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By Michael J. Wiener
Special to Financial Independence Hub
Recently, Braden Warwick at PWL Capital created an excellent CPP calculator that we can all use. One of the numbers this calculator reports is the IRR (Internal Rate of Return) you’ll get between your CPP contributions and the CPP pension you’ll collect. Some financial advisors (but not Braden) decide it makes sense for their clients to take CPP as early as possible (age 60), and invest the proceeds. Their reasoning is that they believe they can earn a higher return. Here I explain why this logic compares the wrong returns.
The return you’ll get on your CPP contributions depends on the contributions you and your employer have made and the benefits you’ll get. These amounts depend on many factors about your life as well as some assumptions about the future. Typically, the return people get on CPP is between inflation+2% and inflation+4%. (However, it can go higher if you took time off work with a disability or to raise your children. It also goes higher if you ignore the CPP contributions your employer made on your behalf, but I think this makes a false comparison.)
If we examine people’s lifetime investment record, not many beat inflation by as much as CPP does. However, some do. And many more think they will in the future. In particular, many financial advisors believe they can do better for their clients.
But what are we comparing here? These advisors are imagining a world where CPP doesn’t exist. Instead of making CPP contributions, their clients invest this money with the advisor. In this fictitious world, the advisor may or may not outperform CPP. However, this isn’t the world we live in. CPP is mandatory for those earning a wage.
The choice people have to make is at what age they’ll start collecting their CPP pension. The CPP rules permit starting anywhere from age 60 to 70. The longer you wait, the higher the monthly payments get. Consider an example of twins who are now 70. The first started CPP a decade ago at 60 and the payments have risen with inflation to be $850 per month now. The other waited and has just started getting $2000 per month. The benefit of waiting is substantial if you have enough savings to bridge the gap between retiring and collecting CPP, and don’t have severely compromised health.
Those with enough savings to bridge a gap of a few years have a choice to make. Should they take CPP immediately upon retiring, or should they spend their savings for a while in return for larger future CPP payments? Some advisors will say to take CPP right away and invest the money, but this is motivated reasoning. The more money we invest with advisors, the more they make.
One way some advisors justify their advice is by claiming they can invest client money to outperform CPP returns of 2% to 4% above inflation. This claim is questionable to begin with, but more importantly, it is a false comparison. The return you get from delaying CPP is completely different from the return you get over the full span of your contributions and benefits.
For example, the return you get for delaying the start of CPP benefits from age 60 to 61 is typically between inflation+8% and inflation+12%, a formidable return to try to beat through investing. This return comes from the rules on how CPP adjusts your benefits when you start collecting early. The fact that your overall return from CPP is a lower figure has nothing to do with deciding at what age to start collecting.
The strong desire some people have for taking CPP early can be baffling. Many people express envy over the great indexed pensions government workers get, but when they get a chance to delay CPP to grow their own indexed pension, they turn it down.
Braden’s CPP calculator is great as it is, but if I could make one addition, it would be to include the IRR for each year’s delay in starting benefits. This would make it clear how high the return hurdle is for those who advise collecting CPP early and investing the money. Braden chooses the best year to start collecting CPP based on a present value calculation using inflation as the rate. I think this is sensible because CPP is guaranteed and higher investment returns aren’t guaranteed. However, for those advisors who aren’t convinced of this fact, it would be good to make it plain how high future returns would have to be to justify starting CPP early.
This issue is a challenging one to tackle. Many financial advisors have spent their entire careers telling their clients to take CPP as early as possible. It’s hard to admit that you’ve been giving bad advice. But the truth is that most reasonably healthy people who have some savings to live on should consider delaying the start of CPP.
Michael J. Wiener runs the web site Michael James on Money, where he looks for the right answers to personal finance and investing questions. He’s retired from work as a “math guy in high tech” and has been running his website since 2007. He’s a former mutual fund investor, former stock picker, now index investor. This blog originally appeared on his site on Dec. 21, 2024 and is republished here with his permission
