Canada Pension Plan and Old Age Security: What’s the difference?
I was talking to a client recently about the pension cheques she was receiving in retirement. They were changing often and it was making it difficult for her to plan her budget.
After asking a few questions, I realized she was confused about the different types of government pensions she was receiving. In her case, she received cheques from the Canadian Pension Plan, or CPP, Old Age Security, or OAS, AND a Guaranteed Income Supplement, or GIS, benefit.
With so many different government pensions, it’s no wonder we can get confused. So let’s talk today about government benefits. Specifically, let’s discuss the difference between CPP and OAS.
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What’s the Difference Between CPP and OAS?
CPP and OAS are similar in that they're both retirement benefits administered by the Canadian government. In both cases, the CRA considers inflation every year and adjusts CPP and OAS payments accordingly.
However, there are some differences. Let’s start with the Canada Pension Plan.
How does the Canada Pension Plan work?
Many of us look at the CPP benefits we will receive in the future as our main source of retirement income.
It’s important to know that CPP was never intended to be a large part of your retirement income. CPP started in Canada in 1965 because so many seniors were living in poverty. When it was created, it was only meant to cover one-quarter of your income needs in retirement. Now, people are relying on it more. Why? Much of that has to do with the fact that back in 1965 when the CPP was formed, there were more employers providing employer pensions than there are today.
Recently, the federal government made some changes that they hope will have CPP benefits provide at least ⅓ of our income needs in retirement.
Where does the CPP Benefit Come From?
Where does the money come from that funds your CPP? It comes from you. You and your employer.
Whenever you are paid a paycheque, part of the money you earn is paid to CPP and your employer also pays into CPP at the same time. If you’re self-employed, you contribute both the employee AND the employer portion.
When you retire, you receive an income stream. CPP is basically a forced savings plan.
How Much CPP Will I Get in Retirement?
The amount of money you’ll receive in retirement from CPP will depend on how much you paid in. So, if you earned more, that means you paid in more and you’ll get more than someone who earned less, because they paid in less. If there were a lot of years you didn’t work at all, that will also affect the amount of income you’ll receive down the line.
The most you can receive in the year 2023 is a little over $15,600 a year. Most people are only receiving $9,700 a year. That’s because most people didn’t earn a top salary in their earning years and there were likely some years when they weren’t working. That means most people will receive a little over $800 a month in income from CPP in retirement. As you can see, it’s not that much, yet a lot of people rely on it solely and they can be put in quite a bind.
Is CPP Taxable?
CPP income is taxable.
You’ll receive a tax slip called a T4A(P) from the government every year when you start receiving CPP income. You’ll use that slip to report your CPP benefits as income on your tax return.
So, how can you find out how much you’re going to receive in CPP income after you retire? Service Canada will give you an estimate If you create a my service Canada account online.
When Should You Take Your CPP Benefit?
One of the questions I often get is: “When should I take my CPP?”
CPP payments are not automatic. You must apply. You should apply to Service Canada several months before you want your CPP benefits to start.
You don’t have to take CPP starting at age 65. You can wait until age 70 or you can take it as early as age 60. When I sit down with a client, I run several cash projection models to determine the ideal time for them to start taking CPP.
Why wouldn’t someone just take it as soon as they can?
If you can wait to receive CPP, there is a benefit to waiting.
The starting point Service Canada uses for how much your monthly payments will be assumes that you will start receiving them when you turn 65. That’s our base point.
Now, If you decide to flip the switch and start taking your CPP payments earlier than that, the amount of your monthly payments forever will be reduced by about one half of one percent every month you start earlier. It’s actually 0.6% per month.
So, if you say, ‘hey, Canada CPP team, start sending me my CPP payments when I turn 64 years and 11 months old,’ so, one month before you turn 65. Your ongoing payments forever will be 0.6% less than they would have been had you waited one more month to turn on the switch. You’re locking those payments in when you turn on the switch.
(The government actually increases your monthly payments every year to adjust for inflation, but you get the idea.)
If you can wait, your payments will be bigger if you wait until age 65. But here’s something else to think about: If you decide not to take CPP at age 65 and instead, turn on the switch and start receiving payments when you’re older, your payments will be 0.7% larger every month you wait than they would be if you turn on the switch at age 65.
So, again, if you say, ‘hey CPP team, start sending me my CPP payments when I turn 65 years and 1 month old,’ the payments will forever be 0.7% larger than they would be if you started them when you turned 65.
This means that if you wait to receive your CPP payments until you’re 70 years old, your monthly payments will be 42% higher than they would be if you flip the switch at age 65. Effectively, you’re earning an annual 8.4% return guaranteed. Where else can you get that?
You may ask, ‘why doesn’t everyone wait until age 70?’ Each situation is unique to that person. It may be that you don’t have many other sources of income for your retirement and in that case, by all means, take CPP as soon as you can so you can live your life.
Some people should take CPP payments early not because they need the income, but because they are already paying too much in taxes in retirement now or they will be later. Their income is already more than they need. In that case, they should take CPP as early as possible and simply invest it, or use it strategically for some estate tax planning.
I worked in the US during my career ... does that affect my CPP?
So, CPP is a major source of income for you in retirement. If you worked for a time in the US, you may qualify for US Social Security, which is the equivalent of Canada’s CPP. If you think you might qualify, it can be difficult to find out that information online from outside the US, but you can call the nearest US Social Security office to find out what you’re entitled to. The beauty of receiving US Social Security while living in Canada is that you’ll be paid in US dollars, which usually amounts to a 20 to 30% premium.
What about OAS (Old Age Security)?
CPP isn’t truly a government benefit because the government didn’t put any money into it, you and your employer did. But in Canada, we do have a true government pension benefit and that is Old Age Security or OAS.
OAS has been around since 1927. The money that funds it to create your income comes from the federal income taxes we all pay. So, it’s a true government pension.
You don’t have to contribute to it to receive benefits. Instead, it’s funded by Canadian taxpayers. To be eligible for OAS benefits, you must have been a citizen or legal resident of Canada for at least 10 years after age 18.
Is OAS Taxable?
When you start receiving OAS income payments, it will be taxable income to you. You’ll receive a T4A(OAS) from the government to use to file your taxes. There’s no mechanism to split OAS income with your spouse to save taxes.
When Can I Take My OAS?
When can you start receiving OAS monthly payments? We talked about how you can start receiving CPP before age 65. That’s not possible with Old Age Security, you can’t receive it before age 65. In most cases, you’ll automatically be enrolled when you turn 65.
But, remember how we talked about how your monthly CPP income payments can go up if you wait until after age 65 to start receiving them? You can do the same thing with OAS. For every month you wait before you hit that switch, you’ll receive a 0.6% higher monthly payment than if you started taking OAS payments at age 65.
If I were you, I would start a conversation with Service Canada when you turn 64 if your intention is to delay receiving your payments. You don’t want them to automatically lock in at age 65.
How Much is Old Age Security in Canada?
Payments are based on your income and how long you’ve lived in Canada. The maximum Old Age Security monthly payment amount is currently $691.00. To see if you are eligible for the maximum benefit in a given year, the government looks at how much income you earned the previous year and they use that to possibly adjust the OAS payments you receive. If you earn more than a certain amount in any given year, right now that’s about $79,845, your OAS income will be reduced or eliminated.
For example, if you sold investment real estate, that may give you a one-time bump to your income for that year. If that happens, and you don’t file the appropriate forms in time, your monthly income from OAS payments will be reduced the following year and possibly eliminated altogether for a year. So, you’ll want to plan for those events carefully with your tax preparer.
I once knew a widow who relied on OAS payments as an important source of her retirement income. She had a mortgage on her home and she wanted to pay it off, so she cashed in her late husband’s entire Retirement Account and used it to pay off the mortgage. She thought she was doing the responsible thing. That income was completely taxable. The following July, she received notice that her OAS payments, her main source of income, would be zero for the next 12 months. Not only did she no longer have a source of income from her husband’s retirement fund, but she also had no income from OAS either and was destitute.
What can she do? Let’s say she cashed in her husband’s retirement account in 2022. In 2023, her first step was to file her taxes as soon as possible, which she did. Next she can have a discussion with Service Canada about her situation. Because her 2023 income will be considerably lower than her 2022 income, and she’s already paid all the taxes owed from 2022, they can work with her to have her OAS payments based on her 2023 earnings and not 2022 so that she isn’t financially burdened for the year.
Another quick note. Once you turn 75 years of age, you’ll receive a raise of 10% of your OAS monthly payments. Remember what I said about staying healthy and fit? This will give you an incentive.
What is ‘OAS clawback?’
If your individual net annual income was higher than $79,845, your OAS payments are subject to a recovery tax, often called a “clawback.”
For every dollar you earn above that threshold, your OAS benefit is reduced by 15 cents. That means if you are eligible for the current maximum pension of $691 per month, you would have your entire OAS clawed back when your net income reaches $129,757.
If you think your income may put you into the clawback zone in the future, financial planning may be particularly important for you. How might you stay out of the clawback zone or at least limit its impact? There are several strategies you can employ ahead of time to reduce your pension income in a taxation year and thus reduce any possible clawback.
For example, you might defer taking your CPP payments until you’re older, if you don’t need the income right away.
If you’re past the age of 65 and still working, holding off receiving your OAS can be a good strategy. For every month that you defer taking your OAS, your payments increase by 0.6%. So by not receiving your OAS payments until you turn 70, you will increase the monthly benefits you begin to receive at that age by 36%. Assuming you stop working at age 70 and your income declines, you’ll receive a larger OAS benefit at that time and you’ll be less likely to trigger clawback.
How does a Guaranteed Income Supplement Work?
As I mentioned, if you earn more than $79,800 from other sources in retirement, expect your OAS monthly income to be reduced. But, if you earn less than about $20,000 per year, you may also qualify to receive an additional government pension called the Guaranteed Income Supplement, or GIS. The good thing is, there’s nothing you need to do to receive this except file your tax return. It is automatically calculated for you every year based on your previous year’s tax return. And remember, in Canada, these benefits are income-based, not assets based. You could have a million dollars saved, but if you only take a small amount in income, you would still qualify for these benefits.
In 2023, if you are a single senior with a total annual income of less than $20,952, you are eligible to receive GIS. There are different income thresholds if you are a couple. You can find the different income thresholds on the Service Canada website. Every quarter, they are adjusted for inflation.
The maximum monthly Guaranteed Income Supplement payment for a single person in 2023 is a bit over $1,000 but that payment is reduced as you get closer to having annual income of over $20,000. By the way, your Old Age Security income is not part of that annual income threshold calculation.
The GIS amount you’re entitled to will be added to your OAS payment cheque. You won’t receive a separate cheque.
And here’s good news about the Guaranteed Income Supplement: It is NOT taxable.
The income you receive from it will appear on your T4A(OAS), but it is reported on a different section of your tax return, not as income.
Final Thoughts on Government Pensions in Canada
Government pensions can be confusing. If you need help figuring out where all your income will come from in retirement, reach out to me through my website for a free consultation and let’s get you on your way.
That’s all for today, if this podcast helped you, please subscribe, leave us a positive review on Apple podcasts, and tell others about it so we can help them too.
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