Optimizing RRSP withdrawals with CPP

Dan and Kate McGlovin are both 60 years old and have just retired.  They each have exactly $500,000 in RRSP savings and both of them will receive 85% of their CPP and 100% of their OAS at age 65. They own a house worth $700,000 that is mortgage free.  They have no other savings, no pensions, no debt, and no kids. 

Their RRSPs are invested in a low cost balanced asset allocation ETF which consists of 60% globally diversified equities (stocks) and 40% bonds.  The expected return on this ETF is 5.22% less management expense fees of 0.25% for a total annual return of 4.97%.  Inflation is assumed to run at 2.2% per year and we have set their life expectancy at 95. They plan to take OAS at age 65.

Also, Dan and Kate want to live in their house until they die and want to pass the proceeds of their estate to their favourite charity upon their death.  In other words, they do not want to use their home equity to fund their retirement.

How Much can Dan and Kate Spend Each Month?

They want to know the maximum amount they can spend each month (and not run out of money) and when is the best time for them to take CPP.  In other words, what is their optimal combined RRSP withdrawal and CPP retirement strategy?

Before we get to the numbers, the above scenario may seem overly simple, and to some degree it is, but I've deliberately set the parameters this way so as to:

a) Mimic something that is realistic and also achievable for most middle class Canadians. This includes use of RRSPs as a primary retirement savings vehicle (a 2023 BMO survey found that 62 per cent of Canadians have either already contributed to their Registered Retirement Savings Plan (RRSP) in 2023 or plan to do so).

b) Minimize other variables so we can focus on RRSPs and CPP and the importance of decisions surrounding these two key factors for retirees

OK, the numbers!  Based on them running out of investment assets at exactly age 95 and assuming everything else holds true, here is what they can spend if they take CPP at age 60, 65, or 70:

The later they take CPP the more they can spend each month for their entire lives! This also means that they are drawing more aggressively from their RRSPs in early retirement to cover expenses while they wait for OAS and CPP to kick in. And, curiously, they will also pay more income taxes in retirement the longer they defer CPP.

How can Dan and Kate have more to spend but also pay more taxes?

To figure this out, it's best to understand how CPP works.

First, know that if you start CPP before age 65, payments will decrease by 0.6% each month (or by 7.2% per year), up to a maximum reduction of 36% if you start at age 60.   If you start CPP after age 65, payments will increase by 0.7% each month (or by 8.4% per year), up to a maximum increase of 42% if you start at age 70.  The longer you wait for CPP, the more you get each month. 

Second, and this is less well known, once you start taking CPP, annual increases to your CPP payment track the Canadian consumer price index (or inflation value).   However, before you take CPP, your future CPP payments are instead tracked to Canadian wage growth which has historically run about 1.0% above inflation.  So, for Dan and Kate, and assuming the wage growth trend holds, they would actually get an additional 10.5% increase by taking CPP at 70 versus 60. 

Third, you may have noticed in the table above at age 60, we set the % of maximum CPP at 90% instead of 85%.  Why?  Well, this has to do with the so-called CPP "drop out" provision. You might have years of low or no earnings and so when CPP is calculated, the government will “drop out” or not include up to 17% of your lowest earning years from your earnings history thus increasing your overall CPP amount.  In the case of taking CPP at age 60 versus 65 or later, this shortens you CPP contributory period and may increase your % of CPP maximum.  Now this is a very complex factor, and results will vary from person to person, but to simulate for this analysis, I have assumed a 5% increase to 90% maximum of CPP.  This actually works against taking CPP at 65 or 70, but I wanted to include it to illustrate that, in general, you are still better off deferring CPP.

As an aside, you can find out what you can expect from CPP by logging into the Service Canada website where you can review your contributions and get an estimate of your CPP amount at age 65. Just remember that the estimate they provide assumes you will contribute to CPP through age 65.  But, if you have retired early or are thinking of doing so, you can still get an accurate estimate by using this CPP calculator put together by Doug Runchey, a long time CPP employee, and Certified Financial Planner David Field.

Other Benefits of Deferring CPP

Moving past the table above there are less obvious, but just as compelling, reasons to defer CPP past age 60.  CPP is something you get for life and is indexed to inflation.  It is more valuable than most people realize and offers protection against specific adverse conditions:

a) CPP is a hedge against inflation.  Periods of high inflation generally do not bode well for equities, bonds, or cash meaning that while both your investments and their purchasing power sink, your CPP payments will retain their value and purchasing power.

b) CPP is a hedge against longevity risk. Mathematically, the risk of depleting your portfolio of stocks and bonds increases the longer you live.  As an annuity, CPP is paid to you no matter how long you live.

c) CPP is a hedge against sequence of returns risk.  While many people think they can do better than CPP in their own investments, it's important to note that CPP provides a minimum and known level of income through all market conditions and at no risk.  CPP will do well in the scenarios where investments typically do not do well.

What if one of Dan or Kate Dies Early?

There is one risk of deferring CPP that I wanted to examine which is the death of one of the spouses at, say, age 70.  If you defer CPP to age 70, then having one spouse pass away exactly at that time would be the worst timing financially. This is due to three factors:

a) OAS does not transfer from the deceased spouse to the living one, it simply disappears

b) CPP only transfers as a survivor's benefit and will not cover the combined CPP amounts being paid to Dan and Kate while both are alive

c) In the scenario where CPP is deferred to age 65 or 70, Dan and Kate are drawing down their RRSP more aggressively and so they have less of their own wealth available.  This magnifies the problems of losing OAS and getting a reduced CPP for the survivor.

In order to provide the most realistic comparison, we will assume that the survivor will be able to reduce their spending and live off 70% of the $5800 monthly income from the "Take CPP at age 60" scenario (i.e. 70% of $5800 = $4060 per month).  Here are the results:

As you can see, taking CPP at age 70 does create a problem and then only very late in life.  In this case, Kate has the option of downsizing her home, selling it, or even getting a reverse mortgage to fund her remaining years.

Conclusions

While everyone's circumstances are different, if you are in good health, and have a reasonable amount of assets that can be used in the early years of retirement, deferring CPP by drawing down RRSP funds first puts more spending money in your pocket and reduces your overall risk.

My hope also is that you see these decisions can have a material impact on your retirement, and while it seems complicated (and it is), the data is readily available for you to do the calculations and consider your options carefully.  You really should do so, or insist that your financial advisor do so on your behalf.