My Portfolio Is Down. Should I Take Social Security or Canada Pension Plan Now To Give My Portfolio Time To Recover?
The goal of every retiree is to make their money last throughout their lifetime. Your financial planner should help you be as efficient as possible with your money to give you the best chance of achieving a successful retirement.
Many financial planners cannot discuss your tax situation because of regulatory restrictions, so it is important to find the right planner for you. If you follow our blog, you will notice that we occasionally write about trying to avoid taking distributions from your investment accounts when the account balance is down. That is not always possible; however, maintaining a healthy cash reserve and being flexible in your spending can help maintain the longevity of your portfolio.
Every time we go through a market correction, some clients will ask if they should take their Social Security, Canada Pension Plan, or Old Age Security now rather than waiting until age 70 to get the maximum benefit. Taking benefits early could give their portfolio some time to recover from the decrease in value. While this can be a good idea and is something you should consider, it rarely makes sense to base your decision on when to take government retirement pensions around current market conditions. That would be like trying to “time” the market which, as most of us know, is a rather difficult undertaking.
Most of our clients are eligible for three government retirement pensions: Social Security (SS, U.S.), Canada Pension Plan (CPP, Canada), and Old Age Security (OAS, Canada). Each of these programs are different, so the decision of when to take each pension has slightly different considerations.
You can take SS anytime between ages 62–70. Most people who are not yet retired have a full-retirement-age (FRA) of 67, so we will use that for this example. If you take SS before your FRA, you will lose approximately 6% of your benefit for each year you take it early. Your benefit is prorated if it is initiated in a month other than your birth month. If you take SS at age 62, your benefit will be approximately 30% less than if you take it at your FRA. On the other hand, you gain approximately 8% on your benefit each year you wait, up to age 70. If you wait until age 70, your benefit will be 24% larger than if you took it at your FRA.
CPP can be taken anytime between ages 60–70, with FRA being age 65. If you take CPP before age 65, it will decrease by 0.6% per month taken early, or 7.2% annually. If you delay CPP until after age 65, it will increase by 0.7% per month taken late, or 8.4% per year. So, if you take CPP at age 60, it will be 36% lower than at age 65, while waiting until age 70 will result in a benefit that is 42% higher than at FRA.
In contrast, OAS is the only government retirement pension that cannot be taken early, so age 65 is the earliest that you can take OAS. The increase in your benefit for waiting until after FRA is 0.6% per month, or 7.2% per year. Waiting until age 70 to take your OAS benefit will result in a monthly payment that is 36% higher than if you took it at age 65.
To recap, CPP has the largest increase for delaying your benefit; it also has the harshest penalty for taking your benefit early. OAS cannot be taken early and has the smallest increase for waiting until after FRA. SS has the lightest penalty for taking benefits early and has a significant increase for delaying benefits past your FRA, but not as high as CPP. To summarize, the annual increase for delaying benefits is:
- CPP – 8.4%
- SS – 8%
- OAS – 7.2%
The takeaway here is that if you are going to claim benefits before your FRA, it makes the most sense to take Social Security early because the penalty for taking benefits before your FRA is less than CPP at 6% vs. 7.2%. The benefit of taking SS late is also less than for CPP at 8% vs. 8.4%.
So, if your portfolio is down, should you take government pensions or give your portfolio time to recover? Let’s use an example to quantify the potential outcome:
- You have a $3,000,000 investment portfolio.
- You are married and both age 67 (full-retirement-age).
- You are expecting Social Security benefits of $3,600 each at age 70. Those Social Security benefits will be reduced by 24% to $2,736 each if you take your benefit now (FRA of age 67).
If you live to age 95, you will receive $1,080,000 from Social Security if you take the pension at age 70 vs. $919,296 if taken at age 67. This is in today’s dollars and does not include any cost-of-living adjustments (COLA). This is a difference $160,704 each between now and age 95. The difference would actually be more because the cost-of-living adjustments (COLA) are a percentage based on the current benefit amount. In other words, your annual increase in dollar terms will be higher if you wait until age 70 because the COLA increase is based on a larger monthly benefit amount.
If you took a $100,000 distribution while your portfolio was down 15% at the time of distribution, you would be locking in the loss of about $15,000. The value of that $15,000 in 28 years depends on the rate of return assumption. For example, the value of $15,000 in 28 years could be:
- 0% average return – $15,000
- 2% average return – $26,115
- 4% average return – $44,981
- 6% average return – $76,675
- 8% average return – $129,407
We recognize that the assumption of a consistent 8% average return for a typical portfolio consisting of 60% equity and 40% fixed income is probably quite a stretch. You are still much better off waiting until age 70 to take your Social Security distributions even if you can achieve such a high rate of return. Assuming you take both of your SS benefits early, and assuming that the investment portfolio is joint, you would be missing out on $321,408 in SS benefits at age 95 vs. only $114,407 in missed appreciation on the $15,000. That is a difference of $207,001 and is much lower than the difference would be using a more realistic return assumption. In this situation, you would have to both take SS benefits early because your combined benefits are not enough to make up for the $100,000 assumed distribution you need for living expenses. Your combined first year benefits at age 67 would be $65,664 and you would still need to take a distribution of $34,336.
It also would not be a fair comparison to assume such a high rate of return because the only reason you are considering taking Social Security early is because you are assuming lower rates of return going forward. You would not be considering taking your SS benefits early if you assume normal rates of return in the future, which have historically been between 8%-10% annually for equities as average rates of return vary globally. Assuming a return of 2%-4% is more reasonable for this example, which would result in a difference of $276,427. The other side of that argument is: why would you give up a guaranteed 8% annual rate of return when you are assuming lower portfolio returns of 2%-4% in the future?
There are a few reasons why you should consider taking Social Security before age 70. Needing the money for living expenses is the first consideration. If you can afford to wait because you have other assets or sources of income, having a shortened life expectancy is the second consideration to make. If your life expectancy is shorter than 80–82 years, you should consider taking your benefits as early as possible. The next consideration is if you have a spouse whose spousal Social Security benefit is much higher than their own benefit. If that spouse is the same age or older than you, then it makes more sense to take Social Security early so that they can take their spousal benefit.
Generally, spousal benefits push up the breakeven age when calculating cashflows to decide when to take benefits. You will still likely be better off waiting if you live to age 95. The Private Wealth Managers at Cardinal Point help calculate those breakeven points for their clients so they can make an educated decision regarding the timing of their government retirement pension benefits. There are no spousal benefits for CPP or OAS, so your spouse is not a consideration when deciding when to take those benefits. The last consideration is to look at how your Social Security benefits may affect your tax planning, such as Roth conversions, planned distributions, or gifting.
To summarize, this example discusses the option of distributing $100,000 of a $3,000,000 portfolio, or 3.33% of the portfolio when the market is down 15% vs. taking SS, CPP, or OAS early to give the portfolio time to recover. If the portfolio suffered a 15% loss, you would essentially lock in a $15,000 loss if you took the distribution at that time. This is a loss of about 0.5% ($15,000 / $3,000,000) of your portfolio. In contrast, taking Social Security early locks in a loss of 8% per year before age 70. The loss in SS benefit relative to your portfolio size is approximately 10.7% ($321,408 / $3,000,000) when comparing taking benefits at age 67 vs. 70. If you take it at your full-retirement-age (67 for most people), you are locking in an annual loss of 24% in perpetuity. As you can see, the loss in your portfolio would need to be much more than 15% for taking Social Security early to make sense. Please note that the calculations in this example have been simplified for illustrative purposes.
We primarily discussed Social Security in this example, but the thinking is the same for Canada Pension Plan and Old Age Security. Many of our clients are eligible for all three pensions, so the decision becomes more complex. If you are going to take any of your government pensions before age 70, it should be in the following order, all else being equal: OAS, SS, CPP. All else is never equal, so the currency conversion rate should also be taken into consideration as well as the taxation of the benefits in your home country.
The U.S. and Canada have a Social Security Totalization Agreement, so SS, CPP, and OAS are only taxable in your country of residence. In the U.S., the first 15% of your SS benefit (and CPP and OAS) is tax-free. CPP and OAS are fully taxable for Canadian residents while the Canada Revenue Agency (CRA) provides a 15% deduction for SS received by Canadian residents. Many people would argue that your confidence in the pension system itself should also be considered. In other words, will the government be able to maintain your pension payments in the future.
These decisions can be quite complex, and no two situations are the same. You don’t know what you don’t know. Everything is available on the internet now, but you can set yourself up for failure when you don’t know the right questions to ask. Cardinal Point is a leading Canada-U.S. cross-border wealth management firm. We specialize in cross-border tax planning, retirement planning, comprehensive financial planning, and investment management. Our planners are the most highly qualified in the industry, and we are prepared to help you sort through these difficult decisions. Hiring a professional to help you make sure all the i’s are dotted and t’s are crossed can help give you the peace of mind you need to live out your cross-border retirement with confidence. As fiduciaries for our clients, our only job is helping them achieve their financial goals from an unbiased and transparent perspective. Get in touch with us today to find out how we can help you and your family.