May 31, 2012 — Reforms underway to the Canada Pension Plan (CPP), which impose higher penalties for opting to receive CPP before age 65 and greater rewards for delaying take-up until after 65, were meant to ensure people do not have a strong financial incentive to retire early and take-up CPP at age 60, according to a report from the C.D. Howe Institute. In “Comparing Nest Eggs: How CPP Reform Affects Retirement Choices,” authors Alexandre Laurin, Kevin Milligan and Tammy Schirle find that once the interaction of these age-based CPP adjustments with the tax system is taken into account, some lower-income Canadians will still have financial incentive to retire early, because they face penalties if they don’t.
“Overall, the reform is a step in the right direction, and enhances the flexibility of Canadians to work longer without being penalized for their choice,” said co-author Kevin Milligan. “But on an after-tax basis, for Canadians who collect Guaranteed Income Supplement (GIS) and have no other separate source of income beyond CPP, pension wealth is maximized at age 60, on average, and is reduced from there on.”
The authors estimate the expected present value of the lifetime flow of CPP benefits for a stylized individual retiring at different ages, from 60 to 70 – a measure of an individual’s pension wealth. The reform should produce expected pension wealth values that are flat across retirement ages, meaning that an individual’s total lifetime consumption possibilities are not changed by his or her retirement-timing choice.
The study examines three cases for “Joe,” a 60-year-old considering his retirement-age options:
- In the first case, the authors do not account for taxes and simply discount the gross CPP benefit flow back to age 60 for each retirement age.
- For the second case, they account for income taxes and income-tested government-benefit clawbacks. They also assume Joe receives $20,000 of employer-provided pension income. This extra income makes Joe ineligible for benefits from the income-tested Guaranteed Income Supplement.
- Finally, in the third case they remove the $20,000 of pension income and observe the significance of the Guaranteed Income Supplement.
On a gross before-tax basis, the study finds that the reforms have steepened the age profile of discounted total benefits across retirement ages. Retire early and an individual receives less; retire later and he receives more than before the reform. However, they find that the size of the gain (or loss) from the new adjustment factors depends critically on the receipt of the income-tested GIS benefit, which is clawed back for lower-income retirees.
The new pension adjustment factors have moved in the right direction, but still fall short of offering many Canadians, who might retire at different ages, the same value for their CPP benefits.
Click here for the full report.
For more information contact: Kevin Milligan, Associate Professor of Economics, University of British Columbia; Tammy Schirle, Associate Professor of Economics, Wilfrid Laurier university; or Alexandre Laurin, Associate Director of Research, C.D. Howe Institute, 416-865-1904, email: cdhowe@cdhowe.org.