What clients should know about the CPP reforms

Changes to the CPP were announced in 2016 to address the shrinking number of Canadians with workplace pension plans. Research showed that many families weren’t saving enough for retirement, and that many Canadians rely on the CPP and OAS programs.

The CPP was amended to enhance retirement pensions by:

• increasing the income replacement level to 33.33% from 25% of eligible earnings, and
• increasing the upper limit for eligible earnings by 14%.

Increased contribution rates relating to these enhancements will be phased in until 2025.

Advisors will want to manage clients’ expectations. Clients who are retiring in the near-term will see only a modest enhancement to their pensions even though their premiums have increased. It’s their children and grandchildren who will reap the rewards.

Let’s examine three scenarios: a person retiring under the old contribution rules; a person retiring in 2023 with the increased contributions beginning in 2019; and a person retiring with the changes fully phased in.

Scenario 1: Old rules

For those retiring this year at age 65, the CPP retirement pension provides a maximum retirement pension equal to 25% of the average of the yearly maximum pensionable earnings (YMPE) for the current and four previous years.

Table 1: 2023 calculations

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Under the old rules, the maximum retirement pension that someone age 65 could have drawn in 2023 would have been $1,288.33 per month or $15,450 for the year.

Scenario 2: 2019 increase

Now let’s look at someone retiring in 2023 under the Phase 1 rules:  the increase in replacement ratio from 25% to 33.33%. Plan participants saw their CPP contributions increase in 2019. For 2023, the maximum employee contribution increased to $3,754.45. Maximum combined employee/employer premiums increased to $7,508.90, which is also the maximum for a self-employed person. As Table 2 shows, premium rates have increased considerably from the 1.8% charged at the program’s inception in 1966.

Table 2: Phase 1 contribution rates applicable to YMPE

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So, where are we with the new regime? If a 65-year-old who made maximum contributions to CPP in the 2019-2022 period retires in 2023, what is their enhancement? As indicated in Table 3, their annual pension would have increased by $218.93.

Table 3: Maximum 2023 increase for a 65-year-old

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The government issues a quarterly report for the CPP and OAS, which is an excellent reference tool for advisors. The $1,306.57 maximum CPP retirement pension shown on the rate card for the first quarter of 2023 reflects the $1,288.33 calculated under the old regime plus the $18.24 from the enhanced benefit.

Scenario 3: Imagining the full benefit

And what if we were to imagine our retiree enjoying the full fruits of the enhanced benefit? Had the change been fully phased in, an individual retiring in 2023 could have received an annual retirement pension of 33.33% of $61,840, or $20,611.27 ($1,717.60 per month).

Maximum benefits require 40 years of maximum contributions and a benefit take-up at age 65. Once someone begins to collect CPP, the 8.33% enhancement will be calculated using the average of the best 40 years of earnings for 2019 and later years.

Phase 2 – Increasing the upper limit for eligible earnings by 14%

The second phase of changes to the CPP affects the upper limit of eligible earnings.

A person earning more than the YMPE in 2024 and subsequent years will benefit from the additional tier of earnings up to the year’s additional maximum pensionable earnings (YAMPE).

YAMPE will equal 114% of the YMPE in 2025 once it’s fully phased in. For 2024, YAMPE will be equal to 107% of the YMPE.

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For 2024, the top of the second tier can be calculated as $66,600 times 1.07, rounded down to $71,200; for 2025, $66,600 times 1.14, rounded down to $75,900. (This calculation is using the 2023 YMPE of $66,600).

Compared to the earlier regime, pensionable earnings would be $4,600 larger in 2024 and $9,300 larger in 2025. The employee and employer will each contribute 4% of this amount. (The self-employed will contribute 8%).

Service Canada will calculate the additional entitlements using the best 40 years of earnings from 2024 on. Thus, the CPP could increase by up to about $2,886 per year. Since the YMPE, YAMPE and CPP are indexed, the actual benefits are expected to be larger when accounting for 40 years of inflation.

Contributions made in respect of the additional tier of income will be identified as the “second additional portion” on the statement of contributions.

Summary

The enhanced CPP benefits will be of value to many Canadians. For some, CPP and OAS may be their only defined-benefit income. Just bear in mind that the new regime is in its infancy and Canadians will not reap the full benefits for approximately 40 years.

Here are a few other points to consider:

• The above calculations reflect the entitlements of someone who retires at 65. They don’t account for the 0.6% per month discount for those retiring before 65 or 0.7% enhancement for those retiring after 65.
• The CPP post-retirement benefit will also increase, but only in respect of contributions made in 2019 and later.
• Those receiving a disability or survivor pension will see an increase in the disability or survivor benefit for contributions made in 2019 and after. The increase will depend on how long someone has contributed to the enhanced CPP.

Lea Koiv

Tax & Estate

Lea Koiv , CPA, CMA, CA, CFP, TEP, is a tax, pension and retirement expert who has held senior roles at a national insurer and international accounting firms. Reach her at info@leakoivassociates.ca.