CPP reform on the right track, think tank report says

On the whole, reforms underway to the Canada Pension Plan (CPP) to aid low-income Canadians are moving in the right direction, suggests a report from the C.D. Howe Institute.

The reforms, which impose higher penalties for opting to receive CPP before age 65 and greater rewards for delaying take-up until after 65, were meant to ensure people do not have a strong financial incentive to retire early and take-up CPP at age 60.

In "Comparing Nest Eggs: How CPP Reform Affects Retirement Choices," the authors find that once the interaction of these age-based CPP adjustments with the tax system is taken into account, some lower-income Canadians will still have financial incentive to retire early, because they face penalties if they don't.

The reforms are a step in the right direction and enhance the flexibility of Canadians to work longer without being penalized for their choice, explains Tammy Schirle, a co-author of the report and an economics professor at Wilfrid Laurier University in Waterloo, Ont.

"We want to design our public pension system so people aren't penalized for choosing to postpone their retirement. With the way CPP is now designed, the average retiree has a flexibility in their retirement choices in the sense that postponing retirement isn't going to reduce their lifetime benefits from the Canada Pension Plan," she says.

"When it comes to low-income seniors, they face huge penalties if they were to delay retirement. If they decide to do so, they can receive a slightly higher benefit from the Canada Pension Plan but that results in a big claw-back from their Guaranteed Income Supplement benefit."

On an after-tax basis, for Canadians who collect Guaranteed Income Supplement (GIS) and have no other separate source of income beyond CPP, pension wealth is maximized at age 60, on average, and is reduced from there on.

"As a whole, they lose out. For every year that they delay retirement, they get less from the Canada Pension Plan on an after-tax basis," she adds. "The GIS is the big thing. For every extra dollar you get out of the CPP or RRSP all counts against your GIS.

"For policymakers, they need to reconsider how they link the GIS to the CPP and by severing that link, a lot of low-income seniors would be much better off and have a lot more incentive to continue working past the age of 60."

The report estimates the expected present value of the lifetime flow of CPP benefits for a stylized individual retiring at different ages, from 60 to 70 -- a measure of an individual's pension wealth. The reform should produce expected pension wealth values that are flat across retirement ages, meaning that an individual's total lifetime consumption possibilities are not changed by his or her retirement-timing choice.

The study examines three cases for a 60-year-old considering his/her retirement-age options: please explain these outcomes:

*In the first case, the authors do not account for taxes and simply discount the gross CPP benefit flow back to age 60 for each retirement age.

*For the second case, they account for income taxes and income-tested government-benefit claw-backs. They also assume the retiree receives $20,000 of employer-provided pension income. This extra income makes him/her ineligible for benefits from the income-tested GIS.

*Finally, in the third case they remove the $20,000 of pension income and observe the significance of the GIS.

On a gross before-tax basis, the study finds that the reforms have steepened the age profile of discounted total benefits across retirement ages. Retire early and an individual receives less; retire later and he receives more than before the reform.

However, they find that the size of the gain (or loss) from the new adjustment factors depends critically on the receipt of the income-tested GIS benefit, which is clawed back for lower-income retirees.

The new pension adjustment factors have moved in the right direction, but still fall short of offering many Canadians, who might retire at different ages, the same value for their CPP benefits.

"For low-income seniors, the way CPP interacts with the Guaranteed Income Supplement, they were always shortchanged," she adds. "With this new policy that's being phased in, they're not as shortchanged as they used to be. They're slightly better off if they continue to work after age 60 but they're still losing out."

For Canadians facing this scenario, Schirle recommends taking the time to understand how the GIS works and what income counts against it. To that end, Service Canada provides straightforward information on the subject.