Good policy and unfortunate timing meet head-on in coming changes to the Canada Pension Plan.
Inflation and high interest rates are steadily grinding away at household financial resilience, and the burning question about the economy right now is how severe an expected recession will be. And yet, CPP premiums for workers and employers will rise on two fronts next year.
What will the extra CPP costs for workers mean in retirement? Let’s zero in on young workers because they’ll pay the most as a result of the changes, and receive the most benefit.
The first change coming next year is that workers and employers will each pay 5.95 per cent of earnings between $3,500 and $68,500 next year, up from the maximum of $66,600 in 2023. This is a normal increase reflecting rising wages, and it amounts to $113.05 per worker for the year. Nothing onerous, in other words.
The second change is somewhat controversial because it will increase costs more substantially for higher-income workers and their employers. Next year, they will each pay a 4-per-cent contribution rate on earnings between $68,500 and $73,200, which means an extra $188 at most for the year. According to Canada Revenue Agency estimates, this second leg of CPP contributions will apply to incomes up to an estimated $79,400 in 2025 and cost roughly $388 each for workers and employers for the year.
These two extra helpings of contributions are the second stage of a CPP enhancement plan that was launched in 2019 with a goal of increasing the maximum amount future retirees receive by as much as 50 per cent. (The first stage of the process increased contributions for workers and employers from 4.95 per cent of what’s called “pensionable earnings” to the current 5.95 per cent.)
The effects of CPP enhancement will be felt by all contributors, but minimally if you’re close to retirement. The full impact will be felt 40 years from now, so let’s look at the how they affect someone who is 28 today and will work until age 68. That won’t in any way be unusual for millennials, by the way.
Numbers in this analysis come from David Field, a certified financial planner at Papyrus Planning, and the co-developer of CPPCalculator.com. They’re based on a hypothetical worker who made $10,000 annually for ages 20 through 22, $60,000 for ages 23 through 25, $65,000 from ages 26 through 27 and then $75,000 or more at age 28 and beyond.
Our 28-year-old would pay $15,008 in additional CPP premiums over their working life as part of the second phase of CPP enhancement, Mr. Field reports. At age 68, this person would receive an additional $305.11 per month over the current CPP benefit level, which means it would take slightly over four years of receiving CPP benefits to make back the additional premiums paid through CPP enhancement.
The reason for beefing up the CPP is to provide more retirement financial stability to future retirees. While reliable as a source of income for life, the CPP pays a maximum retirement benefit of $1,306.57 for people who retire at 65 and an average benefit of $772.71. Annualized, those amounts work out to $15,678.84 on the high side and $9,272.52 for the average.
Mr. Field calculates that our 28-year-old would end up with a CPP retirement benefit of $2,532.75 in 2024 dollars by starting at age 68, or $30,392.64 per year. That’s still not enough to cover retirement expenses, even in combination with Old Age Security. But it is a more substantial foundation.
The financial pressure on people of all ages will make even the modest extra costs of CPP enhancement tangible for some people. But today’s financial stresses also highlight the importance of nudging CPP contributions higher on an involuntary basis.
Coping with costs for groceries, mortgages payments and more, some households may be forced to cut back on saving for retirement. Forty years from now, the extra payments into the CPP in the years ahead may help fill that hole. That’s full value.
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Rob Carrick