CPP Premiums Rise in 2021, Competing for TFSA Savings Capacity

Evelyn Jacks

The Canada Pension Plan (CPP) maximum contributory earnings for 2021 and the new premium rate have both risen, adding another financial burden to both workers and employers as the new year approaches.  With required premiums of $6,332.90, eclipsing maximum TFSA contribution room of $6,000, there may be little left to save for a tax-free retirement. Further, there are several other reasons why this rising CPP obligation may bring the wrong after-tax results over the long run.

Specifically, here are the changes in the contributory earnings, rates and premiums for the past three years.  Note that for the self-employed, who must contribute both the employer and employee’s portion, the actual costs of funding their required CPP contribution has risen by $835.10, which is 15% since 2019 and just over 9% from the 2020 payment. It is now over $6300 for the year 2021:

* beginning in 2019, QPP rates vary from CPP rates.  For 2019, the QPP rate is 5.50% resulting in a maximum employee contribution of $2,991.45 ($5,982.90 if SE); for 2020, the QPP rate is 5.7% resulting in a maximum employee contribution of $3,146.10 ($6,292.80 if SE. For 2021 the QPP rate is 5.9% resulting in a maximum employee contribution of $3,427.90 ($6,855.80 if SE).

Is this the best use of retirement savings capacity? For millions of workers, the answer is clearly “yes,” as their contributions are matched by their employers, as the chart shows.

Not so for the self-employed.  Let’s consider an unincorporated business owner first.   

Given a choice, should the taxpayer’s net income levels reach the $61,600 maximum pensionable earnings level, it is necessary to make the $6,332.90 contribution. Should this be reduced, with discretionary deductions like capital cost allowance on a new asset purchase before year end, for example?

On the negative, there are two cash flow implications to the CPP contribution.  The proprietor must add the amounts owing to the taxes otherwise payable on the T1 return.  Not only does this present a big tax balance due, but the requirement to make the CPP contribution could also push the taxpayer into a quarterly tax remittance profile, sapping cash flow to make quarterly instalment payments.

Later, when it comes time to collect on the CPP retirement benefit, the amounts will be indexed, but they are also taxable.

On the plus side, the CPP has a disability benefit feature, which can be tapped prior to retirement.  There is also a survivors’ benefit, but the surviving spouse can only top up their own CPP retirement benefit to the maximum monthly amount for one person, meaning that the rest of the deceased’s retirement benefit is lost. 

Another option is to incorporate and draw dividends, which will result in more favourable tax treatment than the salary draw and no CPP contribution.  The money saved on the CPP contribution can be contributed to the TFSA instead. (Currently, the maximum annual TFSA contribution is $6000).  The investment earnings will accrue tax-free in the TFSA; later, on retirement, both the earnings and the principal will be received tax free as well.  This is a win over the taxable CPP benefit.  (Granted, taxpayers get a CPP deduction for part of their contributions and non-refundable tax credit for the rest while funding the plan. The TFSA, on the other hand, is funded with tax-paid dollars).

There is another advantage to funding the TFSA instead of the CPP.  Upon the death of the annuitant, the estate can receive the full amounts left in the TFSA, sometimes with a rollover to a successor holder who is a spouse.   With the CPP, a death benefit is payable, but it is limited to only $2500.

The increased CPP retirement premiums may well be a very expensive retirement savings plan for the times, given that the average industrial age went down 3.4% because of COVID in April, May and June, according to Statistics Canada.  It’s a bad time for employees to anticipate further erosion to their take-home pay starting in 2021, which will shrink  other savings capacity.

Worse, the increasing premiums may also provide a disincentive for business owners to hire – or retain -  employees in favor or working with subcontractors, to whom the costs of funding their own CPP are passed down.

Talk the options over with your DFA-Tax Services Specialist before year end, especially if you are the owner-manager of a private corporation, with more options for diversity in your compensation and retirement planning.

Additional educational resources:  Learn more about year-end tax planning at the November 18, 2020 CE Summit Virtual Event!