With tentative agreement between the provinces and federal government to enhance the Canada Pension Plan (CPP), it appears that long-debated changes to the venerable government pension system are on track to become reality. While it is not yet a fully done deal as we went to press, it makes sense to start considering how the CPP changes will impact you.*
Your CPP benefits, together with Old Age Security (OAS), provide much of the foundation for a comfortable retirement, although government pensions have never been enough on their own to pay for a middle class retirement. In recent years, there has been a vocal push for a big CPP expansion. Many conservatives and business groups opposed these changes saying they were unnecessary and costly. The new CPP agreement-in-principle provides a moderate middle ground. “It is pretty remarkable that we have achieved this kind of compromise,” says Fred Vettese, chief actuary at Morneau Shepell, and author of The Essential Retirement Guide.
Of course, these CPP enhancements mainly affect younger Canadians—they won’t have any impact on retirees and little impact on those approaching retirement. That’s because the enhanced benefits need to be paid for by the accumulation of increased contributions. The changes are being phased in over a seven-year period starting in 2019. The current CPP is designed to replace 25% of average earnings up to the current earnings ceiling. The enhanced CPP should eventually replace 33% of average earnings up to a higher ceiling.
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What it means for you: For people who aren’t good at saving and investing on their own, CPP enhancements will help ensure they are better prepared for retirement. But that’s probably not you, since most MoneySense readers are more adept than most at saving and investing on their own. For you, higher CPP contributions may mean less money available to save and invest in RRSPs and TFSAs. So what’s the net impact of getting enhanced CPP benefits but having less money to invest on your own?
Let’s assess the existing CPP program first. Certainly there is lots to like. Your contributions earn you a reliable indexed benefit for life, which is generally superior to annuities that you can buy on your own. At a time when private sector employers are generally watering down workplace pensions (if offered at all), your employer is required to fully match your CPP contribution. Set contributions ensure a steady build-up of your retirement entitlement. Your benefits are more or less guaranteed by government (although future contributions would likely rise if CPP investment and demographic projections don’t pan out).
But the existing CPP program also has two glaring shortcomings, particularly when you compare it to what you can achieve while saving and investing on your own in an RRSP. Firstly, governments only give you a tax credit on your CPP employee contribution, rather than a tax deduction like you get on your RRSP contribution or your workplace pension contribution. While that sounds like a technicality, it can make a big difference. That’s because tax credits shield you from taxes at the rate in effect in the lowest combined federal and provincial tax bracket (which is, for example, 20% in B.C. and Ontario). An RRSP-type tax deduction shields you from taxes at the marginal tax rate you actually pay (up to 48% in B.C. and 54% in Ontario).
Secondly, only about 60% of CPP contributions goes to fund benefits of current contributors, whereas 40% helps pay for the benefits of previous generations. “We are overpaying—and will continue to do so—because the original participants did not pay enough,” explains Vettese.
Fortunately, the CPP enhancement improves on these two existing CPP shortcomings. You get a full tax deduction on your CPP contribution (albeit for the enhanced portion only) and it allows the government to spread the inter-generational subsidy over a larger contribution base. In the end, the enhanced CPP provides a nice complement to managing your investments. By increasing the proportion of retirement income generated by rock-solid government pensions, it allows you a little more leeway to go for higher returns on your stock and bond portfolio.
Takeaway: If, like the average MoneySense reader, you do pretty well saving and investing on your own, you can still benefit over time from the enhanced CPP. The “new and improved” CPP modestly enhances benefits while improving on shortcomings in plan design. That makes for a nice complement to your nest egg.
*This article was originally published Aug. 24, 2016 in our Sept/Oct 2016 issue