until 2016 will see their benefit decreased by 0.02 per cent a month. For example, someone who takes early receipt this year will see a reduction of 0.54 per cent for each month before age 65. In 2016, the maximum annual reduction will be 7.2 per cent per year or 36 per cent for someone who starts at age 60.
Jacks said some people do choose to take the benefit early, especially if they have concerns about longevity. Others, who along with their spouse, will earn the maximum benefit, and have other substantial retirement assets, may also choose early receipt because the maximum survivor's benefit will only top up the surviving spouse's CPP monthly payment to the maximum retirement benefit of $1,012.50. "What that means is if you both worked all your life and you both qualify for the maximum, then there is no survivor's benefit." If a couple both take CPP early, the surviving spouse can still potentially earn the full benefit as a combination of the retirement and survivor benefits.
Continuing to pay premiums
Beginning last year, pensioners who took CPP early have to keep paying premiums into the plan if they continue working. "In exchange for that, they get a post-retirement benefit, with the maximum benefit in 2013 being $25.31, which will be added onto to the pensioner's reduced monthly CPP retirement benefit." Under the old rules, individuals taking CPP early could continue to work without having to pay premiums, but they had to stop working for at least one month to start receiving CPP. Under the new rules, they don't have to stop working. And while they have to pay premiums until age 65, they can elect to stop paying into the plan from 65 to 70 if they're receiving the benefits and still working.
"But you have to do so proactively by filing a CPT30," Jacks said. "People who are self-employed, however, will do this on Schedule 8 of the tax return." Furthermore, this option can help with the substantial premiums, onerous for self-employed workers because they may have to pay premiums of up to $4,712.40.
"This is a fairly significant monthly amount so you might want to choose to put it elsewhere if you're over 64."
Plan ahead and never stop planning
Jacks said the changes to OAS and CPP can be beneficial for retirees, provided they plan ahead for tax-efficient use of these benefits in combination with other sources of retirement income. Income sources need to be layered with the goal of paying as little tax as legally possible. It's not something you can do on the fly. Precision planning is essential. "It is that precision around tapping only the exact amount of capital needed that's going to allow you to continue to accumulate and grow funds throughout your retirement," she said. "Many people are imprecise about the amounts of money they withdraw from an RRSP for example." For instance, they may take out a large sum from their RRSP for a big family vacation, but if they do so without a plan for minimizing taxes, they could find their taxable retirement income bumped into a higher tax bracket. "And worse, they now may have a larger quarterly tax-instalment payment," Jacks said. "Then they're taking more money out of their investments to pay taxes that they may not have needed to pay if they had done their planning properly."
Blending multiple income streams -- such as OAS and CPP and private pensions among others -- can be "complicated," she added. A lot us will need some expert help.
"Having a look at how you layer in different sources of retirement and investment income for each person to get a better tax result is part art and part science," she said. "Income splitting with spouses provides additional opportunities, so working with the right planners is really important."