Canada Pension Plan – Myths, Questions and Facts
There is a lot of confusion, misunderstanding and anxiety about the Canada Pension Plan (CPP) and the government does a poor job of clearing up these misconceptions. Social media has become the venue in which these concerns are aired. It has been a mixture of fact and opinion.
Elements from other programs are sometimes perceived to be linked to CPP when they are not. These include social programs such Old Age Security (OAS) and the Guaranteed Income Supplement (GIS) as well as spending programs such as the Canadian Infrastructure Bank (CIB). They are not related to CPP.
The first misconception is that the program is funded from general income tax revenues… it is not. It is funded by contributions in the form of deductions from payroll with employees and employers both contributing equally. If you are self-employed you pay both halves of the contribution. Your level of contribution is based on your level of earned income.
Benefits – what are they and who qualifies?
The contributions of each individual are used in the calculation of their future benefits. The more you contribute the more you’re eventual benefits will be… up to the maximum. This is not a social program where a small segment of the population helps to create a retirement income stream for those who did not contribute.
There has been occasional fear mongering that “new Canadians” who arrived here later in life will be a drain on the program and enjoying benefits they did not earn. That is a myth. If they haven’t contributed they will receive no CPP benefits. If they contributed for 10 years, they would receive approximately one quarter of the benefits that someone who worked for 40 years with similar income.
In addition to years worked, another factor is the annual income of the wage earner making the contributions. The yearly maximum pensionable earnings (YMPE) are currently $57,800. If you are earning less than that, your contributions will be less than maximum and, in all likelihood, your eventual benefits will be less than the maximum as well.
A person who has averaged 50% of yearly maximum pensionable earnings during their career will qualify for 50% of maximum benefits.
Conversely, those who earn above YMPE will only contribute to the level of YMPE ($57,800 in 2020). Future benefits are also capped to a level based on YMPE. Someone who has earned double the level of YMPE throughout their career will receive the same benefit has someone who earned an income exactly equal to YMPE throughout their career.
Since YMPE changes every year, an accurate calculation of benefits requires that you review each year of your employment income and compare it to YMPE for that year.
So far we have examined two factors that affect your CPP benefits in retirement; they are years of employment and the level of income on which contributions are calculated. A third factor is the age at which you begin drawing your first benefit.
A comparison can be made that measures of the impact of drawing benefits at the normal retirement age of 65, choosing to withdraw them early (age 60 is the earliest you can begin drawing benefits) or deferring until age 70.
Benefits are reduced the rate of 0.6% for each month (7.2% per year) before the age 65 that you choose to start receiving benefits. Someone who is eligible to receive $1000 per month at age 65 would receive only $640 per month for life (adjusted for inflation) if they choose to begin receiving benefits at age 60.
Delaying benefits has an incremental effect on payouts – they increase by 0.7% per month for each month after the age of 65 that you choose to begin receiving benefits. The same individual who qualified for $1000 at age 65 (and $640 at age 60) would qualify for $1420 in benefits at age 70.
In the first instance, the individual receives a significantly lower payout but enjoys an extra 10 years of payments.
And finally another factor playing into the calculations are the enhancements to the CPP program which are being phased in over the next 40 years. They will have little impact on those close to retirement but can significantly increase benefits for those who are young and just entering the workforce.
In broad terms the program is designed to provide benefits equal to approximately 25% of your working income if you contributed for 40 years or more. Enhancements will eventually increase that payout to approximately 33% of your working income. All payouts are subject to a maximum based on YMPE (Yearly Maximum Pensionable Earnings).
How does this play out over a lifetime of CPP benefits? There are a lot of moving parts and the calculations are complicated. Use the CPP/OAS Optimizer to quickly and easily make that comparison. http://moneypages.ca/calculator/22/cpp-oas-optimizer
Viability of the Plan
There is also a great deal of misinformation on how the funds are invested, government access to the funds for pet projects, etc.
The Canada Pension Plan is managed independently of government assets and is not a “slush fund” for the government regardless of who is in power.
As of December 2019 assets in the fund were valued at $420 billion and over the past 10 years it has achieved an average annual return of 10.4% on investments. There are 52 countries in the world where the CPP is actively invested.
An example of a company in which the CPP holds shares is Samsung Electronics.
If there is a future funding shortfall in the CPP is not due to “government skimming” money from the fund it will be because future contributions and rates of return are less than what is required to maintain benefits.
For a detailed look at the Canada Pension Plan you can refer to their website at https://www.cppinvestments.com/the-fund. The CPP is audited independently by the Auditor General of Canada.
A final friendly reminder: Use the CPP/OAS Optimizer to estimate future benefits and compare payouts at various ages.