Canada’s retirement income system is made up of two public retirement income programs – the Old Age Security program and the Canada Pension Plan – as well as the opportunity to accumulate private retirement savings on a tax-assisted basis, through registered pension plans or registered retirement savings plans.
While the purpose of both public retirement income programs is to ensure that Canadians have a basic level of income in retirement, the two plans are very different with respect to funding, eligibility requirements, and benefit amounts.
The Old Age Security (OAS) program, which is funded out of general tax revenues, provides a set amount of income each month to Canadians who are age 65 or older and who have lived in Canada for 40 years or more since the age of 18. (A reduced and pro-rated benefit amount is available to those who have lived in Canada for a shorter period of time). The current maximum monthly OAS benefit (which is adjusted for inflation at the beginning of each calendar quarter) is $691.00 ($760.10 for those aged 75 or older). Where an OAS recipient of any age has income of more than around $86,000, the amount of OAS benefit which he or she can receive is reduced.
By comparison, the Canada Pension Plan (CPP) is funded entirely from mandatory contributions made by every person over the age of 18 who earns more than a minimum amount ($3,500 per year). If that person is an employee, he or she pays half the required contribution and the employer pays the other half. If the individual is self-employed, he or she must make the entire contribution. In all cases, the amount contributed is a percentage of earnings to a specified maximum earnings amount known as the Yearly Maximum Pensionable Earnings, or YMPE, which is currently $66,600.
As early as age 60, or as late as age 70, the individual contributor can apply to begin receiving a monthly CPP retirement benefit. The actual amount of the benefit is different for each individual, as it is arrived at using a formula based on the total amount of contributions made during the individual contributor’s working life. The current maximum monthly benefit is $1306.57. Once an individual begins receiving a CPP retirement benefit, monthly payments of that benefit continue for the rest of the individual’s life and, unlike OAS, is never reduced in any way.
The result of the way in which the CPP is funded means that, unlike the OAS program, the CPP must be entirely self-financed – that is, all benefits paid must come out of the pool of capital created by contributions made by individual Canadian workers and the gains made by investing those amounts.
Several years ago, it was recognized that, for a range of reasons, many Canadian families were not accumulating sufficient savings to ensure adequate income in retirement. In 2016, federal government statistics indicated that 24 per cent of families (1.1 million families) nearing retirement age were at risk of not having adequate income in retirement to maintain their standard of living. The federal and provincial governments determined that the best response to that reality was to make changes to the Canada Pension Plan, in order to increase the extent to which CPP retirement benefits would replace working income.
Those changes to the CPP began in 2019, when the required annual contribution to the CPP rose from 4.95% to 5.1% of earnings. That contribution percentage was increased each year thereafter, such that it now (for 2023) stands at 5.95% of earnings over $3,500.
The second, more consequential, change is that, effective as of January 1, 2024, higher income earners will be required to make a new, additional contribution to the CPP. The change affects only individuals who earn more than the YMPE (currently $66,600).
In effect, there will be two levels of CPP contributions beginning in 2024. There is no change to the current contribution structure for those with annual income of less than the YMPE: such individuals will continue to contribute 5.95% of earnings in excess of $3,500 yearly, and the maximum annual contribution will be 5.95% of the YMPE. However, those whose income exceeds the YMPE for the year will pay 4% of those additional earnings (to be known as second CPP contributions), up to the second earnings ceiling – to be called the Year’s Additional Maximum Pensionable Earnings, or YAMPE.
The practical effect of the upcoming changes is best illustrated by example, as follows:
Sarah earns $85,000 in 2024. Her CPP contribution requirements will be as follows:
- Assume that the YMPE for 2024 is $67,700.
- The basic exemption for the year remains $3,500, meaning that Sarah must pay CPP contributions of 5.95% of $64,200 ($67,700 minus $3,500).
- Her first level CPP contributions for the year will therefore be $3,819.90 ($64,200 times 5.95%), and her employer will contribute an equal amount.
Since Sarah’s income for 2024 is more than the YMPE, she will be required to make second CPP contributions, which are calculated as follows:
- Assume that the YAMPE for 2024 is $72,400.
- Sarah must therefore pay second CPP contributions on $4,700 ($72,400 minus $67,700). Second level CPP contributions are set at 4.0%, so Sarah must pay 4.0% of $4,700, or $188.
- Once again, her employer will contribute an equal amount.
Sarah’s total CPP contributions for 2024 will therefore be $4,007.90.
While it’s important for those who will be affected by the upcoming changes to the CPP contribution structure to be aware of what’s coming, they are not changes for which any financial or tax planning is required – the requirement to make additional contributions (where it applies) is mandatory and will be done automatically. And, while no one really likes to see additional deductions being taken from their paycheque, it may be some comfort to consider that such deductions are really a way to increase one’s chances of not having to stay longer in the work force because of a lack of retirement savings, and being able to look forward to a more financially comfortable retirement.
More information on the upcoming changes to the CPP can be found on the federal government website at https://www.canada.ca/en/revenue-agency/news/2023/05/the-canada-pension-plan-enhancement--businesses-individuals-and-self-employed-what-it-means-for-you.html.