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.

The case for taking Canada Pension Plan at age 70

While playing charades over the holidays, my youngest son stumbled with “a bird in the hand is worth two in the bush.” Eventually we guessed it, and then explained to him that it means accepting a sure thing now rather than holding out for something potentially bigger later.

Coincidentally, that adage also featured prominently in an item on my holiday reading list — a research paper about delaying Canada Pension Plan (CPP) retirement benefits, released by the National Institute on Ageing and the FP Canada Foundation.

My long-held opinion has been to take CPP no earlier than age 65, unless there are compelling personal characteristics or surrounding circumstances that support starting at a younger age. After reading this paper, I’m now leaning toward 70 as the default position.

When we’re starting CPP, and why

The majority of Canadians — seven out of 10 — take their CPP retirement pension at either age 60 or 65. Less than 5% take it after age 65, and only 1% wait until age 70. The research paper’s author, Bonnie-Jeanne MacDonald, attributes this pattern of early uptake to a combination of lack of advice, bad advice, and “bad-good” advice.

The bad advice includes the emotional pull of the bird-in-the-hand: If you die early (so the argument goes), you’ll leave money on the table, so you should take CPP as soon as you can. However, the only guarantee here is that your payments will start sooner, not that you will receive more. And ironically, the early uptake may in fact increase the likelihood that you will receive less, as we will see further down.

The “bad-good” advice is the mainstream practice of using a breakeven age. It compares two starting ages, for example 60 and 65, focusing attention on whether you will reach the age when the cumulative payment receipts are the same. This speaks to our behavioural tendency to favour the near-term (from first age to second age to breakeven age), thereby undervaluing the lifetime income security that CPP offers. On top of that, academic research shows we tend to underestimate our life expectancy, making it even more likely to choose the earlier start.

According to Canada’s chief actuary, life expectancy at age 60 is 85.9 for men and 88.5 for women. In my own experience, I’ve never seen a suggested breakeven/crossover age much over 80. This has long been my discomfort with this approach, as you are betting on being in the “dies-before” half of the cohort population. You lose (statistically) simply by being average, and it gets worse the longer you live.

Measuring the dollar difference

Early uptake would not be a concern if it leads to a better financial outcome. To test this, MacDonald departs from the breakeven approach, favouring a calculation of the current dollar value of the expected loss, or “lifetime loss.”

The model incorporates the annual drawdown of RRSP/RRIF savings equal to the foregone CPP pension each year, until the pension actually begins. Though taking CPP earlier may allow RRSP/RRIF savings to last longer, the model shows that most people will maximize lifetime income from the two combined sources by deferring CPP to age 70.

Notably, among the scenarios canvassed in the paper, for someone entitled to the maximum CPP pension who lives close to age 100 (a 25% probability from age 60 according to the dataset used), the current dollar loss can exceed a quarter of a million dollars.

Sorting through contributing factors and fielding options

To be clear, lifetime loss is not intended to be applied without consideration of individual circumstances. There are many situations where it would make sense to begin early, such as when there is a known life-limiting health condition, or when someone is trying to preserve income-tested benefits or shield against the Old Age Security clawback.

For most people, it’s a challenge just to identify all the contributing factors in making such a decision, let alone evaluate the trade-offs among them. It’s both technically complicated and emotionally charged, which together can be overwhelming.

In addition to being a dependable information source, financial advisors can offer guidance on how to apply some of the lessons of behavioural finance:

• • Loss aversion holds that we feel the pain of loss twice as much as the joy of gain, which is what lifetime loss illustrates in concrete terms.
  • It also frames the discussion on the more-likely scenario of longevity, as opposed to early death.
  • Lastly, by anchoring the thinking on age 70 as the default option, the ultimate decision is more likely to end up near that age, to one’s own benefit.

Ultimately, the decision should be informed by individual particulars and reliable evidence as part of the conversations between advisors and clients.