CPP or TFSA? It’s an Issue of Retirement Security

This week, Canada’s finance ministers met in Vancouver and agreed in principle to the expansion of the Canada Pension Plan (CPP) over a seven-year phase-in period, starting January 1, 2019. Higher contributions by workers and their employers will result. But will the revamped CPP be enough to provide for the retirement security Canadians need?

Although the CPP is large and robust, the issue is a broad one for Canadians to consider carefully from a planning perspective, especially by younger Canadians who will contribute to this new plan longer.

Some interesting statistics about the CPP:

• The CPP paid out $38.7 billion in benefits to 5.3 million Canadians in 2014-15.
• At March 31, 2016, the CPP Fund totalled $278.9 billion.
• Because the CPP Fund is ranked as one of the ten largest retirement funds in the world, its board, the CPP Investment Board (CPPIB), can undertake large transactions with which few others can compete.

The new plan will include some interesting tax changes: CPP premiums would become a tax deduction, at least on the “enhanced portion” of the CPP; and the Working Income Tax Benefit will be enhanced in order to offset the impact of the CPP rate hikes on low earners.  CPP premiums currently qualify for a non-refundable tax credit on the employee’s portion; proprietors can claim a tax deduction for the employer’s portion.

Proposed enhancements to the CPP would increase the premium rate by an additional 2% (1% for employers and 1% for employees) as well as increasing the maximum insurable earnings.  As a result,  more money will come off the top of workers’ pay,  leaving less for voluntary contributions to self-funded sources of retirement income.  This might include the RRSP (which generates an immediate tax reduction for those who are taxable, but taxes future withdrawals of earnings and principal) or the TFSA (which generates no immediate tax deduction or credit, but which creates future tax-free pensions).

Currently the CPP premiums amount to 9.9% of contributory earnings, when both employer and employee contributions are counted.  Individual employees contribute up to a maximum of $2544.30 annually, and their employers contribute an equal amount. These numbers are based on maximum contributory earnings of $51,400 ($54,900 less a basic exemption of $3500).   Those who are self-employed must contribute both portions:  that’s a maximum of $5088.60 per year or $424.05 per month.

Under the new plan, the maximum contribution level will rise to $82,700 by the year 2025, and there will be a five-year phase-in of increased contribution rates for those below the Yearly Maximum Pensionable Earnings, followed by a two-year phase-in of the upper earnings limit.

Another consideration is the fact that future CPP benefits do not roll over on the death of a taxpayer to their spouse or children. A survivor’s benefit may be possible, but combined survivor and retirement benefits are capped, so the more retirement benefits the survivor has, the less survivor benefits they will receive. Those who die early and never collect CPP benefits can’t leave anything to their heirs from their long time investment in the CPP, short of an unindexed death benefit of $2500.

However, the CPP does provide a disability plan, which is important to younger workers in particular.

This new CPP plan will have the objective of replacing one-third of the taxpayer’s employment income to this ceiling, or approximately $27,300. Under the current CPP rules, the plan’s objective was to replace 25% of employment income to a maximum of approximately $51,000. However, despite the fact that the maximum CPP benefit is $13,110, the average CPP benefits are approximately $8000—about 60% of the target. There are many reasons for this, including the fact that very few people work to the maximum earnings level throughout their entire career.

From a planning perspective, then, it is important to consider how the enhanced investment in a taxable CPP benefit compares to a tax-free contribution to the TFSA (Tax Free Savings Account). We will be crunching some more numbers in future editions, taking into account the new proposals. It’s also the question we’ll be asking for your input on in the Knowledge Bureau’s monthly poll in July.

Also see How Much is Enough, this issue.

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