5 Retirement Income Pitfalls to Avoid
Pitfall #1: CPP and OAS
Not understanding CPP (Canada Pension Plan) and OAS (Old Age Security) is one thing that can have a huge impact on the income you bring in during retirement. I’m sure you’ve at least heard the terms before and likely have seen the deduction for CPP on your paycheck. Both programs are run by the federal government (other than in Quebec). If you are unfamiliar with OAS it is not something you contribute to directly like CPP, but is funded through our tax system.
The first point I want to make is, do not rely on these government programs to fund your retirement.
While they do provide a nice source of retirement income for many people, they are generally not suficient on their own to fund retirement. Contributing to a personal retirement savings account of some kind whether it’s a pension, RRSP, TFSA or any other account(s) is likely necessary to live a comfortable retirement.
The maximum CPP benefit per year as of 2024 is $16,375 if you begin to collect at age 65. The maximum OAS benefit per year for a 65 year old is $8,560. You can see how for most people this is not enough to live the retirement they wish.
Also, these are maximum amounts a person can receive at age 65. The CPP you actually will receive is a complex calculation that is based of of how much your income was during certain working years. OAS is based on retirement income earned.
The second point I want to make is that you have flexibility with when you begin to receive these benefits. Age 65 is the standard year for receiving CPP and OAS. However, you can begin to receive them as early as age 60 or push them back up to age 70.
Deferring the benefits is more common because when you defer the government will essentially allow you to accumulate interest. Each month you defer receiving CPP increases your monthly income payment receivable by 0.7%. That’s 8.4% per year. That would change the $16,375 listed above to an annual payment of $23,252. The same is true for OAS where you will gain 0.6% per month each month you delay the payment after age 65.
Receiving the CPP benefits early (as early as age 60) results in something similar except this time you essentially pay the interest. By receiving the benefits early your CPP payment is reduced by 0.6% per month. OAS is not eligible for early payments.
The reasons why a person chooses to receive the benefits early, on time or delay them is very much based on individual situations. Things like health, life expectancy, retirement funds available, desired retirement date, tax situation and many more all come into play.
Understanding what you’re likely to receive and the options available to you in relation to CPP and OAS is one of the key pieces to having the retirement income you desire.
Pitfall #2: Forgetting to account for Life and Health Span
The second pitfall in this series is forgetting to account for life and health span. This point is often overlooked, especially when individuals go it alone with their retirement planning.
The topic is often a little uncomfortable but is very impactful in terms of where retirement money should be allocated. The cost of long-term care is increasing and was not cheap to begin with, even in government subsidized care homes.
Aside from long term care, as we age there are generally more medical costs associated as well. Contrary to popular belief our public health care system in Canada does not always cover everything health related. For instance, I had a client who required cancer treatment and had to pay from their own pocket to receive it.
There are multiple ways to look after these financial needs such as simply planning for them and investing in the right accounts. Or we can look at diversifying and sharing some of that risk with insurance companies who provide options such as long term care, critical illness, health and disability coverages.
Another aspect of health and life span is the idea of outliving your money. It’s important to ensure that how much money is withdrawn for retirement needs/wants, and where the money comes from, is sufficient to maintain their lifestyle 100% of the time. The idea of accomplishing something like turning 95 but having money worries is something I don’t want any person to experience. Inflation, changes in tax law, investment market swings etc. are all important factors to keep an eye on and account for as much as possible.
Of course it’s impossible to predict the future but by acknowledging the potential variable and building contingencies you can handle them smoother if they do arise.
Pitfall #3: Move Your Pension to a Personal Account
The third pitfall in this series is not moving your pension or employer sponsored plan to a personal account as soon as possible. More and more employers are now ofering sponsored retirement plans such as Group RRSPs or company pension plans. These are a fantastic resource to help fund your retirement if you are employed by a company who does this.
Bonus tip: Max out the contribution amount that your employer will match in these plans if you are eligible to do so.
However, a common pitfall I see all the time is these plans staying with the employer and plan provider after a person has left the company. This happens often when someone changes employers or retires.
There are two reasons I always advise that you transfer this account to one you control yourself.
1) You have easier access and more control over what you invest in and at what times
For example, I often see pensions sitting in one of 4 portfolios based of their risk tolerance such as conservative, moderate, balanced growth and growth. By having control yourself you can customize down to the percentage what you hold. For example, you may want to keep 25% in cash within a High Interest Savings Account, 40% in the stock market holding mutual funds, ETFs or individual stocks with the remaining 35% held in bonds or GICs with fixed income sources. There is value in having more control.
2) You will be better able to watch how things progress and make changes as necessary
Often when a person leaves a group plan their investments no longer form part of the main group which results in a transfer of responsibility. The advisor and plan sponsor who would normally watch over the investments often can no longer see what your account is doing. You will likely receive a quarterly statement from the company to help keep you updated but 3 months is a long time to wait if adjustments should be made.
Transferring to an individual account allows you, and your advisor if you work with one, to see how things are progressing, monitor your holdings and react faster if changes need to be made.
Pitfall #4: Not Using the Right Account Type
The fourth pitfall in this series is, not understanding or utilizing the most advantageous account types for your situation and goals.
This is a very broad topic and I don’t want to type two hours worth of reading material to you so I will bring up the key points but this is one of the areas I will often highlight as a benefit of working with an advisor.
We’ve already discussed pensions, RRSPs, CPP and OAS but there are other account types that are very common like TFSA (Tax Free Savings Account), Spousal RRSPs, or non-registered (open) accounts among others.
The nuances surrounding each account type and when to use them are generally focused on the tax treatment of what’s held in the account both for the present and the future. But also around the flexibility each account ofers such as income splitting opportunities or in relation to withdrawals.
Like I mentioned I don’t want to get overly granular with each account type as there is lots to cover and the efectiveness of each type is very individually oriented.
However, the main topics I would recommend researching or asking your advisor about are:
1) How each account works together in terms of limiting the overall tax payable across your life
Some plans create taxable income like RRSPs or pensions which is treated the same as interest or employment income, while others like the TFSA create tax free withdrawals. But an RRSP helps to reduce taxes payable in the present. This leads to my next point.
2) Have a plan for when and where you will draw your retirement income from The first pitfall in this series is where I talked about CPP and OAS options relating to
receiving payment early, at age 65 or delaying it past 65 and the consequences. This is just one example of how that decision stems from other ones including, where and when am I withdrawing retirement income.
3) In what account should you hold a certain asset
Throughout your financial journey you will likely hold some combination of cash, income, and growth producing investments. These allocations will change depending on your goals and what point of life you are in. It can be advantageous to put certain holdings into certain accounts. For example, no matter what you hold in an RRSP when you withdraw it is taxed as income/interest. Therefore, it may make sense to hold GICs, bonds or other interest bearing investments in your RRSP since that’s how they will be taxed anyway.
Whereas we could hold stock market based investments that pay dividends and produce capital gain in a non-registered account because they will be taxed in the form they are earned.
Pitfall #5: Not Having a Hardcopy Plan
The final pitfall in this series is not having a hardcopy retirement plan. According to a study from Savology if you have a written financial plan you are 2.5 times more likely to reach your retirement goals. FP Canada reports that those with a comprehensive plan feel 85% more confident with their financial well being than those who only have parts of a plan in place.
I want to preface this a bit by saying that when it comes to a hard copy plan I still value fluidity and adaptability. Just because something gets written out doesn’t mean it can’t (and shouldn’t) change.
The point of the written plan is to help promote commitment to the things that get you where you want to go. For example if we figure out that to reach all of your retirement goals you need to take 10% of your net income and commit that to your TFSA and RRSP then writing it down will help keep a person on track. You will also be able to see the progress as you go which is always encouraging.
A good plan will take into account everything we’ve talked about already in this series plus more and make it work for your situation.
My mom always said “everything in moderation” and these plans are no different, balance is key. Enjoying today but preparing for tomorrow is critical.
This is where I can help. I want to help you feel comfortable and confident in your finances and your retirement income plan while of course avoiding these pitfalls.
If you would like to work together on planning your retirement send me a message by clicking the link below.