Making Sense of the New CPP Legislation

Last month, Canada’s finance ministers reached an agreement, historic according to some, to expand the benefits of the 44 billion-per-year Canada Pension Plan. The CPP was originally enacted to provide 25% of what actuaries felt would be a comfortable retirement. 

CPP benefits are based on a maximum average income, plus time in, less any gaps in employment. They take the average income over your career and payout 22% of this average income. CPP benefits are paid on a maximum average of $54,900 in annual earnings. Therefore the maximum benefit is $ 54,900 x 22% or about $12,078 per year. If your average earnings exceed $54,900 you cannot, under the old rules receive any more than 22% of $54,900. On the other hand, if you earn less than an average of $54,900 your payout is 22% of the lower amount. 

Contributions to CPP are 4.95 % of your annual income matched by your employer per year (total of 9.90%). Therefore, someone earning $54,900 or more contributes a maximum of $2470.50 per year matched by the employer, totalling $4941.00 per year. A working Canadian earning $40,000 per year for example, is contributing $1800 per year matched by the employer totalling $3600 per year. 

The best way to understand the new rules is to think of a pie split into two equal slices. Part of the pie represents the current CPP rules with one enhancement and the second piece of the pie featuring a new addition to the existing plan. 

First Piece Of The Pie: 

The first piece of the pie will be be providing enhanced benefits. The benefit enhancement means that CPP benefits will be increased from 25% to 33.3% . As mentioned above, CPP is calculated based on a contributors average annual income to a maximum of $54,900. The new maximum CPP benefit will increase from $13,725 to $18,117 per year a princely increase of about $4392.00 per year. 

eg: Mary is currently aged 30. When Mary retires, she will receive 33% of her average income as CPP benefits, whereas current retires only receive 25% of their average income based on a maximum income test of $54,900. 

Second Piece Of Pie: 

The second piece of the pie provides additional benefits for those who earn more than an average income of $54,901 during their working years. 

eg : Mary retires and her average income for CPP purposes is $76,000. Mary will receive the maximum amount under the first slice of pie ($ 54,901x 33%) or $18,117 per year. Because her average annual income is in excess of $54,901 she will qualify for some of the second piece of pie. Mary will receive 33% of the difference between her annual average income of $76,000 and $54,901 ($21,099 x 33%) or $8355.52 per year for a total of $26,472 per year. 

According to MacLean’s magazine, the each slice of pie will be accountable and the contributions may be tax deductible ( for the second piece only) in lieu of the small non-refundable tax credit currently provided on the existing slice of pie. 

Summation: 

Working Canadians who contribute to CPP will receive more, regardless of their income as CPP will payout 33% versus 25% of your yearly average income. For example 

1. The existing piece of pie will increase to 33% from 25% (new) to a maximum capped income test of $54,901(no change) 
2. To qualify for the minimum piece of the second piece of pie your average income for calculation purposes must exceed $54,901. 
3. To qualify for the maximum piece of the second piece of pie you require an average annual income of $82,700. 
4. Typically all Canadians will have to contribute an additional 1% of their pay matched by the employer. 

Now What: 

The new deal was signed by 8 Provinces thus meeting the criteria for CPP reforms. In addition, before you start cheering , very few Canadians will qualify for the maximum amount. In addition, all Canadians will see their pay checks reduced by the amount needed to fund the increased benefits. Furthermore, current retirees will not benefit from these new amounts and pre-retirees based on current age and income will benefit proportionately to the amount of extra premiums they paid including those of the employee. 

As more details emerge I will inform you. Many thanks. 

Written by Robert Roby, CFDS, CPCA 
Senior Wealth Advisor