You, Me and the CPP – Part 1
For many of us, our Canada Pension Plan will play a meaningful role in our retirement planning. All the same, many Canadians don’t fully understand how it works and the choices we have when we look to start retirement benefits. In this article, I will first provide a brief summary of the CPP and some of the changes that have been enacted over the last 15 years to protect its ability to pay out the promised benefits going forward. In later articles, I will briefly discuss some of the non-retirement benefits you can receive, then describe your retirement benefit choices and some of the things you might want to consider when it is time to decide when to start your CPP retirement benefits.
The CPP – An Overview
The CPP has been around since the 1960’s and is designed to provide a series of benefits to Canadians that have paid into the plan during their working lives. Unlike the OAS pension, which is based solely on years of residency in Canada, your CPP pension is based on how much you have contributed to the plan. In other words, if you haven’t paid anything in, you won’t be getting anything out.
When the plan was first created, life expectancies were much lower, which meant that the plan didn’t need to set aside as much money per person as is the case today. Moreover, we are in the middle of a demographic shift that will result in a higher percentage of Canadians taking their retirement pensions compared to Canadians paying into the plan than was originally anticipated. In other words, there are not as many working Canadians per retiree than when the plan was first set up.
Fortunately, these types of changes do not occur overnight and the people running the plan have taken significant steps to increase the chances of the plan having the financial resources to pay the promised benefits in light of the current reality. The first significant change occurred around the dawn of the new millennium, when both workers and employers were forced to significantly increase their contributions into the plan to build up a cash reserve for the future.
Secondly, from that point onward, the formula for calculating combined survivor and retirement benefits post age 65 was altered. As a result, the combined benefit was capped so that the survivor’s combined retirement and survivor benefits couldn’t exceed the maximum retirement pension. The result: someone already receiving the maximum retirement pension will not receive any survivor benefits (other than the taxable death benefit of up to $2,500) on his spouse’s death, no matter how much the deceased had paid into the plan (although the survivor would at least get a survivor’s pension until age 65 if he was widowed before then and the combined pension is calculated by a different formula.) In contrast, non-working spouses are entitled to 60% of their spouse’s pension. Although I suspect there is a reason for this difference in treatment, I doubt that I find it convincing.
Thirdly, and perhaps most importantly, the CPP began to be run like a real pension, hiring professional investment managers and investing the contributions strategically. Before that point, the federal government had simply loaned out the money we had paid in to the provinces at piddling interest rates. At this point, other countries look upon the CPP as an example to follow when setting up or making changes to their pension plans.
A few years ago, the plan made another series of changes that are in the middle of slowing being phased in over time. Although it was always possible to start collecting retirement benefits as early as age 60, it was previously necessary for some people to arrange to reduce their earnings in the month before and the month in which their payments commenced in order to qualify for their pension before age 65. At this point, your income no longer matters if you want to start your pension before age 65. On the other hand, there are some other factors that may discourage you from starting your pension early, even though it is easier to do so than ever before.
To begin, the penalty (although the government prefers the term, “actuarial adjustment”) for starting your pension early is slowly increasing from .5% to .6% per month times the total months you receive your retirement pension before turning 65. In other words, if you start your pension at age 60, your pension will be 64% of what you would have received if you’d waited until age 65. A few years ago, you would have received 70% of your unadjusted amount if you started at 60. We’ll talk a bit more about the pros and cons of starting your pension early in a later article
The second change is the requirement that workers must now continue to pay into the plan until age 65 even already on pension. On the other hand, these additional contributions will be used in part to fund a new top up plan called the, “Post-retirement Pension” or “PRP.” Each ensuing January, workers already on pension will receive a small additional pension that is based on their contributions the year before that is indexed like the regular CPP. Put another way, although the government now requires all working Canadians to continuing paying into the CPP until 65 even if already on pension, at least they will get a small reward for doing so.
The third major change is actually a good news story for workers would wish to defer their CPP pensions. Although workers always had the choice to defer their start date until as late as age 70, the reward for doing so has now increased. Previously, workers would get .5% more per month compared to their age 65 amount for each month they delayed past their 65th birthday. Now, this has increased to .7% per month. Put another way, instead of getting 130% of what you would have received at 65 if you delay as long as possible, you will now qualify for 142% of your age 65 benefit. Of course, whether this is a good decision or not depends on how long you expect to live, your financial circumstances and your tax bracket. You also have the choice of continuing to pay into your pension past age 65 now as well, whether you have started your CPP pension or not.
Finally, there are a few more changes that have occurred over the last 15 years that I will not go into now that might affect some tax payers. Some of those modifications include:
- Workers now get to exclude more years from their work history when determining their benefits. As the pension depends on average earnings, each low or no income year that can be excluded will boost the ultimate payout.
- Retired couples (including common law and same sex couples) can now pool the portions of their pensions that they earned when they were together. Although the ultimate payout won’t change, this change may mean that the couple gets to keep more if splitting their pension puts more income in the hands of the spouse in a lower tax bracket. Unlike the pension income splitting rules for work pensions and RRIFs, however, the CPP pension split can only be done on a 50-50 basis; the rules for the other pensions allow the couple to determine each year how much (up to 50% of the pension) they wish to split at tax time.
- Under the “Childrearing Dropout Provision,” workers applying for their retirement pensions can also apply to exclude any years they were the primary caregivers their children under age 7 from their pension calculations. In many cases, excluding these low or now income years results in a larger pension, since these low income years would otherwise reduce the worker’s average income come;
Although this article may not answer all your questions about the CPP and what to consider when deciding when to start your retirement benefits, hopefully it is a good first step down that road. My next article will continue that journey and the third installment will hopefully fill in the remaining pieces!