Kevin Greenard: Changes to the Canada Pension Plan

For 64 years, Canadians have been contributing to the Canada Pension Plan.

The CPP is a federal program that provides pensions to qualified contributors in retirement. Any benefits paid by the CPP are taxable both federally and provincially.

For Canadians at or nearing retirement, CPP remains a bit of a mystery. Most people realize that they have been contributing to CPP for a good portion of their lives, but they really don’t know much about the program. CPP is meant to replace some of the lost income due to retirement, disability, and death. The Human Resource Development Canada website provides a nice summary of the history of CPP and the changes that have occurred over the years. The following are extracts from the website www.hrsdc.gc.ca.

The legislation has been amended several times. Among the most important amendments between 1966 and 1986 are: the introduction of full annual cost-of-living indexation; the availability of the same benefits to male and female contributors as well as to their surviving spouses or common-law partners and dependent children; the elimination of the retirement and employment earnings test for retirement pensions at age 65; the exclusion of periods of zero or low earnings while caring for a child under the age of seven; the division of pension credits (credit splitting) between spouses if there is a marriage breakdown.

In January 1987, several major new provisions came into effect. These included: flexible retirement benefits payable as early as age 60; increased disability pension; continuation of survivor’s benefits if the survivor remarries; sharing of retirement pensions between spouses or common-law partners; and expansion of credit splitting to cover the separation of married or common-law partners.

In 1991, legislation was passed to assist those people who were denied a credit split as a result of provisions contained in a spousal agreement entered into prior to June 4, 1986. The amendment provides that applicants who were divorced or whose marriage was annulled on or after January 1, 1987 will be credited with the same amount of credits which he or she would have received otherwise.

In 1992, three major amendments came into effect – a new 25-year schedule for employer-employee contribution rates was established, children’s benefits were increased and a provision was made for individuals who were denied disability benefits because of late application.

In 1998, the CPP moved from pay-as-you-go financing to fuller funding. Contribution rates were increased, and a new investment policy was introduced. A Canada Pension Plan Investment Board has been formed and operates at arm’s length from the federal and provincial governments. The Board uses qualified professionals to invest Canada Pension Plan funds in financial markets. The Board broadly follows the same investment rules as other pension plans.

Let us skip to more recent changes that are still in the process of being implemented. In 2016 there was a lot of discussion on how to enhance CPP. Up until 2019, the CPP retirement pension was designed to replace approximately one quarter of your average work earnings. This average was assuming your average earnings from work, was equal to the maximum earnings limit (in 2018 this was $52,400). Other sources of income, including Old Age Security, RRIF withdrawals, and private company pensions would assist in coming up with the addition income need in retirement.

Annually, the maximum contributory earnings are adjusted to keep pace with inflation. Below is a table of maximum contributory earnings from 2010 to 2020.

The maximum contributory earnings numbers above are important to know if you are an employer, employee, or self-employed. You only contribute into CPP for the dollar amount between the exemption $3,500 and the maximum pensionable earnings. The basic exemption amount has been consistent at $3,500.

Below are the annual contribution rates and the maximum contribution amounts (in dollars).

One of the first things that should stand out when you look at the above table is the change in the employee and employer contribution rate beginning in 2019. In 2019, CPP implemented a gradual enhancement to the contribution rate.

The end goal with this enhancement to CPP is that it will eventually grow to replace one-third of your earnings in retirement. As you can recall from above, the goal before 2019 is that CPP was to replace one quarter of your earnings (assuming your pre-retirement income was equal to or below the maximum pensionable earnings).

Prior to 2019, employees and employers contributed 4.95 per cent on earnings to the CPP. Self-employed individuals must contribute both the employee and employer portion which equals 9.9 per cent. Beginning in 2019, the enhanced CPP meant that both the employee and employer have a higher contribution rate, and this rate is escalating each year as following percentages: 2019 (0.15), 2020 (0.15), 2021 (0.20), 2022 (0.25), and 2023 (0.25).

It is expected that in 2023 the contribution rates will level off at 5.95 percent for employees, 5.95 percent for employers, and 11.90 per cent for self-employed. This five year period effectively increased the CPP contribution rate one per cent from the long-standing 4.95 per rate.

As noted above, the maximum pensionable earnings amount is adjusted for inflation every year. Apart from these inflation adjustments, no real changes have been done to the maximum levels. After the contribution rate is phased in, CPP will introduce further changes to the maximum limits used to determine your average work earnings.

The further changes will start in both 2024 and 2025. In these years, a second level will be introduced to enable additional portions of earnings to be contributed into CPP. The additional amount will be referred to as the year’s additional maximum pensionable earnings. This second level is meant to adjust for wage growth, not just inflation.

In 2020, the maximum pensionable earnings is $58,700. Starting in 2024, we will begin referring to this as the first earnings ceiling. With inflation adjustments, this first earnings level is projected to be approximately $69,700 in 2025. The second level will be 14 per cent higher than the first level, estimated at $79,400.

Essentially, if you are earning more than the maximum pensionable earnings of $58,700 currently, you will be contributing more towards your CPP in 2024, and in the future. Let’s assume that in 2025 $69,700 is the threshold for the first level, and $79,400 is the threshold for the second level. The difference between the first and second level is $9,700 ($79,400 – $69,700).

To illustrate we will use Jill who earns $79,400 currently and anticipates earning roughly in the same amount in 2025.

2020 CPP Calculations

• Employee contributions will be: $58,700 x .0525 = $3,081.75
• Employer contributions will be: $58,700 x .0525 = $3,081.75
• Total 2020 employee and employer contributions = $6,163.50

2025 CPP Calculations (Estimate Only)

• Employee contributions will be (first level): $69,700 x .0595 = $4,147.15
• Employee contributions will be (second level): $9,700 x .0595 = $577.15
• Employer contributions will be (first level): $69,700 x .0595 = $4,147.15
• Employer contributions will be (second level): $9,700 x .0595 = $577.15
• Total 2025 employee and employer contributions (estimated) = $9,448.60

In this simple example above, Jill’s portion (the employee) will jump $1,643.30, from $3,081 in 2020 to $4,724.30 ($4,147.15 + $577.15) in 2025. Employees that hit the second level will see a larger portion of CPP withheld off their paycheques. Employers will also have to contribute an equal amount. Self-employed individuals will have to pay both portions, an annual increase of $3,286.60 ($1,643.30 + $1,643.30). In many ways these types of increases are a double edged sword. Many businesses may be less inclined to hire employees knowing that the annual cost of each employee has jumped $1,643.30.

Since its enactment in 1965, CPP has made multiple changes to its program. The more recent changes are some of the biggest with respect to the level of contributions going into CPP. We anticipate that CPP will continue to evolve in the future and adjust to new challenges that are certain to exist. A big challenge currently is the large number of baby boomers that are now entering the period in which they can collect CPP.

One of the most frequently asked financial planning questions relates to when to collect CPP. The earliest age to collect retirement CPP is 60. In our next column, we will outline the process we go through with clients to determine the optimal age in which they should collect CPP. More specifically, should they begin drawing CPP income early at age 60, defer to age 70, or collect CPP somewhere in between?

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director, wealth management, with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138. greenardgroup.com