Budgeting for 2021 CPP changes — and beyond

We’re midway through the first phase of Canada Pension Plan (CPP) enhancements announced in 2016. Over the long term, the enhancement is designed to increase the CPP income replacement level from one-quarter to one-third of eligible earnings.

Phase one, which began in 2019, increases employer and employee contribution rates by 1% over five years. Next year marks the halfway point in both time and amount: the cumulative increase will be 0.50% in 2021, taking the contribution rate to 5.45% from the 4.95% starting point.

The rate is applied to the year’s maximum pensionable earnings (YMPE), recently announced as $61,600 for 2021. At the new rate, the 2021 maximum contribution will be $3,166.45 each for employer and employee. Self-employed individuals pay both parts, totalling $6,332.90.

Table: Annual CPP enhancements

Budgeting for next year

Over the five-year phase-in period, contribution rates will increase by 20%. That will erode an employee’s net paycheque by as much as about $600 once phase one is fully implemented (again, double that for those who are self-employed).

The 20-basis-point addition for next year will probably go unnoticed by most people. Still, it’s a worthwhile discussion to raise in year-end client reviews, as you look toward budgeting adjustments and cash flow planning over the coming few years.

Phase two begins in 2024

Phase two adds a second earnings limit beyond the YMPE, to be called the year’s additional maximum pensionable earnings (YAMPE). The YAMPE will begin as 107% of the YMPE in 2024 and move to 114% in 2025. After that, the two thresholds will be separately indexed using the same standard indexation factor.

Employer and employee contributions up to the YMPE will continue at the 5.95% rate, while the rate between the YMPE and YAMPE will be 4% each. All contributions are deductible for employers.

Employees will continue to claim a tax credit on contributions up to the YMPE, but contributions between the YMPE and YAMPE entitle employees to a deduction. A deduction better aligns to the employee’s cost since it’s set at the marginal tax rate, rather than the lowest bracket rate accorded to the credit.

Will the pandemic prompt more CPP changes?

In its fiscal sustainability report for the third quarter of 2020, the parliamentary budget officer (PBO) raised the spectre that additional funding may be required for the CPP.

The CPP is funded by those employer and employee contributions. Excess cash flow is invested in financial markets to fund anticipated future cash shortfalls as the population ages, which in turn raises the ratio of beneficiaries to contributors.

Analysis from the PBO suggests the CPP is “not sustainable over the long term — albeit to a modest extent.” Though it appears adequate to meet its 25- and 50-year measures, “projected contributions and benefits are not sufficient to ensure that, over the [75-year] long term, the net asset-to-GDP position returns to its pre-pandemic level.” The PBO estimates that increased contributions or reduced benefits amounting to 0.1% of GDP may be required to sustain the plan.

The government is obviously focused on the pandemic for now, but be prepared that we may yet see further CPP adjustments beyond the current enhancement process.

Doug Carroll

Tax & Estate

Doug Carroll, JD, LLM (Tax), CFP, TEP, is a tax and estate consultant in Toronto.