An Enhanced CPP?
Markus Muhs - Jul 23, 2019
2019 marks the first year of the 7 year implementation of the "Enhanced" Canada Pension Plan. What does this mean for your eventual retirement income? What does it mean to your paycheque?
I originally wrote this post back in 2016, when the then new Trudeau government came to an agreement with the various provincial finance ministers to "enhance" the Canada Pension Plan. Much of the post was based on what was known at that time and since we're now in the first year (2019) of the phase in of the "enhancements" it might be a good time to update it.
The TL;DR version of this post is that the CPP is gradually being enhanced over coming years to effectively require greater contributions (especially if your income is higher than around $60K) over your working life in exchange for a higher retirement pension. Where the original CPP aimed to cover one quarter of your pre-retirement earnings (up to a low maximum), the increased amount aims to cover one third of a higher maximum earnings. I'm going to go over the changes and I'm going to explain why, for those of us who are capable of saving for retirement on our own, this "enhancement" really isn't that great a deal.
Why Enhance the CPP?
Okay, clearly Canadians have a problem saving. Every RRSP season some bank or whatnot comes out with stats of how little we're utilizing our RRSPs and TFSAs, or how many of us are living paycheque to paycheque. For many Canadians their pension plans and group retirement savings through work make up the bulk of their retirement savings, and many other Canadians working part time or for small businesses don't have any employer-sponsored savings plans at all. Further, defined benefit pension plans are practically non-existent today for new employees in the private sector.
The Canada Pension Plan is, for many Canadians, the only defined benefit pension plan (one where future payout is specified, regardless of what the markets do) we'll have access to. Heck, it is for me as well; I left the defined benefit pension plan I had through one of Canada's big-5 banks (they don't even offer it anymore; had to get into it when I did in 2007) when I came over to Canaccord Genuity, thus CPP will be the only defined benefit retirement income I'll get.
So, why did the Trudeau government champion this enhancement? To create a bit of a higher retirement income for the many of us who simply don't save enough or have access to DB pension plans, that's all. I'll get into my criticism of the enhancement, and CPP in general, further down in the post, but first some more facts...
First off, remember that none of these changes have any effect whatsoever on those currently collecting their CPP retirement income and will have barely any effect for those about to start. This was a 2015 election promise to attract the Millennial and younger voters--who will see the biggest difference in their future CPP benefits--not the Boomers. So, if you're over 60 you can stop reading now if you just don't care, or keep reading if you want another reason to shake your fist at Trudeau's messed up policies.
For those contributing to CPP now, and past 2025, the calculation of your future benefit gets a lot trickier. Contribution rates are easy enough to calculate, so I put together the below table from the latest numbers available on Government of Canada websites here and here.
What you see happening above is, starting this year (2019), you and your employer are putting a tiny bit more into CPP; 5.1% each instead of 4.95%. This amount gradually goes up until it hits 5.95% each in 2023. These numbers are multiplied by what's now being termed the "First Earnings Ceiling" (aka: Yearly Maximum Pensionable Earnings; a specific number relevant to all pension plans, that's supposed to represent an "average industrial wage" that goes up with inflation).
Starting in 2024, a new "Second Earnings Ceiling" (or Additional YMPE) comes into play. This number is 7% higher than YMPE in 2024 and then 14% higher from 2025 onward. Employer and Employee contributions are 4% each on the SEC, so 8% total. Through a fancy Excel formula, I incorporated this into the maximum annual contributions for 2024 and 2025. Note: in years that your income is below the FEC, the SEC doesn't apply. The maximum annual contributions in the table above assume income higher than the SEC (higher than around $80K).
What this means is that in 2025 you and your employer will be contributing around $3500 more annually to CPP than in 2018. The end goal is that someone who will have contributed to the enhanced CPP for 40 years from 2025 onward (again, not you or me reading this, at best we get a partial benefit, but rather someone who is probably 18-19 years old today and will contribute the maximum from ages 25 to 65) will have a CPP income equivalent to $20,000 per year at age 65, in today's dollars.
Opponents argue that there is no free lunch; that in order to have a bigger and better CPP it’ll mean higher contributions, more deducted from our paycheques (a "payroll tax"), and a greater strain on job creators. Canadians should learn to live within their means and be responsible for their own retirement savings, through RRSPs and TFSAs, not depend on the government to force them to save. Besides, Old Age Security enhances most Canadians' retirement income (subject to clawback at higher incomes) and Guaranteed Income Supplement (GIS) takes care of those worst off at retirement.
My own argument against expanding CPP is that we get far more bang for the buck just investing the money ourselves. In the previous version of this blog post I included all my calculations backing that up, but to make this a less lengthy read, I'm going to be splitting that up into a new blog post (stay tuned!). Taking the numbers I extrapolated above though, you can do some very basic math on the back of a napkin (forget about inflation and growth rates; if we applied investment growth rates the calculation becomes even more unfavorable) and estimate for the person contributing for 40 years into the new enhanced plan, with an additional $3500 per year (employee+employer) flowing into the plan, that's a total of $140K. Coming out of the plan would be an additional $6000 or so a year. That person has to live past 88 just to get that money back out.
The CPP is also a very crappy defined benefit compared to other DB pension plans. If you're someone fortunate to have a DB pension plan through your workplace, compare your and your employer's contributions to the numbers in the table above. Contributions to your pension plan are likely around double CPP contributions (if your income is around the YMPE limit), but your expected monthly income tends to be quite a bit more than double CPP plus you generally get your full entitlement after less than 40 years of contributions and/or before age 65. The CPP equivalent to the popular "85 factor" used in most defined benefit pension plans is literally a "105 factor", in that your age plus years of contribution equals 105 to get full CPP.
Additionally, most DB pension plans guarantee pensions for X years or joint pensions with spouse (both at reduced payouts, but very useful if you don't live long past retirement and want to ensure your surviving spouse is taken care of). CPP has a terrible death benefit: $2500 lump sum (I'm not even sure what that's for; final expenses tend to be quite a bit more) and 60% of your retirement pension to the surviving spouse up to his or her own CPP limits (so if both spouses are already earning maximum CPP, a survivor gets nothing and essentially the household's CPP income is cut in half).
At the end of the day, Canadians earning more than $80,000 - and their employers - will see their CPP premiums increase by 66% only to see at most a 33% increase in retirement income.
The CPP in its current form does have its place, because if you suddenly took it away and left it up to everyone to fund their own retirement, many people still won’t do it and will be S-O-L when they retire. I'd never advocate for its removal entirely, and these enhancements will mean a lot for those completely unwilling or unable to save.
My suggestion though, since the additional savings from the "enhancement" will supposedly go into a different pot anyway (not the same pool of money that our past regular CPP contributions have gone into), is to make the whole enhancement scheme entirely optional. Those of us who have pensions through work, and/or save diligently into our own RRSPs, should be able to opt out, and put the difference from our paycheques into our own savings plans. Likewise, the incentive of a lower CPP "tax" on employers might motivate more of them to offer pensions or group savings plans to their employees.
Finally, keep in mind that the intention of CPP was never to replace your full pre-retirement income; it intends to replace 25% of your income, up to YMPE, and now these changes aim to replace 33% of a slightly higher (14% higher) amount. Old Age Security makes up for a bit more, but for the remainder of your income in retirement you need to SAVE.
Most importantly, have at least a basic retirement plan in place, which plots your savings, accumulation, and eventual depletion. Contact me now if you'd like to get started on a retirement plan or if you have any other questions or comments.
Markus Muhs, CFP, CIM
Investment Advisor & Portfolio Manager