Go DIY on your own CPP

Turn your savings into a reliable stream of cash

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From the November 2015 issue of the magazine.

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You’ve no doubt heard lots of talk these days about government pensions. More than a few plans have been floated for expanding the Canada Pension Plan (CPP) or introducing entirely new programs with names like PRPPs, VRSPs and ORPP.

Some of these schemes will never be more than figments, and even those that become concrete reality will take some time to be implemented. Instead, if you don’t want to wait for government initiatives to bear fruit, you can always consider creating something equivalent on your own. Of course, nothing compares to the CPP when it come to ease of providing a rock-solid set pension payout without conscious effort. But if you use the CPP as a benchmark and break down its key features point-by-point, you can create something somewhat similar in your own unofficial personal pension plan. You won’t be able to replicate all CPP’s advantages fully, but you do have a lot more flexibility to meet your individual needs and also avoid CPP’s little known dark side. We’ll take you through the process step-by-step.

CPP takes automatic contributions from you and your employer, invests it professionally at low cost, then at retirement provides you a defined benefit for life based on your contributions. Your benefits will never be impacted by disappointing investment returns. The only decision you need to make is when to start collecting it, between age 60 and 70.

Your personal pension will never match the certainty of the CPP. But with a little effort you can still accumulate savings steadily, find high quality professional investment management at low cost, and at retirement create a stream of reliable cash. This puts more responsibility on your shoulders, but gives you more flexibility to meet your particular needs, and gets you better tax breaks. And you capture the full fruits of your contributions and investment gains without worrying whether your contributions will be used in part to fund somebody else’s benefits.

Beware CPP’s dark side

With your personal pension, you’re guaranteed to get the full fruit of your contributions based on the decisions you make. In contrast, CPP benefits are based on your contributions, but include a complicated formula that gives preferential treatment to some participants. For example, CPP contributors who take a few years off plus a few additional years for child-rearing get a much better deal than someone who works and contributes steadily from age 18 to age 65. While you can argue that’s good for society, the steady-eddy contributor probably feels differently.

Remember that CPP promises are pretty much guaranteed, but the same cannot be said for contribution levels. So if CPP finances prove to be inadequate, expect future contributions to rise. In fact, early CPP participants contributed too little to sustain the program, so combined employer and employee contributions had to be increased to the current level of just under 10% to compensate for past underfunding as well as to pay for current contributors. “We’re paying 10% for something that’s worth only 6% and that’s because we’re paying for the pensions of our parents and grandparents,” explains Fred Vettese, chief actuary at pension and benefits consultants Morneau Shepell.

Kicking in money

It all starts with putting money away. With CPP, you and your employer both contribute automatically. You each kick in 4.95% of your gross paycheque up to $53,600 annually (with minor adjustments), which roughly corresponds to the average Canadian salary. The formula for determining your retirement benefit is complicated but based generally on your contributions. You can earn a maximum regular retirement benefit of $12,780 a year if you retire at 65 and worked at an average salary or better for at least 39 years since turning 18 (or fewer years if you weren’t working because of child-rearing or disability). Most Canadians don’t earn the maximum because they started their benefits early, earned lower salaries or took more years off. You can also earn a “post-retirement benefit” for working and contributing after you draw your regular CPP benefit and a “survivor benefit” as the surviving spouse of a CPP beneficiary who dies.

In contrast, building up savings in your own pension is more complicated and requires some self-discipline. But if you like the way CPP takes deductions from your paycheque automatically, you can achieve the equivalent result by setting up an automatic transfer at your bank to whisk a set amount from chequing to savings on the same day your pay is deposited.

When it comes to the rate of saving, you can always mirror CPP and save a steady percentage through your career. But if you have a different priority early on—such as paying down student debt or saving for your first home—you can sensibly defer saving for retirement until later, provided you then save at a higher rate. In structuring your personal pension, take advantage of the potent tax-reducing combination of RRSPs and Tax-Free Savings Accounts (TFSAs), which provide superior tax savings compared to what CPP contributions give you. If you’re in the classic case where RRSPs work best—you earn a fairly high income now but expect to be in a lower tax bracket in retirement—RRSPs beat the tax benefits from your CPP contributions hands down. That’s because RRSPs give you a full tax deduction upfront at your marginal tax rate (e.g. you get a 43% rebate on a $1,000 contribution if you have annual taxable income of $95,000, using Ontario as an example), whereas CPP only gives you a tax credit at the lowest tax bracket (20% in Ontario).

In other situations, TFSAs work best for reducing tax and are superior to CPP. TFSAs don’t provide a tax break upfront, but unlike CPP benefits and RRSP withdrawals, don’t impact taxes or seniors benefits when you take the money out. That’s an advantage if you expect in your senior years to have either high income (TFSA withdrawals aren’t subject to Old Age Security clawbacks on taxable income over $72,809) or low income (TFSA withdrawals avoid Guaranteed Income Supplement clawbacks costing about 50 cents/dollar of taxable income from CPP benefits).

Find good investments with low fees

One reassuring aspect of CPP is the money has been invested wisely at low cost by the Canada Pension Plan Investment Board. The CPPIB’s impressive annualized average return of 7.6% over 10 years has exceeded most (but not all) of the identified alternatives by a modest differential—but as the financial industry disclaimer says, past performance doesn’t guarantee future results.DIY CPP chart

The average person investing in mutual funds can’t expect to match the performance of the CPPIB, in part because they usually pay much higher investment fees. However, if you choose carefully in picking proven long-term investments with relatively low fees, you can still expect to do well on your own. While we don’t have space here to fully discuss your options, I’ve listed (see table) what I consider to be three good categories of choices for your personal pension. They include: low-cost balanced mutual funds from top-notch fund providers with proven long-term track records, passive investing using ETFs, and an unusual savings option little known outside its home province called the Saskatchewan Pension Plan. (Despite its name, the SSP accepts direct contributions Canada-wide and works much like a large-scale, low-cost balanced mutual fund.) I have shown 10-year average annualized returns and have deliberately kept the choices simple. (In real life, you should consider a broad range of qualitative and quantitative factors and will probably want to construct a more sophisticated portfolio.)

Taking the money out

You no doubt appreciate the ease and reliability that you get from tapping your CPP benefit, which is fully indexed for inflation and continues as long as you live.

If you want something that comes as close to mimicking the steady benefit for life provided by the CPP, you can always buy annuities. But here’s a conundrum: people love to receive a set benefit for life in the form of a government or employer defined benefit pension, but they seldom want to part with their own cold, hard cash to buy an annuity on their own. To be fair, a personal annuity lacks the seamless inflation-indexed efficiency of a CPP benefit. Unlike your CPP benefit, your annuity payout is hurt by low interest rates at the time you purchase one, so annuities don’t seem like much of a bargain these days. And it isn’t cost-effective to buy a personal annuity indexed to inflation. Still, they can be worth it if you fear outliving your nest egg. Many experts say the sweet spot where purchasing annuities makes the most sense is to gradually use some of your money to buy them when you’re in your early- to mid-70s.

But many people would prefer to keep their nest egg intact and try to create reliable cash flow from conventional investments in stocks and fixed income. But here you have a dilemma because you have to be prepared to absorb the possibility of a big market decline or adverse changes in interest rates, which can be especially devastating if it happens in the first few years of retirement. As a result, there are two key things that you can do to protect yourself. First, you need to keep withdrawals from your nest egg at a sustainable level. The most widely accepted rule of thumb is that if you retire at 65, you can afford to withdraw 4% of your initial nest egg each year plus inflation adjustments and run only a small risk of running out of money.

Second, you can construct your portfolio in the early years of retirement so that it generates reliable cash flow without the need to sell investments at potentially beaten-down prices for at least five to 10 years. You can generate this reliable cash flow through a combination of: interest on deposit-insured GICs and investment-grade bonds; reliable stock dividends; a sizeable cash and short-term fixed-income position; a bond or GIC ladder; and, purchasing annuities.

Plans for more plans

Which initiatives are most likely to achieve a strong positive result any time soon? Many experts think Quebec’s Voluntary Retirement Savings Plans (VRSPs) strikes the best balance between compulsory plan strength and free choice. “I think Quebec has it right,” says Fred Vettese, chief actuary at Morneau Shepell, a pension and benefits firm. First phase of the plan’s rollout is set to be completed by year-end 2016. The VRSP has compulsory enrolment with a default contribution by employees who don’t benefit from other workplace savings plans. Employees can change their contribution rate or opt out entirely, while employer contributions are entirely voluntary. The multi-employer nature of the plans should help keep costs relatively low. So far nine private financial firms are registered to each and provide a small menu of investment options, with most funds charging 1.2% to 1.5% for balanced funds or equity funds. (Vettese’s company is one of those providers.)

Slower to get off the ground are Pooled Registered Pension Plans (PRPPs), which are similar to VRSPs except they’re entirely voluntary. Various versions are at various stages of implementation in B.C., Alberta, Saskatchewan, Ontario, Nova Scotia, and by the federal government (for parts of the labour force under federal jurisdiction). Vettese believes they’ll eventually catch on, because they’re easier to administer and cheaper than conventional retirement savings plans for small- and medium-sized businesses. In the current federal election campaign, each major party advocates different forms of an expanded CPP. Liberal and NDP versions are compulsory, whereas the Conservative’s is voluntary. But changes won’t come easy regardless of the election outcome because changes require federal-provincial agreement. Another major initiative is the Ontario Registered Pension Plan (ORPP), a compulsory defined benefit plan requiring equal 1.9% employee and employer contributions (up to income of $90,000) for workplaces without employer pensions. The first phase is scheduled for rollout by year-end 2016, but the Ontario government says it will nix those plans if the CPP is expanded.


7 comments on “Go DIY on your own CPP

  1. I have taken CPP at age 60. Because I am still working, I contribute to the plan to enhance my income. Last year I calculated my gain in monthly income related to my extra contributions. My contributions paid me close to 10%. This is a good rate of return, however the contributions are not and at death the balance is lost. Is this a good investment or should I put an equivalent amount into an ETF or other investment vehicle.


  2. Does the 4% withdrawal rate include any dividend or interest payments?.


  3. The CPP & ORPP and building your own pensions sounds good for employees who only have to pay for half and for those people who don’t look deeper. Self employed have to pay 9.8% CPP and 3.8% ORPP premiums or a total of 13.6% for underfunded government pensions that we have no control over. This is on top of income taxes. If you look at pension premiums as a form of tax, then marginal tax rates are about 33% for self employed income over $13,000 up to about $41,000.
    Sure, go save to start a business, save for your own pension plan when the government takes so much. The CPP is not a good deal for us. It is a good deal for the people who started in CPP. The original premium at inception was only 1.8% of employees salary! Sounds like the ORPP! It has a $829 billion unfunded liability. Wynn wants to build up a debt like this!

    We are a country of small businesses. The governments are killing us and our country’s future with payments for their past mistakes and plans for more mistakes!

    The CPP is 20% only funded and liabilities are being paid for with current premiums. Earning 7.6% sounds good, but not so good when you’re only 20% funded. There is an argument that the fund is returning 1.52% and not the 7.6% because it is only 20% funded. Therefore i would be surprised if the assets are keeping up! The rates will probably have to go up when the baby boomers retire. Wynn says she wants something like CPP and plans to “invest” the money on “infrastructure”! Another government building or bridge needing maintenance will not generate income.
    I would prefer if governments would let us decide what is best for us and not think that they know better.


    • Mark, your assessment of the current CPP and proposed ORPP is bang on. Well said!

      As a self-employed business person, I resent the fact that the Federal government makes us pay double the CPP premiums. There is so much more we can do with this money. I am ok with a Federal pension plan as it does form part of one of the best social programs in one of the best countries in the world. I am, however disgusted at Wynn’s ORPP idea disguised to help those who can’t help themselves. It is just another tax grab to make up for lost revenue foolishly spent under the former Liberal empire. This Liberal government (old and new) should have been held accountable for the waste of our taxpayers dollars in excess of $1.8 billion but instead they dream up new revenue ideas and mask them as pension plans. Why were they not held accountable for these past financial disasters? Our government is to fat and ignorant of how business should be run. Now we hear this week that the Liberal government paid into the Teachers Union to the tune of several million dollars … this is certainly a political payout for votes. How corrupt can they get before the public finally wakes up to this injustice.

      Our Provincial government needs to stay out of the “pension” business because this ORPP program will serve to cripple small business in Ontario and make it less affordable for larger companies to do business here. Case in point is the exodus of a number of industries. Furthermore, this plan takes $$$ away from the average taxpayer so they have less disposable income so less money will be used to stimulate the economy. How short sighted is that????? This government is self serving and ignorant of it takes to truly govern.


  4. I an not a great believer of these enhanced CPP plans because the payout more or less finishes on death except for a portion that could go to a survivor spouse & we have other avenues to save for retirement A wiser move in my opinion pay off morgage & debts & any extra money put in your RRSP or TFSP The TFSP is especially good since you can take out money for emergencies You can arrange payments or start with as little as $10 a month & increase it as money becomes available I started a separate TFSA balanced fund at $25 per month when it first came out & is now worth over $4000 to pay for my burial with the cemetery already paid leaving my final assets of my estate to my heirs Retired very comfortly debit free with the CPP / OAS & private RIFF / TFSP & never made huge money but put a few $ away each month It just take a bit of discipline Terron


  5. CPP is not a good investment. My wife and I are early 50’s and just applied to receive a statement from the Feds re; CPP. We are both at the max already to receive as per present guidelines. What that means is that ANY more payments I put in now will not increase my bottom line at all (until we reach 65 and defer collecting until 70, which for us will not happen) from this point forward. I also investigated the death/survivor-ship clause and it clearly states that my spouse will receive some of my component ” up to the maximum allowable amount per individual” which for us means she gets nothing as she as worked all those years as well and is at max already. I view CPP as more of a tax then a benefit.


  6. Can you tell me what happen if I turn 65 and continue to work and and contribute to CPP? Is it better to collect CPP at 65, but continue contribute while I am still working?


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