Category: Invesco Fundamentals

Recent CPP changes: Your clients will be seeking your guidance in the coming years

The Canada Pension Plan (CPP) comes up for formal review on a triennial basis, with the 2009 recommendations having made their way into law with Royal Assent granted to Bill C-51 on December 15, 2009.  

It appears that structurally the new rules encourage the coming generation of retirees to think twice before triggering their pensions at early ages, which will likely influence the course of advisor conversations with clients and, potentially, the recommendations made.

The changes

Work cessation test – Until now, a person under age 65 had to “retire” (cease work or at least reduce income) before commencing with CPP payouts, but could then return to work after two months. The work cessation test will be eliminated in 2012. 

Working beneficiaries participating in the CPP – In the past, once a pension had begun, there would be no further CPP premiums paid. Beginning in 2011, premiums will be mandatory for those under age 65 and voluntary from age 65 to 70. Ongoing retirement benefits will increase based on those premiums paid.  

General low earnings dropout – In the calculation of pension entitlement, the dropout of low- or nil-earnings years will increase from seven years to eight years by 2014, leading to improved pensions for many people. 

Adjustments for early and late CPP take-up – The current adjustments reduce a pension by 0.5% per month that the pension begins before the age of 65, or increase it by 0.5% for each month after the month of a person’s 65th birthday. The early pension reduction will gradually increase to 0.6% by 2016, and the late pension augmentation will gradually increase to 0.7% by 2013.

Impact on pensioners and the system

As indicated above, the changes will be phased in over the next six years and generally will not affect existing CPP beneficiaries or those who take their benefits before the changes come into effect.  

As stated in an information paper issued by the federal Department of Finance, the package is “expected to improve the long-term financial sustainability of the CPP.” With respect to the early and late take-up adjustments, it notes that these “have been left unchanged since 1987 despite significant shifts in the economic and demographic factors that affect their ‘actuarially fair’ levels.”

Practical value to advisors

The changes – particularly these take-up adjustments – present financial advisors with an opportunity to provide insight and guidance to clients in determining how best to manage their CPPs.

And given the ease of opting in presented by the elimination of the work cessation test, advisors may be having many more of these discussions over the next few years.

Taxing Canadian dividends The continuing evolution

With the turn of the calendar to 2010, we also turned the page to the next chapter in the ongoing evolution of Canadian dividend taxation.

The year 2009 was the low-water mark for eligible dividend taxation, with all provinces and territories set to see increased effective rates as we move toward 2012.   

Integration model recap

The tax integration model is a mechanism used to eliminate potential double taxation on income earned in a corporation, followed by a dividend distribution to a shareholder. 

The dividend gross-up emulates the pre-tax value of the income to the corporation

The shareholder calculates tax owing based on the grossed-up dividend

The dividend tax credit is applied to reduce this preliminary tax liability by the estimated tax already paid by the corporation  

Since 2006, Canadian dividends have been distinguished as “ineligible,” generated out of income where the small business corporate rate has been applied, and “eligible.” Though eligible dividends can also be generated out of small business corporations, most taxpayers would receive them via portfolio investments.

Adjustments for 2010

Beginning in 2010, both the federal gross-up and tax credit rates applying to eligible dividends will be adjusted downward:

Year             2009    2010    2011    2012

Gross-up       45%    44%     41%     38%

Tax credit*   19%    18%   16.5%    15%

* These percentages are approximate; Actual calculations use fractions 

The federal gross-up also applies in calculating provincial/territorial gross tax due, though somewhat indirectly in Quebec. Each province and territory independently sets its own dividend tax credit to use in determining provincial/territorial tax liability.

The net effect of the federal adjustments and provincial/territorial coordination is that the effective rate on dividends will increase in 2010, except in New Brunswick where the government is collapsing the number of brackets and reducing rates as part of an overhaul of the system leading up to 2012.

Considerations for taxpayers below the top bracket

It is important to understand that the integration model is based on the shareholder being at top marginal tax rate, and that at lower income levels the effective rate on dividends is also lower. For example, at the $60,000 income level the average federal-provincial combined rate is at or near 30%, whereas the effective rate on eligible dividends is at or below the single-digit threshold.  

While potential clawbacks have to be factored in, particularly for senior-aged investors, clearly dividend-producing investments continue to warrant consideration and inclusion in a tax-informed investment portfolio, even with these recent changes.