Tuesday, April 17, 2007

How Much Do You Need to Retire - Part II

In yesterday's post I walked you through how to come up with a yearly income requirement for retirement in today's dollars. Now today we are going to look at government benefits.

In Canada there are a few different programs you can tap into during your retirement. The most common programs people have to account for is Old Age Security (OAS) (which is vaguely similar to Social Security in the US) and the Canada Pension Plan (CPP).

Both are important to account for in your plans in some form or another. Some people don't believe the programs will continue when the baby boomers hit retirement. I think you can't estimate inflation for twenty years either, but we still try. So for now keep them in and we will add some buffer to our calculation later. Also if you really have problems with the OAS program you can drop it out of your calculations, but I would suggest leaving the CPP in as it is a pension plan run by a government. Let's face it you've got a higher risk of your work pension going belly up that the CPP running out of money.

1) Canada Pension Plan

You’ve seen the deduction on every pay cheque for years and now here is the good news. You get to cash in on some of that forced savings. The earliest you can collect is age 60. Since you don’t know when your going to die I suggest that most people just take the cash and accept that your going to have a pension reduction of 30%. The 30% reduction is worth it when you consider you are being paid for any addition five years.

I suggest you request a statement of your CPP contributions to date to determine where you currently are. If you take that you can plug it in to an online calculator and get an estimate of what you are going to earn. If you don't have a statement still check out that online calculator link as you can get an estimate based on your income. Also you have the option of adding an age where you stop contribution to simulate early retirement. In my case I got $7100/year for me while I've been playing for the numbers for my wife and I'm going to drop back her amount to $1200/year. The reason is it is becoming apparent that after doing my taxes that she won't be contributing much for the next few years. This year's total contribution for her was under $100.

I know that doesn’t look like a lot but combined, the $8300/year is still a useful base for your retirement income. The added tax benefit of a CPP pension is income splitting is allowed. Please note that if your from Quebec you fall under the Quebec Pension Plan (see here for information).

2) Old Age Security

Just about everyone qualifies for the OAS. All you have to do is live in Canada for 10 years prior to your retirement but after you turn 18 (and be a Canadian citizen or legal resident). If you've lived in Canada for 40 years or more after you turned 18 you will qualify for the full pension. If your not there I suggest you go read the fine print to find out if you can expect anything or if you qualify for other benifits such as the Guaranteed Income Supplement or the Allowance. Based on the current rates, I expect my wife and I will collect an additional $5900/year each after we turn 65. So that would add another $11,800 to our retirement income.


Therefore in total OAS and CPP will pay me and my wife $20,100/year of inflated indexed money in today's dollars. Depending on if required retirement income is fairly modest you might find yourself most of the way towards your goal after you turn 65.

Tomorrow we will continue our series and see how a work place pension and RRSP's fit into the mix.


Anonymous said...

If your wife is staying at home to care for a child under the age of 7, she can exempt these years (or partial years) from her CPP calculations. This will significantly improve her average contribution.


Middle Class Millionaire said...

I'm not sure if you or "anonymous" know the answer to this...but I was just wondering if the CPP exemption also applies to parentals leaves where part of your salary is topped up by the employer ie-85% for 6 months (55% from EI and 30% from employer)

Canadian Dream said...

Actually CPP drops your some of your lower income years regardless if you use the child drop option.


and scroll down to "How does CPP calculate my pension?"


SavingsJourney said...

I sort of like CPP contributions - the way my company handles them seems sort of haphazard though. As of now, I've already contributed the maximum CPP this year. It basically gives me about $300 a pay period net income now, so in a way it's kind of nice additional cash flow, but at the same time, I really wish that it was spread out evenly throughout the year so that I don't get a sudden huge paycut when January comes! I will look at that calculator, thanks for the info.

Canadian Money said...

Good post CD!

I included both CPP and OAS for both of us when forecasting our retirement income stream. Our numbers are similar to yours - about $20,000 for my wife and I. I was surprised by how much we were going to get. With respect to "The will it be there in the future?" concern I asked myself...If the $20,000 dropped to $10,000 would I still do it? My answer was yes!

I have two recent posts about the Canada Pension Plan and I am currently crunching some numbers related to the "Take it at age 60 or wait?" question.

Sarah said...

Not so anonymous here. :)

You can to exempt any years as parental leave - all you need is the birth certificate of your child.

The exemption for child care is in addition to the standard drop of your 15% lowest income years. Unlike the standard adjustments, you have to let them know about the child care years.

From the service canada website:

Child rearing drop-out provision:
Months of little or no earnings because of caring for children under seven years of age who were born after December 31, 1958, can be excluded from the contributory period when benefits are calculated. Unlike the other three drop-out periods listed below, this benefit must be applied for by the client.

+ 65 drop-out:
If a contributor works between the ages of 65 and 70, higher earnings from those years can be used to replace months of little or no earnings earlier in the contributory period.

15 percent drop-out:
The 15 percent drop-out applies to everyone who has contributed to the CPP for at least 10 years. After the number of months in a person's contributory period is determined, the 15 percent of that period when his or her earnings were lowest are dropped out of the benefit calculation. The benefit amount he or she receives is calculated on the earnings and contributions recorded in the remaining 85 percent of the contributory period.

Disability drop-out:
The months in which a person receives CPP disability benefits are excluded from his or her contributory period when benefits are calculated.

Canadian Dream said...

Thanks everyone for all those great comments.

That was a great comment with lots of details. Thanks for taking the time to write it.


I believe the amount they take off every month for CPP is supposed to be a percentage of your income. So if you have a REALLY high income you can expect to max it out quickly.