Take the right steps now, avoid “pension envy” later

TECHNOLOGY

If you work in the private sector and are wondering how you
can replicate the “gold plated” pensions of your friends in the
public service, envy not! You can enjoy a similar pension
experience while complementing your private investment
savings (e.g., RRSP, TFSA, etc.).

My wife, brother and some of my friends are teachers, and my
parents are retired teachers, so I am well versed when it comes to
what’s on the minds of teachers. One topic that never seems to
concern them is retirement security – if you bring up retirement and
investing, they are happy to boast about their incredible pension.

And why shouldn’t they? Teachers’ and most other public service pensions are what you call the “gold plated” pensions in Canada, because they are the best available for retirement income. This is mainly because these pension funds are shrewdly managed and have thus yielded historically high returns, and the payout formulas that determine benefits typically work in the recipient’s favour. Also, the pensions are backed by the power of the government and, under most circumstances, are protected from inflation.

If you are a private sector employee, your pension might not have all these bells and whistles. For instance, I am helping a client complete her pension package after years of working for one of Canada’s big banks; the pension package she received shows the pension is underfunded (meaning they don’t have enough assets to cover their obligations to pensioners), no inflation protection at all and underwhelming pension formulas.

Government pension benefits available to Canadians

In Canada, we are fortunate to have access to two government-sponsored pension plans outside our
workplace pensions: Canada Pension Plan (CPP) and Old Age Security (OAS). CPP is based on your
earnings while working, while OAS is based on how long you have lived in Canada.

As prospective retirees approach retirement age (say, age 60-plus), understanding when to begin collecting your pensions becomes an important planning point and forms my central argument on how to overcome any pension envy you might have.

Traditional views of government pension plans

Historically, it seems that most Canadians have decided to start their government pensions as early as
possible (CPP at age 60 and OAS at age 65). Reasons Canadians have reported that they elect to start these benefits early are:

• They are predicting a certain life expectancy.
• They do not have enough personal savings to supplement their retirement income until their government benefits start.
• They want to manage any tax consequences.
• They wish to attend to their estate planning.*

In my experience, the other key reason I believe Canadians tend to start their pension benefits early is because, quite simply, they can. If the government is handing out cookies to Canadians in the form of government pension benefits today, it’s no surprise that Canadians would not want to wait to start eating them.

How to reduce your pension envy

It is possible to achieve similar pension benefits to your family and friends in the public service. How? By considering the option to defer your entitled government pensions (e.g., OAS and CPP).

More specifically, you have the flexibility to elect when to start your CPP benefits (between age 60 and 70) and your OAS benefits (between age 65 and 70).

This decision on when to start your government benefits is a critical choice that you only have one chance to make. So, you want to make sure you are making it with your eyes open.

What is at stake?

How about $83,000 more in retirement income, lower risk of outliving your money and higher-quality income, to start? Consider these factors for help deciding whether delaying your pension benefits might fit in with your overall retirement plan:

• Enhanced income: Each month you defer CPP and OAS, you receive an increase in your pension benefits of close to 0.7% per month, or 8% per year.

  Here is how this would look if you lived to be 90: If you are eligible for the maximum of both pensions and defer each pension from age 65 to 70, your retirement income will be $83,390 higher overall, and you will receive greater cumulative dollar value after your 81st birthday.**

• Lower risk of outliving your money: Over the last two decades, private sector pensions have shifted from a defined benefit (similar to public service pensions) to a defined contribution pension scheme. This change has meant that retirees may have less certainty of their guaranteed pension income over their lifetime.

  You can lessen this worry by maximizing your government pension sources, as these provide retirement income for life. In this way, Canadians – who are living longer than ever – can rest assured that they will continue to receive a higher retirement income, with annual inflation protection to boot.

• Higher-quality returns: As noted in the first point above, each year that you defer your CPP and OAS to the maximum age 70, your retirement benefit goes up by close to 8% per year.

  Going forward, if you are a typical Canadian retiree running a balanced portfolio with your retirement savings (such as in RRSPs), a return of 8% per year is likely to be a difficult target for you to reach without taking on excessive risk. Half of your balanced portfolio invested in fixed income is only earning between 0 and 2% today. More importantly, your returns on your private savings are likely not entirely guaranteed, while your government pension deferral benefit is.

Over the past few decades, changes to pension regimes have highlighted the value of the public service pension plans. As part of your detailed retirement plan, electing to defer your government pensions may help reduce or eliminate your pension envy.

To be sure if this retirement strategy is ideal for you, it is important to work with a financial professional to come up with a plan that is ideal for your unique retirement circumstances.

* “Taking CPP early can come at a steep long-term cost” by Rob Carrick, published in the Globe & Mail print edition on December 9, 2020.

** For the examples used in this article, we assume that the person is eligible for the maximum of both CPP and OAS benefits, with no inflation adjustments in the calculations..