The Canadian federal, provincial, and territorial finance ministers have recently announced some noteworthy changes to the Canada Pension Plan (CPP). In short, we are all going to have to pay more into the plan; however, we should all get more out of it when we retire.
First and foremost, it’s important to understand that the CPP prescribes a notional, yet specific, level of income on which it bases all of its calculations. This prescribed amount is called the Maximum Annual Pensionable Earnings (MAPE). The MAPE is prescribed on an annual basis, and tends to grow with inflation. In 2016, it is equal $54,900. As I mentioned above, this amount is strictly notional. In other words, the amount of CPP one can collect will never equal the MAPE because the figure is simply used for calculation purposes.
The MAPE has now been set to rise significantly in the coming years, and is projected to reach $82,700 by the year 2025, when the enhanced CPP changes will be completely phased in. As discussed above, both contributions to CPP, as well as anticipated payouts are based on this number, so these changes will impact everyone participating in the plan in the coming decade.
How much do we pay into CPP?
The amount we contribute to CPP on an annual basis is based on our income as well as the MAPE. We pay nothing on our first $3,500 of income, but on any income we earn over and above that, we pay 4.95%, up to a maximum. The maximum payable is capped when an individual’s income exceeds the year’s MAPE. In other words, once a person’s income exceeds $54,900, they pay no further CPP premiums – their contributions are capped for the year.
Our employers are required to ‘match’ the contributions that we make to the CPP, which is important to note. Every extra dollar that we contribute is one less dollar in our employer’s pockets, which could mean any number of things (perhaps a dollar less of salary that they can afford to pay). As mentioned above, the MAPE is set to increase, so we can all expect a commensurate increase in our CPP contributions; however, I should also point out that the contribution rate (the 4.95% noted above) could also change. This rate hasn’t changed since 2003; however, it increased six times in six years prior to 2003.¹
How much can we expect to collect?
The objective of the announced enhancements to the CPP is to ensure Canadians receive more. The CPP was never designed to serve as a full retirement pension; rather, it aims to serve as a minimum basic pension for working Canadians who don’t have a full salary-replacement pension with their employer(s). The government has taken note that both living costs, as well as the number of Canadians who do not have a formal pension plan in place through their employment, are on the rise. As such, there is good news inherent in these changes. The current CPP payout amounts aim to equal approximately 25% of the MAPE. As you might expect, the maximum payable amount (for an individual who retires at age 65) is just over $13,000 (roughly 25% of $54,900). The enhancements to CPP aim to increase this target payout from 25% of the MAPE to 33%. Accordingly, if we look ahead to the year 2025, when the MAPE is expected to be $82,700, we can expect (and perhaps be cautiously optimistic) that the maximum CPP payout will be approximately $27,300 ($82,700 x 33%).
These changes have come with some notable controversy. The province of Ontario spent millions preparing to introduce a provincial pension plan, which was set to be launched if the CPP enhancements weren’t enacted. Once the enhancements were announced, the Ontario pension plan was promptly abandoned. Some view the investment as money well spent; others as wasted.
Moreover, I’ve never understood why Canadians only receive a mere non-refundable tax credit for our CPP contributions (which is granted at the lowest marginal tax rate in the country). Don’t get me wrong – a tax credit is better than nothing; however, CPP payments are taxable income, and as such, our CPP will ultimately be taxed at our individual marginal tax rate. For those of us who work hard, plan ahead, and secure a reasonable level of income in retirement, our marginal tax rate will likely be higher than the rate at which we received our credit. The net effect has never seemed fair to me. There is talk that the government is going to (at least partially) correct this, and allow a full tax deduction for contributions to the CPP – at least the new, enhanced portion. Only time will tell.
Personable and professional, Brent Soucie specializes in cross-border tax and financial planning for U.S. citizens and/or Green Card holders residing in Canada, as well as Canadian residents with U.S. employment and/or property. His clients include professional athletes, entrepreneurs, and corporate executives.
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