Pensions and Government Benefits in Canada
UPDATED JAN 31, 2023
There have been many women who have inspired me over the years. One of these was Mary Kay Ash. She had been a very successful salesperson, but in 1950’s Texas, she was always passed over for management jobs in favour of her male counterparts. So, she decided to go out on her own and start a company alongside her husband and son.
One week before they were to open, her husband, who was also her Chief Financial Officer, died of a massive heart attack at their breakfast table. Mary Kay faced a decision. She was 45 years old. She knew nothing about the financial aspects of running a business. Should she give up this dream of starting a company from scratch or should she go ahead and take a chance, possibly ruining not only her own financial future but her son’s as well? She and her son took the chance and the rest is history. They went on to build Mary Kay Cosmetics into the multi-billion dollar company that is still owned by her family today.
Mary Kay was always dispensing gems of wisdom and motivation to her sales force in that soft, East Texas drawl of hers. One of the ones I love most is this:
"Until a girl is 14, she needs good health and good parents. From age 14 to 40, she needs good looks. From 40 to 60, she needs a good personality. After that, I’m here to tell you, what a girl needs is cash."
So true! When you’re working, you may be used to a paycheque being deposited automatically for you. What happens when you retire and the paycheques stop? A girl needs cash, and that’s the name of the new series we’re starting today. We’ll talk about all the different sources of cash you can create for yourself to support your lifestyle after the paycheques of your full-time working years stop coming in.
In our Downsizing series, we talked about how to figure out how much you need to save for your retirement. If you’re not sure how much income you need to bring in for your retirement, you can go back and listen to Episode two where we cover that.
What’s Inside?
Prefer to Listen?Here’s the podcast episode!
Rather Read All About It?In today’s series, we’ll be talking about the different types of income you can create. So let’s quickly run through them before we go into each one in detail.
7 Types of Retirement Income in Canada
We have:
Part-time work
Home equity line of credit
Government benefits (CPP, OAS, and Foreign Pension Schemes)
Corporate or Government Pensions (the pensions you receive from your previous employer)
Retirement investment accounts (TFSAs, RRSPs, etc.)
Taxable Investments, such as investment accounts that aren’t part of your retirement investment accounts and Rental Properties
Life insurance Investment products (Investment accounts that you purchase from a life insurance company)
I didn’t mention the sale of a business. For my business owner clients, I always suggest they include their business exit strategy within their overall business plan.
It seems strange to plan your business around figuring out how you’ll get out of it, but when you own a business, the sale of that business is probably the largest part of your retirement plan, so it’s important to know how, or at least have a good idea of how, you will turn that business into retirement income for yourself. In most cases, you’ll either get a lump sum or be paid a stream of income for a time by the purchaser of your business. We won’t get into the specifics about obtaining retirement income from the sale of a business in this particular series. If you have any questions about that, feel free to reach out to me.
Let’s look at each of these types of income in detail.
Part-Time Work
Part-time work after you retire can be appealing. You just need to be aware of its effects on your tax situation. It may turn out that, with all the other sources of income you’re bringing in after you retire, you may be paying too much in taxes already and part-time work will cause you to pay even more. So, take a look at that.
Home Equity Line of Credit
A home equity line of credit can be a source of emergency income, especially if you don’t owe much on a mortgage on your home. It may be a good idea to put that line of credit in place before you retire, while you’re still showing a larger income, even if you’re not going to borrow any of it anytime soon. The amount a bank is willing to lend you depends on your income.
Pensions
What about pensions you might get from your previous employer? Perhaps you were a government employee or a teacher? If you’re going to get income from that kind of pension, consider yourself lucky. Very few people do these days and it can really give you a nice stream of income to start with. You won’t have to find as many other sources of income as someone who doesn’t have that pension.
If you do have this kind of pension, the best source of information about it is the employer or union that manages it. They will provide you with an annual statement that will give you estimates of how much income you can expect in the future You can use this statement to figure out when you might like to retire. Your financial advisor can help interpret the statement for you. Most of these pension plans also have websites that explain your benefits and what to expect.
After you retire and start receiving income from your former employer or union, remember it will be taxable. But, if you have a spouse, you’ll be able to split this type of income between you and your spouse. That will help you pay a lower tax bill overall.
Side note: If you have a pension from the UK, there was a time when pensioners were not allowed to transfer their UK pension to their new home in Canada without paying exorbitant taxes. That has changed in recent years. It is now possible to transfer a UK pension to your Canada investment accounts.
Government Benefits
Let’s talk about government benefits. The biggest one for Canadians is CPP, which stands for the Canada Pension Plan. 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 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. When you retire, you receive an income stream. CPP is basically a forced savings plan.
To give you an idea of how much income you’ll receive in retirement from CPP, it 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 $15,500 a year. Most people are only receiving $8,600 a year. Most people didn’t earn the top pay in their earning years and there were likely some years when they weren’t working. That means most people will receive a little over $700 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.
We mentioned that employer pension income you receive is taxable. Is CPP income taxable? Yes, You’ll receive a T4A from the government every year when you start receiving CPP income. You can split the income you receive from CPP with your spouse to reduce the taxes you pay, but not in the same way you split the employer’s pension we talked about earlier. It’s a different calculation.
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 I take my CPP?
One of the questions I get in my practice often is “When should I take my CPP?” 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. Stay with me now…
The base point we’re going to start from for how much our monthly payments will be assumes that we will be 65, right? That’s our base point. Now, If we decide to flip the switch and start taking our CPP payments earlier than that, the amount of our monthly payments forever will be reduced by about one half of one percent every month we 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,’ your ongoing payments forever will be about half a percent 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.
(By the way, the government actually increases your monthly payments every year to adjust for inflation, but I want you to understand the concept.)
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 all 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? Even if I’m managing your investments for you, I can’t offer you that kind of return guaranteed. If I do a projection and it turns out my client is better off waiting to take CPP income and instead they’re better off drawing down on the investments they hold with me to provide an income for themselves, then that’s what they should do. And if your financial advisor isn’t looking out for your best interests like that, then get another financial advisor.
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.
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. Bonus!
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.
When you start receiving OAS income payments, it will be taxable income to you. You’ll receive a T4A 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 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. 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 0.6% higher payment monthly than if you started taking OAS payments at age 65.
Be aware that OAS starts automatically at age 65, so 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.
Another tip I want to mention is that every 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. CPP payments stay pretty much the same, but OAS payments are based on your income. So, 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. If you earn more than a certain amount in any given year, right now that’s about $79,000, your OAS income will be reduced or eliminated. 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 the following year. 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.
Luckily, a friend was a former tax advisor and helped her prepare the proper forms to amend her return and start the OAS income again.
So, if you earn more than about $79,000 from other sources in retirement, expect your OAS monthly income to be reduced. If you earn less than about $19,000 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, 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.
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.
Whoa! What about the other sources of income such as:
Retirement investment accounts (TFSAs, RRSPs, etc.)
Taxable Investments, such as investment accounts that aren’t part of your retirement investment accounts and Rental Properties
Life insurance Investment products (Investment accounts that you purchase from a life insurance company)
We are going to cover these off in our next blog post … stay tuned!
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