In the eyes of people planning their retirement, the Canada Pension Plan has a fairness problem.
The CPP offers fatter payouts if you delay the start of your retirement benefits past age 65, but there is little take-up of this offer because people worry about dying prematurely. In that case, money put into the CPP while working is seen as being lost.
Addressing this perceived unfairness is the focus of a recent research paper that aims to improve decision-making by CPP recipients. The solution the team behind this research came up with is brilliantly simple. Just give people who die prematurely the money they lost out on because they delayed the start of CPP.
The concept is called the Pension-back Death Benefit. Some rewiring of the CPP would be required to bring it to life, but nothing major. The only cost felt by CPP recipients would be a slightly lesser financial incentive to delay the start of benefits.
You can start CPP with a reduced benefit as early as 60, and there are two good reasons to do so. One is that you have health concerns that limit your life expectancy, the other is that you simply need the money and can’t wait. Otherwise, delaying as late as 70 allows you to lock in bigger inflation-adjusted payments for as long as you live.
The traditional thinking on why people choose not to delay has been that they put greater emphasis on having money in hand right away. Also, that they’re concerned about dying prematurely and losing out on CPP benefits they paid for. “It’s just a feeling of what’s fair,” said actuary Bonnie-Jeanne MacDonald, lead author of the paper and director of financial security research at Toronto Metropolitan University’s National Institute on Ageing.
The Pension-back Death Benefit addresses the fairness issue by giving people and their estates the difference between what they actually collected in CPP and what they would have received if they started at age 60. The paper offers an example of his works using someone who would be eligible to receive $1,000 a month in CPP retirement benefits at age 65, or a reduced benefit of $640 at age 60.
If this person died at 65 without having started CPP, their Pension-back Death Benefit would be $38,400. That’s $640 a month over five years, a huge improvement over current payments to spouses or estates when a CPP recipient dies.
The CPP death benefit has been capped at $2,500 for many years, while the survivor’s benefit for spouses and common-law partners is subject to a calculation that tends to produce disappointingly low results. No one should expect to get their deceased spouse’s full CPP payment.
The CPP is a finely tuned mechanism that cannot simply deliver better payouts on demand – something has to give. In the case of the Pension-back Death Benefit, it’s the financial reward of delaying the start of CPP that suffers.
Each year you delay past 65 currently gives you more in benefits, with a maximum gain of 42 per cent if you start at 70. Under the Pension-back Death Benefit, the maximum gain for delaying five years would fall to 37 per cent.
Ms. MacDonald argues convincingly that the reduction in benefits under the Pension-back Death Benefit will not be a deal-breaker for people considering a later start to CPP. As it is now, without the death benefit, the incentive for waiting isn’t doing the job.
“People are not delaying, even though it’s a great deal,” she said.
One objection to the idea of a Pension-back Death Benefit is that you receive only the payments you missed out on. There’s no interest tacked on to reflect what you might have made if you started CPP at 60 and invested the money rather than spending it.
Ms. MacDonald acknowledged this reality, but she noted there’s a risk that someone who invested CPP benefits would lose money. The Pension-Back Death Benefit at least preserves the payments missed out on by someone who dies prematurely.
Introducing this new death benefit to the CPP would take some doing – Ottawa and two-thirds of the provinces representing two-thirds of the population would have to agree. But Ms. MacDonald believes the idea would be seen favourably because it doesn’t require higher CPP premiums from workers and their employers.
Getting people to delay CPP is in the public interest because it promotes financial security for seniors. Wouldn’t it be easier to achieve this goal simply by raising the minimum age for starting CPP?
Ms. MacDonald says no. “There are people who are vulnerable, and they do need to claim early,” she said. “We believe that flexibility is a good thing.”
Are you a young Canadian with money on your mind? To set yourself up for success and steer clear of costly mistakes, listen to our award-winning Stress Test podcast.
