Tag: CPP

A sea change for the CPP

More benefits and premiums on the horizon

It may seem to some people that the Canada Pension Plan (CPP) is constantly changing, as it has regularly been in the headlines since the 2008–09 economic downturn. The truth is the CPP goes through incremental indexing every year, while wholesale revisions are uncommon.

But with the recent change in political leadership in a number of provinces and at the federal level, the most significant changes to the CPP since the 1990s have gone from talk to action.

On June 20, 2016, Ottawa and the provinces reached agreement in principle to enhance the CPP. First reading of Bill C-26, which contains the proposed CPP enhancements, was on October 26. At the time of writing, the bill continues to work its way through Parliament, having passed second reading on November 17 and been reported back without amendment from the Finance Committee on November 24.

Here’s what to expect as we transition into this new normal. 

Why increase the CPP?

Research commissioned and analyzed by the Federal Department of Finance points to a concern about both current and projected future under-saving for retirement.

Based on Statistics Canada’s Survey of Financial Security 2012, it is estimated that 24% of families nearing retirement age are at risk of not having adequate income in retirement to maintain their standards of living.

At the other end of the age spectrum, young workers face longer life expectancy, which in turn requires more conscientious long-term savings. With workplace pensions becoming rarer and those already established shifting away from defined benefits, the pressure on individual savings is accentuated. Add to that the current (and potentially prolonged) low-interest-rate environment, and a perfect storm may lie ahead for many working Canadians seeking the safe harbour of a comfortable retirement. 

The components of change

The CPP is structured as an insurance arrangement where premiums during working years fund pensions in retirement.

The retirement pension is calculated as a replacement percentage of a target income level. Accordingly, there are two large levers that can be used to increase pensions: adjust the replacement percentage or the target income level. These changes will effectively do both:

  • The income replacement level will increase from 1/4 to 1/3 of eligible earnings
  • The upper earnings limit will be increased by 14%

Of course, hikes to employer and employee premiums will be required to pay for those increases.

Timelines, and projecting the dollars and sense of it

The plan is to have all changes in place by 2025, with the seven-year transition to begin in 2019. It will occur in two phases.

For the five-year period from 2019 to 2023, the rate of contributions based on the existing year’s maximum pensionable earnings (YMPE) will be raised each year. Currently, employers and employees each contribute 4.95% of the YMPE. By 2023, that will be 5.95% each, based on the following implementation schedule:

Table: Upcoming CPP premium increases

Year / Cumulative addition

  • 2019  0.15%
  • 2020  0.30%
  • 2021  0.50%
  • 2022  0.75%
  • 2023  1.00%

The second phase of the transition will be the augmentation to the earnings limit. The YMPE will continue as a concept, and a new concept will be introduced to track the upper earnings limit: the year’s additional maximum pensionable earnings (YAMPE). The YAMPE will begin as 107% of the YMPE in 2024 and move to 114% of it in 2025, after which the two thresholds will be separately indexed, though using the same standard indexation factor.

The Office of the Chief Actuary projects the YMPE (currently $55,300 for 2017) will rise to $72,500 by 2025, putting the YAMPE at $82,700 (in round terms). On the enhanced portion between the YMPE and YAMPE, the premiums are expected to be 4% each for employers and employees.

Some offsetting relief

To recognize the difficulty low-income individuals may have in budgeting for higher premiums, the working income tax benefit (WITB) is being raised. The WITB is a refundable tax credit that is reduced to zero at an income of $18,292 for unattached individuals and $28,209 for couples with children, in current-dollar values. The value of the WITB will be increased to roughly offset the incremental CPP premiums.

At the upper income end, those employees required to pay premiums on the enhanced portion of the CPP (the range between the YMPE and YAMPE) will be entitled to claim a tax deduction for this amount. The prevailing tax-credit structure will continue to apply to existing employee premiums based on the YMPE. As the tax credit is at the lowest-bracket rate, a tax deduction is more valuable as an employee’s income increases. This has the added effect that, should an employee reduce registered retirement savings plan or pension contributions (both being deductible amounts) in response to the increased premium on the CPP enhancements, there would be no increase in that person’s current taxes.

Retirement reform debate heats up – Does the ORPP foreshadow the future?

By most accounts, the Ontario Liberal Party’s majority election victory was unexpected, particularly for the opposition parties that defeated the then-minority government’s budget to force the election. Regardless, the budget has now been reintroduced, and probably will be passed by the legislature pretty much intact.

A centrepiece of the budget is the proposed Ontario Retirement Pension Plan (ORPP). Beyond the implications for Ontarians, this initiative could tip the balance on retirement income security discussions elsewhere in the country. Arguably, that’s what it was intended to do, at least in part.

Somewhat provocatively in the pre-election budget, the proposal was cast against “the federal government’s decision to shut down discussions on an enhancement to the CPP [Canada Pension Plan]” In response, the ORPP is positioned to “build on the key features of the CPP, and could later be integrated with the CPP should negotiations on an enhancement be successful in the future.”

So what does this made-in-Ontario alternative look like?

ORPP design features

In structure, the ORPP appears to parallel the key features of the CPP.

Employers and employees will be required to share the burden of premium payments equally. The premium rate will be 1.9% (3.8% combined) up to a maximum annual earnings threshold of $90,000. (This threshold is expressed in 2014 dollars, to be indexed annually.) Premiums will not be required below a low-income threshold. Subject to further consultation, that may in fact end up mirroring the (non-indexed) CPP annual basic exemption of $3,500.

Total annual contributions are projected to be approximately $3.5 billion. Administration and investment management would be in the hands of a publicly run body operating at arm’s length from the government. At the same time, the budget text intimates some kind of coordination with the private sector, mentioning the desire to “leverage” the expertise of pension fund managers and the strong financial services sector in Ontario.

Like the CPP, ORPP pensions will essentially fall within the defined-benefit category, allowing individuals to plan based on a predicable retirement income stream. The aim is to achieve a 15% replacement rate up to the maximum earnings threshold mentioned above. By comparison, the CPP uses a 25% replacement rate, with the current upper threshold being $52,500 (again indexed annually).

Examples of the combined effect of the CPP and ORPP are provided in the budget, though caution should be exercised as to the applicability in real life. In principle, someone with career earnings over 40 years of $52,500 (2014 dollars) could see a 60% increase over the CPP alone, and someone with a $90,000 annual income over those years could see a doubling over CPP alone.

Importantly, benefits are to be earned as contributions are made. In effect, a person will not be grandfathered into a larger pension (as a burden on younger generations) than what the person’s own premiums have paid for.

Implementation

The government plans to consult with employers and labour in the coming months to gauge and minimize the impact on businesses in Ontario. In addition, coordination with federal counterparts will be necessary to get the ORPP operational.

There is a commitment to release “further technical details later this year prior to introducing legislation.” Without splitting hairs too much, there is no more specific date for when the legislation may be introduced. Still, this should proceed at a reasonable pace, as the planned introduction is 2017, to coincide with expected reductions in Employment Insurance premiums.

Employer implementation is to apply on a staged basis, beginning with the largest employers. No details are given on how large that is, how many size categories there may be or the length of time that will be staggered among them. As well, ORPP enrolment would not be required for “those already participating in a comparable workplace pension plan.” Again, clarification is required on this issue.

Once those details are ironed out, a given employer will still have a two-year phase-in period for contribution rates. Presumably this means that the contribution rate will begin at a lower level that escalates to plateau at 1.9% over two years.

Cross-country dialogue?

The ORPP is explicitly premised on the CPP, both in terms of the rationale for its introduction and the foundation for its operation. Additionally, the budget makes numerous references to the potential for collaborating with the federal government and other provinces and territories.

With the ORPP having been an election issue and a newly elected majority government in place, there is little question as to the path Ontario is taking. The question now is whether it will have company.

Your quinquennial retirement check-in: A five-year tax retrospective

No, “quinquennial” is not part of my everyday vocabulary.  It is however a handy milestone for evaluating retirement planning progress, if not on an immediate personal basis then at least in terms of changes in the tax landscape.  

By its nature, the retirement/tax system evolves incrementally, principally in step with the annual federal budget process.  To those of us involved day-to-day in the financial advisory field, at times such change may seem to flow as slow as molasses in January.  By contrast, the general population might only contemplate these matters periodically – often only when prompted by their advisors – so developments may appear more momentous once brought to their attention.   

However, over the most recent five-year stretch, it could be argued that the sum of these developments is nothing short of astounding, whether planning your own retirement or advising others.  With that in mind, consider how the following items will affect retirement planning conversations today compared to a mere quinquennium ago.  

2008 – Pension income splitting

Technically a little outside the timeframe, pension income splitting was announced in the Halloween 2006 Economic Statement and introduced in the 2007 Budget.  The first opportunity to elect to split up to 50% of such income with a spouse would have been in filing one’s 2007 tax return in/by April 2008.  

In addition to the obvious potential to push income to a lower bracket spouse, the maneuver could help preserve the pensioner’s age credit, fend off OAS clawback and assist in making fuller use of the spouse’s pension credit.

2009 – Tax-free Savings Account

Introduced in the 2008 Budget, Canadian residents over the age of 18 received their first $5,000 annual allotment of TFSA room on January 1, 2009.  

The structure allows for contribution of after-tax funds, with any subsequent growth and withdrawals being tax-free.  In addition, there is a dollar-for-dollar credit on those annual withdrawals that increases contribution room the next January 1st.  Apart from being a welcome gift for those with excess cash to invest, the TFSA offers lower bracket individuals a more viable alternative or complement to the traditional RRSP structure.

The indexing formula boosted the annual dollar limit to $5,500 beginning in 2013.

2010 – Canada Pension Plan

While it is patently obvious that this is not a new program, the 2009 triennial review proposed significant changes to the CPP.  These changes were legislatively approved in 2010.

With the elimination of the work cessation test, it became administratively simpler to commence a retirement pension, and all future pensions will be marginally improved as the low earnings drop-out increases from 7 to 8 years.  However, the decision as to when to commence that pension has become more complicated with new mandatory premium payments for working beneficiaries (voluntary after 65), an increased monthly early take-up penalty from 0.5% to 0.6%, and an increased monthly deferral premium from 0.5% to 0.7%. 

2011 – Registered Disability Savings Plan

The RDSP was actually introduced in the 2008 Budget, but took 2 or 3 years of tweaking before those in the target population could fully avail themselves of the program.

A key benefit is the access to matching Grant and free Bond support money.  The 2010 Budget made provision for carryforward of unused Grant and Bond entitlements.  Perhaps the most important modification occurred in the 2011 Budget with the relaxation of stringent rules that up to then would have forced mass repayment of Grant and Bond money at inopportune times.  

The RDSP is now coordinated in many ways with the beneficiary aspects of RRSPs, RRIFs and RESPs, making for much more flexible planning options for individuals and families with disability planning needs.

2012 – Old Age Security

The 2012 Federal Budget will probably be most remembered for raising the OAS qualification age from 65 to 67.  Those born prior to April 1958 will remain eligible at 65, with those born after January 1962 having to wait all the way to 67.  The rest of us will be somewhere in between, with the phase-in period ranging from April 2023 to January 2029.  

As well, as of July 2013 an eligible individual may defer OAS pension for up to five years, in exchange for a 0.6% increase in the pension amount per month deferred.

2013 – Pooled Registered Pension Plan

As we head into the next quinquennium, the PRPP warrants mention before signing off.  

Discussed since 2010, the program is aimed at encouraging workplace savings where no current pension arrangement is in place.  The federal tax amendments out of the 2012 Budget are now passed, but there is yet to be any concrete action from the provinces.  As the program design dovetails contribution room with RRSPs, ever more opportunities and trade-offs may lie ahead, further feeding those retirement planning conversations.