Final steps in a decade of CPP enhancements
We’re entering the final year of Phase Two of the Canada Pension Plan (CPP) enhancements announced in 2016. Over the long term, these enhancements are designed to increase the CPP income replacement level from one-quarter to one-third of eligible earnings.
Phase One ended its five-year run in 2023
Phase One, which began in 2019, increased employer and employee contribution rates by 1% over five years. The 2023 increase of 0.25% brought the cumulative increase to that target full percentage point from the 4.95% starting level in 2018 to 5.95% for 2023 and following years. For the self-employed, who bear both parts of the premium obligation, it’s been double the ascent from 9.9% to 11.9%.
The rate is applied to the year’s maximum pensionable earnings (YMPE), which is $68,500 for 2024. At that rate, the maximum contribution is $3,867.50 each for employer and employee. Self-employed individuals pay both parts, totaling to $7,735.00.
Personal budgeting from 2023 onward
Over the five-year phase-in period, that cumulative 1% addition to the prevailing 4.95% rate worked out to an increase of just over 20%. While each annual addition over the five years may not have been all that noticeable to workers, in total it eroded as much as $631 on a person’s annual paycheque in 2023 from what it would have been without the changes. For those self-employed it’s as much as double that, or $1,262.
Keep in mind that, though some people may call it a ‘payroll tax’, it truly is a premium payment that contributes to that person’s own CPP retirement pension down the road. As well, on a current basis employees get some relief when they claim a tax credit for CPP premiums paid when filing their annual income tax return, and for the self-employed the employer-side premium is deductible against business income.
Still, this bit of imposed belt-tightening does reduce current annual cash flow, which could present a budgeting challenge for those living close to the financial edge. Things may have gotten even tighter yet coming into 2024 as Phase Two of the changes began to apply to those with income over the YMPE, which is where we turn next.
Phase Two runs for 2024 and 2025
Phase Two adds a second earnings limit beyond the YMPE, to be called the year’s additional maximum pensionable earnings (YAMPE). The YAMPE begins as 107% of the YMPE in 2024, then moves to 114% of YMPE in 2025 and later years. After that, the YMPE and YAMPE thresholds will be separately indexed, but using the same standard indexation factor, so the YAMPE will remain at 114% of YMPE ongoing.
Employer and employee contributions up to the YMPE will continue at the 5.95% rate, while the rate between the YMPE and YAMPE will be 4% each. All contributions are deductible for employers.
Employees will continue to claim a tax credit on contributions up to the YMPE, with contributions between the YMPE and YAMPE entitle them to a deduction. A deduction better aligns to the employee’s cost since it’s effectively at the individual’s marginal tax rate, rather than the lowest bracket rate accorded to the credit.
The YAMPE for 2024 is $73,200, being 107% of the 2024 YMPE of $68,500. The difference between the two is thus $4,700, which means that the maximum additional premium for each of employer and employee in 2024 comes out to $188 once the 4% rate is applied. Alternatively, if the employee’s income is less than the YAMPE, the additional premium is based on income minus YMPE, so for example at $69,000 in 2024 it would be 4% of $500 = $20.
Will the pandemic prompt more CPP changes?
The CPP is funded by employer and employee contributions. Excess cash flow is invested by the CPP Investment Board in financial markets to fund anticipated future cash shortfalls as the ratio of beneficiaries to contributors rises due in large part to the ageing of the Canadian population.
In its fiscal sustainability report in 2020 – in the midst of the Covid-19 pandemic – the parliamentary budget officer (PBO) raised the spectre that additional funding may be required for the CPP. At the time, the PBO estimated that increased contributions or reduced benefits amounting to 0.1% of GDP may be required for the CPP to meet its 75-year sustainability metric. In subsequent fiscal updates in 2021 and 2022, the PBO was no longer seeing a fiscal gap in the 75-year measure.
Still, the pandemic brought to light how the economy can be disrupted by unpredictable (or at least unpredicted) events. As the economic settles into a more normalized condition post-pandemic, economists and policymakers will eventually revisit the CPP (it’s actually required to be reviewed triennially), so we may yet see further CPP adjustments beyond the current enhancement process.