The ABCs of the CPP

By Guest Blogger Ryan Lewenza

A key pillar of retirement planning is the Canada Pension Plan (CPP). When doing a financial plan for clients we consider this, their investment savings, employer pensions (if any) and their Old Age Security (OAS) pension when modelling out retirement cash flows. We get lots of questions on the CPP with one reoccurring question; will it be there when they retire? This week I try to address these questions and examine the long-term sustainability of the CPP.

Let’s begin with a look back at the history of Canadian government pension plans. Exciting stuff! In 1952 the OAS pension was introduced for Canadians 70 years and older. In 1965, when the CPP program was rolled out, the qualifying age for OAS was lowered from 70 to 65, where it currently stands. The Guaranteed Income Supplement, which is an additional pension program for low-income seniors, was introduced in 1967. The OAS and GIS were established to provide a basic minimum amount for seniors in retirement.

The maximum monthly OAS pension benefit in 2019 is $601.45 for those 65 and older and those who have lived in Canada for at least 10 years since the age of 18. Unlike the CPP plan, you don’t pay into the OAS pension – it’s funded from the general tax revenues of the government. The OAS is means tested, meaning it will clawback a portion of the monthly amount for those with an annual income above $75,910. The government claws back the OAS amount by 15 cents for every dollar above the $74,788 and it’s completely clawed back for those making more than $122,843. The GIS pays an additional maximum monthly amount of $898.32 if you are single and earn a maximum annual income of $18,240. Finally, the OAS pension amount is taxable while the GIS amount is non-taxable.

In contrast to the OAS and GIS, the CPP is a mandatory plan that Canadians (excluding Quebec which has its own government pension plan) and their employers are require to pay into. If you are employed you are required to pay half of the contributions through payroll deductions with your employer matching this amount. For those self-employed, they have to make the whole contribution. The maximum annual contribution for employers and employees in 2019 is $2,748.90 each.

The annual contribution amount was increased this year with the “CPP Enhancement” announced back in 2016. Known as Bill C-26, it involved increasing the CPP contributions from a total of 9.9% to 11.9% over a 5-year period and increasing CPP benefits from 25% of your “average lifetime earnings” to 33.33%. Now before you CPP recipients  get all excited and head down to the local shuffleboard or bocce ball courts and discuss how you’re going to spend the increase, note this is being phased in over a 45-year period!

CPP Contributions Following the CPP Enhancement

Source: Government of Canada

You can apply for full CPP at age 65, but receive it as early as age 60 with a reduced amount, or extend it to 70 with a higher amount. The amount of CPP benefits you receive depends on how much and how long you’ve contributed into the plan. To receive the maximum amount you must meet two criteria – you must contribute into the CPP for at least 83% of the time (39 years in total) that you are eligible to contribute (age 18 to 65) and you must contribute enough over those 39 years.

For 2019 the maximum pension amount is $1,154.58/month or $13,854.96/year but few actually receive this maximum amount. The average CPP amount is $640/month and it’s why you need to research what you will receive in retirement ahead making the big decision to retire. Could you imagine planning on getting the maximum amount to only receive the average in retirement? This could be the difference between ordering off the value menu at Micky D’s or enjoying a nice ribeye a few times a month. This is also why you need a good advisor/planner to help you with this critical decision.

Now the key question: take CPP early at 60, or delay to 65 and longer? Well, for any long-term reader of this blog and with a pulse knows that Garth and our team prefers to take it early. There’s a lot of debate around this topic but Garth breaks it down to these key factors:

• The government is giving you money for once so take it as early as you can (this is bird in the hand thinking).
• You could croak early and since you paid into the plan take it as soon as you can. In a blog post Garth quipped on the topic “a dollar when you’re healthy is worth more than a buck when you’re on meds, watching Oprah and trying to breathe”.
• By delaying it until 65 or 70 the CPP income could put you in a higher tax bracket if you’re drawing on RRSPs, thus potentially wiping out the benefit.
• Lastly, if you don’t need the money you can invest it and let it compound over time. If you invest the average monthly CPP amount of $640/month at 6% in a TFSA, that would grow to $45,577 in 5 years based on the pension payments of $38,400.

So take it early and either spend it before you’re on meds and watching Oprah (or now The View), or invest it and let it grow.

Finally, let’s look at the key question of CPP sustainability. With aging demographics in Canada and in most developed countries, combined with low global interest rates, many question the long-term sustainability of the CPP and overall government pensions. Not this guy!

In reviewing CPP investment returns and reading the last CPP Actuarial Report (for Garth it’s reading the tax code that gets him revved up, for me it’s actuarial reports – what can I say we’re a couple of wild and crazy guys!), I have complete confidence that the CPP is going to be just fine in the years and decades ahead despite the challenges noted above.

First, based on the current contribution amounts and the expected returns on the $356 billion fund, the Chief Actuary estimates that the CPP is sustainable over a 75-year projection period. This projection is based on a conservative long-term real rate of return of 3.9%. According to the Chief Actuary “despite the projected substantial increase in benefits paid as a result of an aging population, the Plan is expected to be able to meet its obligations throughout the projection period.”

Second, due to concerns about the long-term viability of the plan in the 1990s, major reforms we’re implemented to ensure its sustainability. This started with the CPP Investment Board taking over control and the management of the CPP assets in 1990. The CPPIB is a respected and well-managed investment organization that employs a diversified and global investment approach across a number of different asset classes. This now includes public markets (stocks and global bonds), private companies (stocks and debt) and real assets like real estate and infrastructure. This approach has yielded solid results with the plan realizing a 6.2% annualized real rate of return over the last 10-year period. So, while the Chief Actuary projects the sustainability of the fund over a 75 year period based on a conservative 3.9% return, the actual results have far exceeded this.

Lastly, if the fund was to encounter difficulty as a result of lower returns or higher than anticipated benefit payments, the Federal government can always increase the contribution amounts to address any shortfall. Yes this will increase contributions and reduce one’s take home pay for the people paying into it, but it would address any sustainability issues.

CPP Fund Projections to 2040

Source: 27th CPP Actuarial Report

That’s a lot to take in and to be honest a bit dry (clearly I’m no Garth!). But this is important stuff so hopefully this clears up some confusion around the CPP. And if not just call Trudeau to get his take, that is if he’s not busy with this SNC debacle.

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.