Retirement Planning

Retirement Planning

Whether you're still years away from retirement or it's just on the horizon, like many Canadians, you're likely considering your future financial needs. However, the reality for most of us is quite different from having all the necessary funds neatly set aside. This is a fact that the government acknowledges and prepares for accordingly. So, what sort of assistance can you anticipate from the government once you reach the age of 65? And will it suffice to ensure a comfortable and prosperous life? In this article, we will dissect the primary financial aids provided by the government.

What is OAS and how does it work?

OAS, which stands for Old Age Security, may seem straightforward at first glance, but it's a bit more nuanced than it appears. According to Bonnie-Jeanne MacDonald, the director of financial security research at Toronto Metropolitan University's National Institute on Ageing, OAS is designed to be a universal benefit for all Canadian seniors. It's a monthly payment provided to any Canadian who has reached the age of 65. In most cases, individuals are automatically enrolled when they turn 65, eliminating the need for an application.

However, it's essential to pay attention to Ms. MacDonald's crucial point, the phrase "supposed to be." To receive the maximum OAS benefits, you must be a Canadian citizen or permanent resident and have lived in Canada for at least 40 years after turning 18. If your Canadian residency falls short, such as only living in the country for 20 years, you'll only qualify for partial payments. New immigrants with less than 10 years of residency in Canada are not eligible at all. Ms. MacDonald explains that the primary requirement is a straightforward residency criterion, but many people in Canada do not meet it, which poses a significant challenge.

Nonetheless, the majority of Canadian seniors will likely meet the requirements for Old Age Security, regardless of whether they've worked consistently and paid taxes throughout their lives. In 2022, the maximum monthly OAS amount was $685.50 (with an average of $666). At the age of 75, recipients receive a 10 percent increase in this amount. Additionally, OAS payouts are adjusted quarterly to account for inflation.

One substantial caveat to OAS eligibility pertains to income. If you have substantial income from sources such as investments, a company pension, or withdrawals from your registered retirement savings plan (RRSP), you may earn too much to qualify for full or any OAS benefits. Once your income surpasses a specific threshold (approximately $82,000 in 2022), you become subject to clawbacks. If your income exceeds the ceiling (for the 2022 income year, it's $134,626 for those aged 65 to 74, and $137,331 for those 75 and older), your OAS benefits will be entirely clawed back. As Ms. MacDonald notes, the top 15 percent of seniors won't receive the maximum OAS benefit because their income from other sources is too high. While you can strategize how to access your savings to minimize clawbacks, it's worth remembering that this is a fortunate predicament to be in.

What is CPP and how does it work?

In contrast to the seemingly universal OAS, the Canadian Pension Plan (CPP) is specifically designed for individuals who have worked, earned income, and filed taxes within Canada during their lifetime. (If you work in Quebec, you'll contribute to a similar program known as the Quebec Pension Plan or QPP.) Doug Runchey, a pension consultant at DR Pensions in British Columbia, explains that the CPP functions as a social insurance program aimed at replacing employment earnings once an individual stops working.

To qualify for CPP benefits, you must have engaged in income-earning work, declared that income, and made contributions to the pension plan in advance. The good news is that you've likely fulfilled these requirements without even realizing it. "Anyone over 18 with employment earnings automatically accrues CPP benefits by simply filing their taxes," notes Mr. Runchey. (Interested in opting out? Unfortunately, CPP contributions are mandatory for Canadian workers.)

Ms. MacDonald adds that while the calculation is not straightforward and varies annually based on average salaries, you can access your specific contribution amounts for any given year by logging into the Canada Revenue Agency (CRA) portal. If your net income falls below $3,500, you won't contribute anything, and your contributions cease when you reach the "maximum pensionable earnings" for the tax year (which was $64,900 in 2022). Although the mathematics may seem complex, you can easily find the exact dollar amount of your CPP contributions on your annual Notice of Assessment or your T4 form from your employer.

Speaking of employers, there are a few key points to clarify. "If you're a traditional employee, it's common for your employer to cover half of your CPP contribution," explains Mr. Runchey. Self-employed individuals also contribute to CPP, a topic of common questions and concerns. Unfortunately, they cannot opt out, and they technically pay both the employer and employee portions. To accommodate self-employed individuals and those who took parental leave or experienced periods of unemployment due to disabilities or other reasons, the CPP calculates your payout by excluding your lowest seven or eight contribution years (depending on your work history) to avoid negatively impacting your overall average income.

The more you contribute throughout your working years, the higher your monthly CPP benefit is likely to be. Initially, the CPP was intended to replace 25 percent of an individual's pre-retirement income. However, in 2019, the Liberal government increased contribution rates to correspond to 33 percent of post-retirement income. These enhanced contribution rates are being phased in, and the amount you receive will depend on the extent and duration of your enhanced contributions. Presently, someone who consistently paid the maximum amount each year they earned the maximum income can expect to receive around $1,250 per month from the Canadian Pension Plan upon retiring at 65. Nevertheless, the average CPP payment in 2022 stood at just $728. (CPP benefits are indexed to inflation, albeit annually, so you can anticipate both figures to increase over time.)

CPP VS OAS - What is the difference?
The primary and most significant distinction lies in the fundamental qualification criteria: "OAS eligibility is determined by your residency, whereas CPP eligibility is contingent on your employment history," explains Ms. MacDonald. Consequently, it's possible to qualify for one, the other, both, or neither.

Another distinguishing factor is the age at which you can start receiving benefits. OAS payments typically commence in the month following your 65th birthday, with no option for earlier receipt. In contrast, CPP offers a broader window that allows for early retirement as early as age 60. Both OAS and CPP can also be deferred, with larger monthly payouts as an incentive for delaying. Consequently, many individuals opt to defer their CPP benefits until age 70, which represents the latest starting point for collection.

Another noteworthy difference pertains to funding mechanisms. Ms. MacDonald points out that "CPP is pre-funded, whereas OAS is not." As a result, OAS draws from the general tax revenue of the federal government each year, making it subject to potential changes. Recently, Ottawa introduced a permanent increase in OAS payouts, unrelated to normal inflation-related adjustments, for the first time in decades. However, a different government could potentially modify these figures in the opposite direction if they choose to do so.

On the other hand, CPP represents a substantial pool of funds that have already been accumulated and are waiting to be accessed when the time comes. (It's important to note that your money isn't simply sitting idly; it's invested.) The more you have contributed to this fund over the years, the higher your eventual benefit, up to the maximum allowable amount. Unlike OAS, CPP benefits are not subject to clawbacks, regardless of the amount of money you have saved or invested elsewhere.

CPP and OAS and your retirement planning

Let's assume that you've been a responsible Canadian citizen throughout your working years and are on track to receive the maximum benefits from both CPP (approximately $1,250) and OAS ($685.50). While this monthly sum of around $1,900 is a substantial amount, it may not be sufficient to ensure a comfortable retirement, especially if you have ambitions like extensive travel, taking up golf, or buying a boat. In fact, this income level only slightly exceeds the poverty line in Ontario.

It's important to understand that neither CPP nor OAS was designed to serve as a sole source of retirement income; they were never intended to be. Think of them as two of the three essential components in your retirement income plan. CPP represents one leg of the stool, OAS is another, and the third leg is made up of your personal savings and/or a private pension plan, if you have one. While some financial experts divide the third leg into two parts, for the purposes of this discussion, let's stick to the three-legged stool model.

This stool analogy is fitting because each "leg" has an impact on and complements the others. For instance, when you withdraw money from an RRSP, it becomes taxable income. Therefore, it's crucial to consider how this interacts with your other sources of income. To make the most of your retirement benefits, you may want to seek professional guidance to determine the best approach for tapping into each "leg" and crafting a retirement plan that provides financial security and comfort.

Are there any other government supports available?

Within the Old Age Security (OAS) program, there exists the Guaranteed Income Supplement (GIS), which is designed to assist individuals with extremely low incomes and prevent them from falling into poverty. The specific income thresholds may vary slightly from year to year, but as of 2022, a single, widowed, or divorced senior with an annual income below $20,784 could qualify for a maximum monthly benefit of $1,024.

It's important to note that the government takes into account all other sources of financial assistance and income when determining the amount of GIS you receive. This includes income from personal savings, such as an RRSP, or government benefits like the Canada Pension Plan (CPP). Essentially, for every dollar you receive from another source, you'll see a reduction of 50 cents in your Guaranteed Income Supplement. Additionally, your marital status is considered; if your spouse is also receiving or already collecting GIS benefits, their amount will also be factored into the calculation.

Should you defer my government retirement supports?

Determining the ideal time to begin collecting CPP benefits is a complex matter that hinges entirely on an individual's unique circumstances. Furthermore, the advice you receive might vary depending on the type of expert you consult. A stockbroker, for instance, is likely to advocate for initiating benefits as early as possible to enable investment opportunities with the money. Similarly, financial advisors could potentially lose fee revenue if you deplete your retirement account as a means to bridge the gap until you qualify for the higher CPP benefit at age 70.

However, the allure of having money at your disposal today is undeniably strong. "Ninety-five percent of Canadians commence their CPP at age 65 or even earlier," notes Ms. MacDonald. She likens this behavior to the classic marshmallow experiment, where children are asked to choose between one marshmallow immediately or two marshmallows in an hour. It's a test of delayed gratification, and most adults aren't much better at it. Yet, the 5 percent who opt (and can afford) to wait until age 70 to collect CPP will enjoy significant advantages. Delaying CPP until 70 translates to a 42 percent increase compared to starting at 65. In essence, by postponing CPP collection, you're essentially buying a larger pension.

Of course, there's the uncertainty of the future to contend with, including factors like inflation and interest rates. As Ms. MacDonald acknowledges, these variables can be estimated but not predicted with absolute certainty. Unexpected events, such as the pandemic, can disrupt inflation rates and disrupt traditional calculations. However, lacking a crystal ball or clairvoyance, the best approach is to focus on what is known.

What we do know is that employer-sponsored pension plans are dwindling, people are living longer lives, and the baby boomer generation, representing a significant portion of the population, is approaching retirement with extended life expectancies. If parents' RRSPs run dry by age 85, there's a potential risk that their children might bear the financial burden. This prospect could lead to a shift in how Canadians think about and plan for retirement in the near future.

Will you have enough?

Many experts advise that your combined savings and support systems, including CPP and OAS (which have no expiry), along with personal savings like RRSPs (which can deplete), should ideally amount to somewhere between 60 and 80 percent of your typical pre-retirement income. "It all depends, of course," notes Mr. Runchey, "but I often hear 70 percent as a common benchmark."

Regardless of your financial circumstances and retirement plans, this phase of life brings conflicting considerations. On one hand, you might have to stretch your retirement funds over a potential 30-year period. On the other hand, you're faced with a substantial sum of money, no employment income, and uncertainty about your lifespan.

For Ms. MacDonald, the ideal retirement income isn't defined by a specific numerical value or percentage. Instead, it's a point where the inherent tensions of this Catch-22 scenario no longer fill you with fear and anxiety. She suggests that the best retirement income is whatever amount provides you with a sense of security and removes the fear of uncertainty.

CPP AND OAS - Quick Facts

1. Old Age Security (OAS) is a federal government benefit available to individuals aged 65 or older in Canada, provided they have resided in the country for at least 10 years.

2. The Canadian Pension Plan (CPP), or the Quebec Pension Plan (QPP) for Quebec workers, is designed for employed Canadians who have contributed to the CPP through mandatory contributions over their working years.

3. In 2022, the maximum monthly OAS benefit stood at $685.50, while the maximum monthly CPP payment was approximately $1,250.

4. Both OAS and CPP benefits can be deferred for a few years, and the longer you delay, the larger your monthly payments will be.

5. OAS and CPP represent two of the three key components in building a solid retirement plan. The third element is personal savings, which may encompass investments such as RRSPs, tax-free savings accounts (TFSAs), non-registered investments, and real estate.

6. Low-income seniors can access additional financial support through the Guaranteed Income Supplement (GIS).

7. While many experts suggest aiming for 60 to 80 percent of your pre-retirement income to enjoy a comfortable retirement, the most important factor is achieving an income level that eliminates financial worries and provides peace of mind.

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Use the Canadian Retirement Income Calculator linked below to get an idea of your annual retirement income:

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Canadian Retirement Income Calculator

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