Seniors are set to be rewarded for working to age 65 and beyond under proposed changes to the Canada Pension Plan, but experts say the incentives may be too small to prompt many Canadians to adjust their retirement plans.

After the federal/provincial/territorial finance ministers’ meeting in late May, the federal government released several proposed changes intended to modernize the CPP to reflect the different paths people now take to retirement. “A modern public pension plan should treat workers fairly, regardless of the age at which they take their retirement pension or how they choose to retire,” concluded a statement issued after the meeting.

One of the changes would adjust the level of benefits for early and late CPP take-up, enhancing the rewards for those who postpone taking benefits beyond age 65 and scaling back income for those who take their benefits early.

Currently, those who begin receiving benefits before age 65 receive a pension that’s reduced by 0.5% for each month that it is taken before their 65th birthday. The adjustment accounts for the fact that early retirees make CPP contributions for fewer years and receive benefits over a longer period. Likewise, late retirees’ pensions are increased by 0.5% for each month that the pension is taken after their 65th birthday, up to age 70.

Under the proposed changes, which would be implemented gradually beginning in 2011, those collecting early would see their CPP payments reduced by 0.6% per month. As a result, someone who begins to collect at age 60 would receive a pension that is 36% lower than the amount they would receive if they began at 65. This contrasts with a 30% reduction of the basic amount under the existing rules.

Meanwhile, the pensions of those retiring later would be increased by 0.7% per month after they turn 65 under the changes. This means someone who begins receiving pension benefits at age 70 would receive a pension that is 42% higher than it would be if they began their benefits at 65, vs an amount 30% higher under the current rules.

To illustrate the impact of the change, the government says that a woman entitled to receive an annual CPP benefit of $6,410 who decides to delay taking her pension until age 66 would receive $538 more per year, or $6,948. The change represents an increase of $153 from the annual amount of $6,795 that she would receive under the existing rules if she delayed until age 66.

The reason for these changes is to restore the pension adjustments to their “actuarially fair” levels, the federal government says. Federal officials say that the current levels have been left unchanged since 1987 despite significant shifts in economic and demographic factors.

But another reason for the change is to encourage Canadians to stay in the workforce longer, according to Jacques Lafrance, a Canadian Institute of Actuariesboard member in Montreal and a principal and pension actuary with U.S.-based human resources consultants Towers Perrin. “They want to encourage people to work longer,” he says. “That’s part of the strategy.”

But the incentive may be too small to prompt Canadians to delay collecting their pensions, particularly as the average annual pension benefit in Canada is only about $6,000 to begin with. The maximum annual CPP benefit a person could receive is $10,905 — far short of what a person needs to live on, according to Susan Eng, vice president of advocacy at the Canadian Association of Retired Persons, a national advocacy group for older Canadians.

“It’s a very small proportion of what you actually need,” she says. “[The incentive is] not enough dollars that it’s going to make or break a decision to retire or not retire.”

The adjustments are especially insignificant for high net-worth clients, according to Lynn Biscott, a financial educator with Toronto-based Fernwood Consulting Group Inc. and author of the recently released book The Boomers Retire. “For high net-worth clients,” she says, “the CPP is really just a small part of their retirement income anyway, so it’s not a big deal.”

But for low-income individuals, the incentive could be enough to prompt a later retirement, she admits: “Where it might have more impact is on people who are looking to CPP for a more substantial part of their retirement income.”

@page_break@For example, she says, individuals with low income and no employer pension may see value in postponing retirement once the changes have been implemented.

Other CPP changes proposed by Ottawa seek to provide Canadians with greater flexibility in retirement — something that is long overdue, according to Eng.

One proposal would eliminate the “work cessation” test, which requires individuals who apply to take their CPP benefit early either to stop work or reduce their earnings. By removing the test, individuals could take their CPP benefits as early as age 60 without any work interruption. This change could allow individuals to use CPP income to phase into retirement or supplement their earnings.

“That change was extremely important,” says Eng. “It certainly recognizes the reality that people in fact want more flexibility in retirement.”

But there’s a catch for individuals who decide to keep working while receiving benefits: one of the proposed changes would require both the beneficiary and the employer to continue making contributions until the worker’s 65th birthday.

This change could have a hefty impact, affecting anyone who planned to take their CPP pension at age 60, based on the assumption that they would no longer have to contribute if they continued working.

“A large proportion of Canadians decide to collect the pension as soon as possible,” says Lafrance.

This is a particularly popular option among self-employed individuals because they pay a hefty double contribution rate as both an employee and an employer, and are often eager to cease contributions as early as possible, Biscott says.

“If you’re self-employed, you’re contributing more than $4,000 a year into [the CPP], and you’re not really getting a commensurate benefit with that,” she says. As a result, Biscott has always advised such clients to begin taking their pension at age 60.

Although working beneficiaries will receive increased retirement benefits as a result of the continued contributions, Biscott says, the increase isn’t likely to be worthwhile for most contributors: “I’m not sure that the additional contributions are going to be worth the additional money that you eventually get out of it.”

CARP commends the proposal as a way of forcing Canadians to increase their savings for retirement. “People don’t save enough as it is for their retirement,” says Eng. “We think this mandatory contribution is a good idea because it will increase their retirement benefit.”

The final change proposed by Ottawa would improve the basic retirement pension for virtually all CPP contributors, by increasing the “general low earnings dropout.” The dropout is a provision allowing for a percentage of the years during a contributor’s career to be excluded from the calculation of the average career earnings. This ensures that average earnings are not affected by a certain number of years of unusually low earnings that occur during periods of unemployment, full-time post secondary attendance or for other reasons.

This proposal, which would increase the dropout from its current level of 15% to 16% in 2012 and to 17% in 2014, would allow contributors to exclude up to eight years of low earnings, up from the current limit of seven years.

The increase is a step in the right direction, Eng says, as it provides more flexibility during contributors’ working years. “Increasing the dropout provision,” she says “is a very good idea for everybody.” IE