CPP: GETTING THE MOST OUT OF YOUR RETIREMENT PAYMENTS

 

Maximize Your Benefits

8 – 10 minute read

Employed Canadians have all come across the term “Canada Pension Plan” (or CPP). Most likely, they pay into it each year they are part of the workforce. 

But what exactly is it? What kind of income is it supposed to provide?

A large misconception about CPP is that it was created to completely replace someone’s income in retirement. Unfortunately, this idea has been one of the causes of the retirement crisis.

The truth is, it was only created  with the intent to replace 25% of the average Canadian’s pre-retirement income. This percentage is lower for those Canadians who earn above the Yearly Maximum Pensionable Earnings ($64,900 for 2022). The retirement crisis is not a result of insufficient funds in the CPP to meet its commitment for Canadians. It is due to Canadians undersaving because they overestimated the income CPP (and other government benefits) will provide in retirement.

A couple on pension stand smiling outdoors. The mad has his arm around the woman's shoulders. He carries a bouquet of flowers.

CPP is inherently complex and the new CPP enhancement has only complicated it more. However, there are some very important points to know about CPP and what one can do to potentially increase payments in retirement. 

This article will break down the important components of CPP with an aim to shed light on possible strategies you can take to generate a higher payment in retirement.

The Credit System

In general, CPP is based on a credit system. Each year a person works and pays into CPP, they generate entitlement to benefits in retirement. The way the government calculates entitlement is by determining minimum yearly pensionable earnings and maximum yearly pensionable earnings and then prorating benefits based on where a person’s income falls within that scale. They keep track of this prorated benefit using credits.

Therefore, if you make exactly $64,900 in 2022, you will generate a CPP credit of 1.

Earnings along a spectrum which explains the CPP credit system.

If you make $32,450­—half the Yearly Maximum Pensionable Earnings—your CPP credit for the year will be 0.5. This means that, in 2022, you will earn 50% of the Yearly Maximum Pensionable Earnings (YMPE). Similarly, if you make $50,000 in employment income in 2022, you will generate a CPP credit of 0.77 ($50,000 divided by $64,900).

But if you made $130,000 in 2022, your CPP credit would still be 1.00, as any amount beyond the maximum makes no difference in regards to CPP. 

And if you made less than $3,500 in a year, you would not be required to pay into CPP at all, and your credit would be 0.

What is the Point of the Credit?

For context, the YMPE was $28,900 in 1990. At the time, 2.2% was the maximum contribution rate. So the most a person could contribute from their paycheque was $635.80 (2.2% of the YMPE) or $1,271.60 when we incorporate the matching contribution made by some employers. This $1,271.60 decreases in value because of inflation and does not provide much benefit to a someone retiring decades later.

A logo saying, "CPP Investments"

To combat the diminishing value of cash, all CPP contributions get pooled and invested by the Canada Pension Plan Investment Board into a heavily regulated pension fund. To keep track of the investment return one should receive based on their CPP contributions, the credit system was created.

If a person contributes an average of 80% (a credit of 0.8) of the YMPE over their lifetime, they will be entitled to 80% of the average YMPE for the five years preceding their retirement year. This allows them to receive their fair share of the investment returns, and keep their prorated benefit consistent with the YMPEs determined closer to retirement. Effectively, this brings early career CPP contributions up to “present value dollars” right before retirement.

This calculation would be done for every year a person participates in the workforce, then summed up and averaged. The calculated amount would then be multiplied by 25%. (Remember, CPP is meant to replace only 25% of income.)

Increasing CPP Payment Through Deferral 

A popular tip is to defer receiving CPP benefits until past the age of 65, which increases payments into perpetuity (while taking payments before 65 results in the opposite). A person receives 8.4% more in payments each year they defer past 65, up to the age of 70. That means, if one elects to begin receiving CPP at 70, payments will be 42% higher than they would be at age 65. 

Not only do benefits automatically increase each year deferred past 65, if a person continues to work, they can use their earning years after 65 to make up for lower earning years pre-65 in the CPP calculation.

Counteracting Lower Income Years

Lower income years will lower CPP payouts in retirement. To keep it fair, everyone’s CPP contributions are based on the same minimum and maximum ($3,500 and $64,900 for 2022) as well as the Contributory Period. 

The Contributory Period is calculated from the month after an individual turns 18 to the month before an individual starts taking CPP (or the month they turn 70, whichever is sooner). For an individual taking CPP at the age of 65, the Contributory Period will be 564 months (47 years). Not only is the CPP benefit calculated on how much income an individual made in relation to the YMPE, it also incorporates the number of months an individual made CPP contributions over their life span. 

It is unreasonable to require an individual make at or above the YMPE every year for 47 years in order to receive the full CPP benefit. Anyone who went to post-secondary school, did unpaid work for a trade certificate, or simply chose a career path that wouldn’t provide compensation at the YMPE level would be penalized. Luckily, the federal government agrees, and developed a few provisions to forgive lower earnings years.

The General Dropout Provision

The General Dropout Provision (GDP) is automatically given to any Canadian applying for CPP. Since 2014, the allowable dropout provision is 17% of an individual’s Contributory Period. It essentially allows forgiveness of 17% of an individual’s lowest earning months.

If 564 months is the baseline Contributory Period, then 17%, or 96 of the lowest earnings months, are ignored. Therefore, to receive the full CPP benefit before any other provisions, an individual must have 39 credits (468 months of earnings at or above the YMPE).

For example, compare Taylor’s CPP benefit under two different scenarios. To keep it simple, assume that Taylor’s salary is above the YMPE each year, so the CPP credit for every year of employment is 1. We compare Taylor working every year from age 26-65 to a scenario where Taylor works from age 26-30 before taking a 5 year break and then commencing employment through to retirement. We will also assume that Taylor is 65 this year. (The 2022 CPP maximum benefit is $1,253.59/month).

Since Taylor didn’t begin working until 26 in both scenarios, she lost CPP credits for age 18-26 (8 years). We will automatically forgive these as per the General Dropout Provision. 

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Taylor's CPP calculations showing a significant difference in monthly pension benefit

So, if Taylor took 5 years off of work, the CPP benefit would be $160 less per month, or $1,984 less per year.

  1. For every year of employment, the year’s credit is multiplied by the 5-year YMPE average for the years closest to retirement.
  2. Step 1 is summed up and divided by the Contributory Period.
  3. Multiply Step 2 by 25% and then divide by 12 to find the monthly CPP benefit.
This article only provides a simplified overview of CPP calculations, and disregards CPP enhancement. To calculate CPP benefits, have your CPP Statement of Contributions handy and use this tool. 

Because the cost of living is increasing, and post-secondary education is becoming the baseline for making a living in Canada, it is common for an individual to begin work in the latter end of their 20’s. However, even with the GDP, this system still greatly disadvantages the partners that forego career advancement to stay at home and take care of family after they had already gone to school. Those who sacrifice employment to raise the next generations of the Canadian workforce should not be penalized for doing so. 

Fortunately, the federal government adopted the Child Rearing Provision as well.

The Child Rearing Provision

If you recall in the last example, the Contributory Period did not change when Taylor took the 5 years off work. This was the driving factor behind the penalty Taylor saw through the CPP benefit. Her zero-income years were still counted when calculating her average lifetime credit. 

The Child Rearing Provision (CRP) allows a parent to “knock out” the years spent caretaking for children. To ensure these years do not affect the average, the government allows the CPP calculation to be changed in two ways:

Part 1: For every year a parent makes below the Yearly Basic Exemption ($3,500), they can exclude those months from the Contributory Period as well as Average Lifetime Earnings (ALE) calculation.

Part 2: With Part 1’s months dropped out, the parent can then exclude the years where the earnings were below their ALE  (Part 1 reduces ALE to benefit Part 2 further). The parent can drop out each year—up to 10— that fell below these earnings. The CRP allows for the child-rearing years to be completely excluded from the CPP benefit calculation, instead of penalizing it. In order to be eligible for this provision, CRP can be used only for months when:

    • you received Family Allowance payments or were eligible for the Canada Child Tax Benefit, and
    • your earnings were lower because you either stopped working or worked fewer hours to be the primary caregiver of a child of yours under the age of seven.

If you have multiple children, the CRP can be used for the time period between your oldest being born and your youngest turning 7, up to a maximum of 10 years. Either spouse can claim the provision, but both cannot use it for the same period of time. 

CRP is not automatically given to Albertans; it needs to be applied for manually. If you are currently receiving CPP and never applied for the CRP, you can apply retroactively.
Click here for directions on how to receive the provision and the relevant documents needed.

CRP and GDP Combined

If the individual is eligible for the CRP, then the General Dropout Provision is 17% of the Number of Contributory Months after dropping out the relevant months for child-rearing. CRP is always calculated before GDP, so GDP is not automatically 8 years in this case.

Since Taylor has taken 60 months for CRP, her GDP is 17% of her Contributory Period after excluding the 60 months (564 months minus 60 months, multiplied by 17%=additional 86 months of dropout).

Re-examining Taylor’s situation, if she took 5 years off for child-rearing, the CPP benefit calculation would look more like this:

Taylor's CPP calculations after accounting for the child-rearing provision.

After 65 Dropout Provision

This provision is relevant for those individuals who have not always made the YMPE and have some employable years with partial CPP credits. As established, it makes sense to consider knocking out our low-income years if we are working past the age of 65.

Not only do benefits automatically increase each year one defers past 65, if they continue to work, they can use those earning years after 65 to make up for lower earnings years pre-65 in the CPP calculation.

Often, an individual making their peak income at the end of their career. Delaying CPP will also give us more high-earnings years to choose from for CPP purposes.

In Conclusion…

Retirement can be a daunting prospect, but a better understanding of the Canadian Pension Plan can help put your mind at ease. Luckily, there are provisions put in place by the government that reflect an empathy for the different lives one might lead. Below, you can see the summation of all the tips and provisions discussed.

A graph summarizing the discussed CPP benefits for retirement.

With the retirement crisis looming, it is crucial to plan ahead. Seeking professional expertise is one of the ways you can better prepare for financial security. To discuss retirement planning and how we can make your wealth matter, reach out to us by email or call (780) 463-2688.

Ready to check your understanding?
Click below to test your knowledge!

DISCLAIMER

Qube Investment Management Inc. has authored the material presented above for the promotion of financial literacy and professional development. Qube makes no warranty for the accuracy, validity, or completeness of the above information. It is not intended to provide specific advice with respect to individual financial, investment, tax, legal or accounting matters.

 For advice specific to your situation, consult appropriate investment, legal or accounting professionals.

PLANNING FOR YOUR INVESTMENTS SHOULD NOT BE OVERWHELMING.

Book a quick chat with us to see if we can help you plan for your goals.

CPP: GETTING THE MOST OUT OF YOUR RETIREMENT PAYMENTS

 

Maximize Your Benefits

8 – 10 minute read

Employed Canadians have all come across the term “Canada Pension Plan” (or CPP). Most likely, they pay into it each year they are part of the workforce. 

But what exactly is it? What kind of income is it supposed to provide?

A large misconception about CPP is that it was created to completely replace someone’s income in retirement. Unfortunately, this idea has been one of the causes of the retirement crisis.

The truth is, it was only created  with the intent to replace 25% of the average Canadian’s pre-retirement income. This percentage is lower for those Canadians who earn above the Yearly Maximum Pensionable Earnings ($64,900 for 2022). The retirement crisis is not a result of insufficient funds in the CPP to meet its commitment for Canadians. It is due to Canadians undersaving because they overestimated the income CPP (and other government benefits) will provide in retirement.

A couple on pension stand smiling outdoors. The mad has his arm around the woman's shoulders. He carries a bouquet of flowers.

CPP is inherently complex and the new CPP enhancement has only complicated it more. However, there are some very important points to know about CPP and what one can do to potentially increase payments in retirement. 

This article will break down the important components of CPP with an aim to shed light on possible strategies you can take to generate a higher payment in retirement.

The Credit System

In general, CPP is based on a credit system. Each year a person works and pays into CPP, they generate entitlement to benefits in retirement. The way the government calculates entitlement is by determining minimum yearly pensionable earnings and maximum yearly pensionable earnings and then prorating benefits based on where a person’s income falls within that scale. They keep track of this prorated benefit using credits.

Therefore, if you make exactly $64,900 in 2022, you will generate a CPP credit of 1.

Earnings along a spectrum which explains the CPP credit system.

If you make $32,450­—half the Yearly Maximum Pensionable Earnings—your CPP credit for the year will be 0.5. This means that, in 2022, you will earn 50% of the Yearly Maximum Pensionable Earnings (YMPE). Similarly, if you make $50,000 in employment income in 2022, you will generate a CPP credit of 0.77 ($50,000 divided by $64,900).

But if you made $130,000 in 2022, your CPP credit would still be 1.00, as any amount beyond the maximum makes no difference in regards to CPP. 

And if you made less than $3,500 in a year, you would not be required to pay into CPP at all, and your credit would be 0.  

What is the Point of the Credit?

 For context, the YMPE was $28,900 in 1990. At the time, 2.2% was the maximum contribution rate. So the most a person could contribute from their paycheque was $635.80 (2.2% of the YMPE) or $1,271.60 when we incorporate the matching contribution made by some employers. This $1,271.60 decreased in value because of inflation and does not provide much benefit to a someone retiring decades later.

A logo saying, "CPP Investments"

To combat the diminishing value of cash, all CPP contributions get pooled and invested by the Canada Pension Plan Investment Board into a heavily regulated pension fund. To keep track of the investment return one should receive based on their CPP contributions, the credit system was created.

If a person contributes an average of 80% (a credit of 0.8) of the YMPE over their lifetime, they will be entitled to 80% of the average YMPE for the five years preceding their  retirement year. This allows them to receive their fair share of the investment returns, and keep their prorated benefit consistent with the YMPEs determined closer to retirement. Effectively, this brings early career CPP contributions up to “present value dollars” right before retirement.

This calculation would be done for every year a person participates in the workforce, then summed up and averaged. The calculated amount would then be multiplied by 25%. (Remember, CPP is meant to replace only 25% of income.)

Increasing CPP Payment Through Deferral 

A popular tip is to defer receiving CPP benefits until past the age of 65, which increases payments into perpetuity (while taking payments before 65 results in the opposite). A person receives 8.4% more in payments each year they defer past 65, up to the age of 70. That means, if one elects to begin receiving CPP at 70, payments will be 42% higher than they would be at age 65. 

Not only do benefits automatically increase each year deferred past 65, if a person continues to work, they can use their earning years after 65 to make up for lower earning years pre-65 in the CPP calculation.

Counteracting Lower Income Years

Lower income years will lower CPP payouts in retirement. To keep it fair, everyone’s CPP contributions are based on the same minimum and maximum ($3,500 and $64,900 for 2022) as well as the Contributory Period. 

The Contributory Period is calculated from the month after an individual turns 18 to the month before an individual starts taking CPP (or the month they turn 70, whichever is sooner). For an individual taking CPP at the age of 65, the Contributory Period will be 564 months (47 years). Not only is the CPP benefit calculated on how much income an individual made in relation to the YMPE, it also incorporates the number of months an individual made CPP contributions over their life span. 

It is unreasonable to require an individual make at or above the YMPE every year for 47 years in order to receive the full CPP benefit. Anyone who went to post-secondary school, did unpaid work for a trade certificate, or simply chose a career path that wouldn’t provide compensation at the YMPE level would be penalized. Luckily, the federal government agrees, and developed a few provisions to forgive lower earnings years.

The General Dropout Provision

The General Dropout Provision (GDP) is automatically given to any Canadian applying for CPP. Since 2014, the allowable dropout provision is 17% of an individual’s Contributory Period. It essentially allows forgiveness of 17% of an individual’s lowest earning months.

If 564 months is the baseline Contributory Period, then 17%, or 96 of the lowest earnings months, are ignored. Therefore, to receive the full CPP benefit before any other provisions, an individual must have 39 credits (468 months of earnings at or above the YMPE).

For example, compare Taylor’s CPP benefit under two different scenarios. To keep it simple, assume that Taylor’s salary is above the YMPE each year, so the CPP credit for every year of employment is 1. We compare Taylor working every year from age 26-65 to a scenario where Taylor works from age 26-30 before taking a 5 year break and then commencing employment through to retirement. We will also assume that Taylor is 65 this year. (The 2022 CPP maximum benefit is $1,253.59/month).

Since Taylor didn’t begin working until 26 in both scenarios, she lost CPP credits for age 18-26 (8 years). We will automatically forgive these as per the General Dropout Provision. 

Taylor's CPP Calculations

So, if Taylor took 5 years off of work, the CPP benefit would be $160 less per month, or $1,984 less per year.

  1. For every year of employment, the year’s credit is multiplied by the 5-year YMPE average for the years closest to retirement.
  2. Step 1 is summed up and divided by the Contributory Period.
  3. Multiply Step 2 by 25% and then divide by 12 to find the monthly CPP benefit.
This article only provides a simplified overview of CPP calculations, and disregards CPP enhancement. To calculate CPP benefits, have your CPP Statement of Contributions handy and use this tool. 

Because the cost of living is increasing, and post-secondary education is becoming the baseline for making a living in Canada, it is common for an individual to begin work in the latter end of their 20’s. However, even with the GDP, this system still greatly disadvantages the partners that forego career advancement to stay at home and take care of family after they had already gone to school. Those who sacrifice employment to raise the next generations of the Canadian workforce should not be penalized for doing so. 

Fortunately, the federal government adopted the Child Rearing Provision as well.

The Child Rearing Provision

If you recall in the last example, the Contributory Period did not change when Taylor took the 5 years off work. This was the driving factor behind the penalty Taylor saw through the CPP benefit. Her zero-income years were still counted when calculating her average lifetime credit. 

The Child Rearing Provision (CRP) allows a parent to “knock out” the years spent caretaking for children. To ensure these years do not affect the average, the government allows the CPP calculation to be changed in two ways:

Part 1: For every year a parent makes below the Yearly Basic Exemption ($3,500), they can exclude those months from the Contributory Period as well as Average Lifetime Earnings (ALE) calculation.

Part 2: With Part 1’s months dropped out, the parent can then exclude the years where the earnings were below their ALE  (Part 1 reduces ALE to benefit Part 2 further). The parent can drop out each year—up to 10— that fell below these earnings. The CRP allows for the child-rearing years to be completely excluded from the CPP benefit calculation, instead of penalizing it. In order to be eligible for this provision, CRP can be used only for months when:

    • you received Family Allowance payments or were eligible for the Canada Child Tax Benefit, and
    • your earnings were lower because you either stopped working or worked fewer hours to be the primary caregiver of a child of yours under the age of seven.

If you have multiple children, the CRP can be used for the time period between your oldest being born and your youngest turning 7, up to a maximum of 10 years. Either spouse can claim the provision, but both cannot use it for the same period of time. 

CRP is not automatically given to Albertans; it needs to be applied for manually. If you are currently receiving CPP and never applied for the CRP, you can apply retroactively.
Click here for directions on how to receive the provision and the relevant documents needed.

CRP and GDP Combined

If the individual is eligible for the CRP, then the General Dropout Provision is 17% of the Number of Contributory Months after dropping out the relevant months for child-rearing. CRP is always calculated before GDP, so GDP is not automatically 8 years in this case.

Since Taylor has taken 60 months for CRP, her GDP is 17% of her Contributory Period after excluding the 60 months (564 months minus 60 months, multiplied by 17%=additional 86 months of dropout).

Re-examining Taylor’s situation, if she took 5 years off for child-rearing, the CPP benefit calculation would look more like this:

Taylor's CPP calculations after all provisions are applied.

After 65 Dropout Provision

This provision is relevant for those individuals who have not always made the YMPE and have some employable years with partial CPP credits. As established, it makes sense to consider knocking out our low-income years if we are working past the age of 65.

Not only do benefits automatically increase each year one defers past 65, if they continue to work, they can use those earning years after 65 to make up for lower earnings years pre-65 in the CPP calculation.

Often, an individual making their peak income at the end of their career. Delaying CPP will also give us more high-earnings years to choose from for CPP purposes.

In Conclusion…

Retirement can be a daunting prospect, but a better understanding of the Canadian Pension Plan can help put your mind at ease. Luckily, there are provisions put in place by the government that reflect an empathy for the different lives one might lead. Below, you can see the summation of all the tips and provisions discussed.

A graph summarizing the discussed CPP benefits for retirement.

With the retirement crisis looming, it is crucial to plan ahead. Seeking professional expertise is one of the ways you can better prepare for financial security. To discuss retirement planning and how we can make your wealth matter, reach out to us by email or call (780) 463-2688.

Ready to check your understanding?
Click below to test your knowledge!

DISCLAIMER

Qube Investment Management Inc. has authored the material presented above for the promotion of financial literacy and professional development. Qube makes no warranty for the accuracy, validity, or completeness of the above information. It is not intended to provide specific advice with respect to individual financial, investment, tax, legal or accounting matters.

 For advice specific to your situation, consult appropriate investment, legal or accounting professionals.

PLANNING FOR YOUR INVESTMENTS SHOULD NOT BE OVERWHELMING.

Book a quick chat with us to see if we can help you plan for your goals.