The foundation of many Canadians’ retirement is the Canada Pension Plan (CPP). The CPP is designed to replace a certain amount of your average work earnings, up to maximum limits each year.
CPP is a government mandated pension plan. Anyone who is older than 18, employed, and receives a salary must pay into the Canada Pension Plan until age 65. The CPP provides retirement benefits, benefits to yourself and/or your children if you become disabled, a small lump sum death benefit and a survivor benefit to your spouse and/or children if you pass away.
Prior to 2019, CPP was designed to replace one quarter of your average work earnings, up to a limit. The government has enhanced the CPP so that it will grow to replace one third of your average work earnings. The maximum income is also going to be increased by year 2025.
If you are an employee, you pay the employee contributions and your employer will also contribute towards CPP on your behalf. If you are self-employed and earning employment income, you must pay both the employee and employer portions.
Currently, in 2019, the CPP contributions automatically deducted from your pay are 5.1% over income of $3,500 up to a maximum income of $57,400. By 2023, the annual employee contribution rate will rise to 5.95%. For a self-employed individual who must pay both the employer and employee portion of CPP contributions, they will pay 10.2% in 2019, increasing to 11.9% by 2023.
| Year | Employer/Employee rate | Self-employed rate |
|---|---|---|
| 2019 | 5.10% | 10.2% |
| 2020 | 5.25% | 10.5% |
| 2021 | 5.45% | 10.9% |
| 2022 | 5.70% | 11.4% |
| 2023 | 5.95% | 11.9% |
The enhanced CPP will also include a second ceiling for those earning more than the current maximum earnings. This second ceiling adds 14% to the maximum income, which is currently $57,400. In today’s dollars, that means anyone earning up to $65,400 will pay an additional 8% in contributions on their income between $57,400 and $65,400, or $640 in additional contributions if you make up to or more than the second ceiling maximum.
The premiums you and your employer pay go to the CPP Investment Board (CPPIB), where they invest the contributions on Canadian’s behalf. The Chief Actuary of Canada monitors the CPP to ensure that the plan is sustainable; in other words, the assets will be able to cover the monthly pension for Canadians. In the latest report, it was indicated that the CPP is sustainable for the next 75 years.
In 2019, the maximum payment was $1,154.58 per month. However, the average payment is more like 60% of the maximum, or $723.89 per month. These amounts are increased by inflation each year and paid to you until you die. Since you pay into the CPP based on your employment income, you receive a pension based on the proportion that you’ve paid into the plan. If you earn the maximum income, adjusted for inflation, every year between the ages of 18 and 65, you’ll receive the maximum payment each month. If not, you still might receive the maximum or a smaller portion of CPP payments. There are a couple of rules that allow you to still get the maximum even if you didn’t pay into it at the maximum every year between ages 18 and 65.
The first is the general dropout provision. Currently, the CPP automatically drops out 17% of your contributory period (from age 18 to age 65 or when you take your CPP if before age 65). If you take CPP at age 65, there are 564 months in the contributory period; 17% of that is 96 months, or 8 years. That means that you can drop out 8 of your lowest earning years from the 47 years of your contribution period. If you were attending school when you’re younger or go through a period of low or no earnings, that won’t necessarily hurt the amount you get from CPP.
The second major rule is the child rearing drop-out provision. This allows you to drop out low-income years when you were the primary caregiver raising children under the age of 7 and doesn’t penalize you for doing so.
Finally, if you were disabled according to the CPP legislation, these periods are excluded from your contributory period, again, not penalizing you for being unable to work.
Assuming you didn’t take time off to care for young children or didn’t become disabled according to CPP, you would have to contribute the maximum CPP amounts for 39 years in order to receive the maximum pension amount. If you decide to take CPP early, you’d need 35 years of maximum contributions.
The standard age to start taking CPP is 65. However, you can take CPP as early as age 60, or choose to delay it to age 70. You might be thinking, why wouldn’t I take it early, and why on earth would someone delay money from the government? If you choose to take your pension early, the amount you are eligible to receive is reduced by 0.6% for each month you receive it before age 65, or 7.2% per year. If you take your CPP at age 60, it will be 36% less than if you waited until age 65. In other words, you receive a guaranteed return of 7.2% for each year you wait until age 65. If you take your pension early and continue to work up until age 65, you must continue contributing to the CPP, which increases your benefits.
On the other hand, if you take CPP late, your payment will increase by 0.7% per year for each month after age 65, or 8.4% per year. Waiting until age 70 means you’ll receive 42% more than if you took it age 65. In other words, you get a guaranteed return of 8.4% each year you delay. If you work between ages 65 and 70, you have the option to continue contributing to the CPP.
Finally, your surviving spouse will continue to receive CPP payments up to the maximum limit. The calculation for these survivor benefits is complex and outside the scope of this summary post.
