It has been more than two years since the federal and provincial Finance Ministers came to an agreement to expand the Canada Pension Plan (CPP) in an attempt to strengthen Canada’s retirement system. The last time such an expansion occurred was in 2003 when total CPP contribution rates were increased from 6% to 9.9%. Once the changes have taken full effect in 2025, the enhanced CPP will provide benefits equivalent to 33.33% of an average worker’s income. This will be funded by an incremental increase of CPP contributions from employees and employers from the current 4.95% to 5.95% for a total contribution rate of 11.9%.
Reasons for the expansion
In determining the reasons for CPP expansions over the past two decades, one first needs to look at changing life expectancy. When the CPP was first established in 1965, the average life expectancy of a Canadian at birth was 72 years (68.73 years for men and 75.25 for women).* By 2017, this had risen to 81 years (79 for men and 83 for women).** This trend of people living longer is expected to continue over the coming decades. This in turn means there will be more pressure placed on the CPP to remain solvent in the face of an aging population.
The challenge posed by an aging population is compounded by the fact that most Canadians are not saving enough on their own. The days when Defined Benefit plans addressed this gap are long behind us. Nowadays, it is mostly public pension plans that continue to offer guaranteed income in retirement. Overall, only 60% percent of Canadians have access to a workplace savings plan. And even for those who are participating in a group RRSP or DC plan, contribution rates are often far below what is required to fund a lengthy retirement.
Starting from January 2019, employee/employer contributions to the CPP will rise in small increments every year until 2023 when they reach a total contribution rate of 11.9% (or 5.95% for employers and employees). These contributions are calculated from the Yearly Maximum Pensionable Earnings (YMPE) minus the basic exemption amount of $3500, the YMPE traditionally being the maximum earnings subject to CPP contributions and pensions.
As the table above shows, the contribution increases will be phased in very gradually in order to give employees and employers time to adjust to the change. To illustrate this, let’s use the example of an employee earning $50,000 in 2019. The 0.15% increase in that year will mean that CPP contributions will rise by a mere $69.75 (or $5.81/month). In 2020, employee/employer contributions would rise by an additional $69.75 resulting in a total increase of $139.6 (or $11.63/month) from 2018, assuming the salary remained constant.
As part of the CPP expansion, a new contribution bracket will be created for higher earners. Starting from 2024, earnings above the YMPE but under the new upper earnings limit will be subject to a 4% contribution from employees and employers (or 8% for self-employed individuals). By 2025, the upper earnings limit is projected to be 14% above the YMPE.
Source: Department of Finance Canada
Only employees who contribute to the revamped CPP for 40 years will reap the full benefit of the enhancement. Rather than being paid 25% of their eligible earnings, retirees can expect to receive 33.33%. And as illustrated above, higher earners will particularly benefit from these changes thanks to the 14% increase in the upper earnings limit.
Despite all these advantages however, it should be noted that the enhanced CPP does not benefit all Canadians equally. Employees who are approaching retirement will see very little change in their income. Those who are already retired will not see any improvements. Only those who are entering the workforce now or in the coming years will benefit from a 33.33% replacement of eligible earnings.
Workplace retirement plans will thus continue to be an essential supplement to the CPP. Many experts argue that people should seek to replace no less than 70% of their income in retirement (more than twice the replacement rate that the enhanced CPP offers). With that in mind, Canadians should not take the changes to the CPP as a reason to decrease their contributions to their RRSP or DC pension plan. By the same token, employers would be doing their employees a disservice if they choose to reduce the match they offer in response to the CPP enhancement. There is still much work left to be done to ensure that all working Canadians can retire well. The CPP expansion is merely a step in the right direction.