There has been much discussion, in recent years, about whether Canadians are adequately prepared for retirement and, more specifically, whether Canadians are saving enough to ensure a retirement free of undue financial stress. While the financial health of current and soon-to-be-retirees is a concern, the more pressing question is whether, under our current system, younger Canadians can expect to have some degree of financial security in retirement.
The workplace has changed significantly in the past 25 years and many of the retirement income options, which were relied upon by previous generations, such as an employer-sponsored defined benefit pension plan, are all but unknown to private sector workers under the age of 30 or even 40.
There is no shortage of opinions on how financial security, in retirement, for younger Canadians can best be achieved. Some argue for changes which will enhance the ability of Canadians to accumulate private savings, generally through RRSPs, while others take the position that enhancements to public pension plans, or the creation of new ones, is the solution.
Those in the latter group will be uplifted by a recent announcement from the federal Department of Finance, indicating that the federal government, and most of the provinces, have reached an agreement in principle on changes that will expand and enrich the Canada Pension Plan.
A brief bit of background: virtually everyone who works in Canada, whether as an employee or in self-employment, contributes to the CPP, generally through payroll deductions. Such contributions are set at a percentage of the employee’s pensionable earnings for the year. Employers are required to match employee contributions dollar for dollar, and to remit all contributions to the federal government on the employee’s behalf.
Contributions are structured so that an employee can receive a CPP retirement benefit equal to about 25% of his or her average annual pensionable earnings. Although the formula for determining entitlement is complex, the amount of CPP retirement benefit, which can be received, generally depends, for the most part, on the amount contributed during a person’s working life. A recipient can choose to begin receiving his or her CPP pension at any time between the ages of 60 and 70, with the monthly pension benefit increasing with each year that receipt is deferred past the age of 60.
The agreement in principle reached by the federal government and 8 of the provinces calls for a number of changes, which will begin to be implemented in January 2019. All of the changes are directed at increasing the amount that Canadians can receive from the CPP in retirement.
Increase in CPP Maximum Pensionable Earnings
Under the CPP, working Canadians contributed a percentage of their income (or pensionable earnings) to their CPP “account” each year. The amount of those pensionable earnings is, however, capped by a figure known as the maximum pensionable earning amount, and contributions on income amounts over that cap are not permitted.
The maximum pensionable earning amount for 2016 is $54,900. As a result, Canadians who earn less than that amount are contributing to the CPP in an amount which should provide them with a CPP retirement benefit which equals 25% of their average annual pensionable income during their working life. However, individuals who earn more than the maximum pensionable earnings, in any given year, cannot make contributions on the “excess”. As such, their CPP benefit in retirement will fall short of the 25% income replacement goal. The proposed changes to the CPP will increase the maximum pensionable earnings amount. That increase will be phased in between 2019 and 2025, with the expectation that maximum pensionable earnings will reach about $82,700 in 2025.
Increasing CPP Income Replacement
Using the current formula, which aims to provide contributors with 25% of annual pensionable earnings in retirement, a contributor who earns $50,000 in pensionable earnings will receive a CPP retirement benefit of $12,000 per year. The new CPP proposals would increase that income replacement percentage to 33%. This meand that the same contributor, earning $50,000 in pensionable earnings, would receive $16,000 in CPP retirement benefits. Of course, an increase in retirement benefits has to be financed through an increase in the annual contribution made by the employee (and an equal contribution by his or her employer) during the years of employment or self-employment. As of this point, no details have been provided on what those amounts will be.
Allowing Deduction for “Excess” CPP Contributions
As the maximum pensionable earnings amount and the replacement income percentage are increased, the result will be higher contribution amounts. According to the CPP proposals, in situations where employees must make higher contributions, due to the increased CPP contributions, they will be able to deduct any of those additional contributions from income earned in that year. In effect, contributors will not pay tax on any income which is used to make the additional CPP contributions for the year.
It should be emphasized that the changes to the CPP, which have been agreed to in principle, will have absolutely no impact or effect on individuals who are retired and currently receiving CPP retirement benefits or, indeed, on those who plan to leave work and begin receiving CPP benefits before January 1, 2019. These changes are long-range in nature, and will have the greatest impact on those who are 20, 30, or even 40 years away from retirement. The information released to date by the Department of Finance with respect to the proposals can be found on its website atwww.fin.gc.ca/n16/16-081-eng.asp.
