Understanding Your Retirement Benefits: Part 1 – CPP

Imagine celebrating at your retirement party without a clue as to how much you can expect to receive in pension income. It sounds incredible, but many people who will end their career in a few years are in just that situation.

When you work for an employer you receive your salary, but once retired your income can come from multiple sources. You need to know how much you will receive from these sources.

Related: Necessity Tetris – Retirement Income Edition

Since CPP is one of the cornerstones of retirement income, this is where I will begin.

A brief history of the CPP

The Canada Pension Plan (CPP) is a national public plan that covers people in all provinces except Quebec. It was created in 1966 by the government under Lester B. Pearson. Quebec wanted their pension monies to be under their control and so became the only province with its own program.

When CPP was created the contribution rate was 1.8% of pensionable earnings to be shared by employers and employees, and self-employed persons were on the hook for the full amount. The first deductions were so minuscule that they were unsustainable to fund the retirement costs of the baby boom generation who were just beginning their working years. Also, life expectancies were starting to increase substantially.

The contribution rate rose steadily until now where it stands at 9.9% of pensionable earnings (between $3,500 and $53,600 per year). The required contribution increases each year because of indexing.

Retirement benefits

CPP offers several types of payments, but for most people the most important payment is the retirement benefit. You can begin to draw it as early as age 60 or as late as 70.

Your CPP pension is based on how much you have contributed to the plan and provides income for life.

Related: An easy way to estimate your CPP benefits

The amount is indexed to inflation, so your payment will gradually increase each year. In 2015, the maximum benefit for a sixty-five-year-old is $1065, or $12,780 per year. However, most people don’t receive the maximum because their income was below the ceiling (MYPE) and/or they don’t have enough contribution years. The average monthly payment is $618.59.

Even those who qualify for the maximum are replacing only a small portion of their income. The 2015 annual payment was only about 24% of the year’s maximum pensionable earnings. Those earning more than the maximum pensionable earnings receive no additional credits so the percentage of income replaced by CPP lessens the higher a person’s earnings.

Drop out years

The number of low-income years that can be dropped out of the pension calculation increased to 17% in 2014, which will increase your monthly payment.

Related: CPP’s Child Rearing Dropout Provision

Someone who starts contributing to the CPP at age 18 and continues until 65 has a career span of 47 years. Since the retirement benefit is calculated on “average career earnings,” the more low-income years you record over that period, the smaller the payment.

Under the 17% rule, eight years can be dropped. Workers can also apply to exclude any low-income years when they were the primary caregivers of their children under the age of seven. Excluded as well are any months when a person received CPP disability payments.

Receive benefits early or late?

You can increase the amount of your pension by postponing your application. As of 2014 your CPP payment will increase by 0.7% for every month you delay drawing benefits after you turn 65. You must begin drawing benefits by age 70. If you wait until then, you’ll receive 42% more than if you had applied at 65.

Conversely, if you apply early you’ll pay a penalty of 0.58% a month in 2015, increasing to 0.6% in 2016. At that point, a person who starts receiving benefits on her 60th birthday will receive 64% of the benefit she would have received if she had waited until 65.

Related: 8 retirement mistakes to avoid

If we apply those percentages to the 2015 maximum retirement benefit (not counting yearly indexing), the person who waits until 70 would get $1512.30 per month. Someone who begins to collect at 60 would receive $694.38 per month.

Although there are many calculations around about the mathematical break-even points of taking your CPP benefits at various ages, the benefits are designed to be actuarially neutral for average life expectancy.

So, when does it pay to take CPP benefits early?

• If you expect your life expectancy to be reduced due to poor health.
• If you retire before age sixty-five and had several no- or low-income years over and above the allowed drop out years there may be no advantage to waiting.
• Your income is low enough to qualify for GIS.

Why delay taking benefits?

• If you expect to have a longer than average life expectancy.
• You plan to continue working and earn a good income.
• Your benefit amount is tiny and you want to beef it up.

Quite simply though, if you need the money, you need the money. Many planners suggest taking the money as soon as possible, but a lot depends on your personal circumstances.

Taking benefits while working

In the past, once you began drawing CPP benefits you no longer had to make contributions – you were CPP exempt. Now, anyone between 60 and 65 who draws CPP benefits while continuing to work will be obligated to carry on making contributions to the plan.

Related: Do we need to beef up our CPP?

From these extra contributions you will receive a small annual post-retirement benefit (PRB) to a maximum of $26.63 that will be added to your retirement pension in January, even if the maximum CPP benefit amount is already being received.

Contributions after 65 are voluntary until age 70.

Pension sharing

Retired couples can now pool the portions of their pensions that they earned while they were together. The total payout won’t change, but couples may get to keep more of it if splitting the pension puts more income in the hands of the spouse in a lower tax bracket.

Unlike other pension splitting rules however, the CPP pension split can only be done on a 50-50 basis. Couples must agree to this in writing.

Related: Do you support a guaranteed minimum income for Canadians?

Also, CPP credits earned by divorcing partners during their time together from 1977 onward may be subject to division.

Survivor benefits

When changes were made to the CPP, the formula for calculating combined retirement and survivor benefits after age 65 was altered. As a result the combined benefit is capped at the maximum retirement pension, adjusted based on the survivor’s age.

So, someone already receiving the maximum CPP benefit will not receive any survivor benefits on his or her spouse’s death, no matter how much the deceased had paid into the plan.

Non-working spouses are entitled to 60% of the spouse’s pension, and if you are widowed more than once, only one survivor pension will be paid.

Final Thoughts

In planning your retirement income needs you need to discover how much you will receive from CPP. Many people assume they will get the maximum because that is the amount used in many income calculators and articles.

Related: Can I afford to retire?

Go on line to My Service Canada to obtain your most recent CPP statement of contributions. Check your current CPP entitlements and get some estimates of your future benefits with their calculators. If you prefer the personal touch, just give them a call at 1-877-454-4051.

If you’re still with me, you should soon have some understanding of how much you will receive in CPP benefits at various ages. Jot these figures down in your retirement income planner. Next time, I will discuss the other government income support programs – OAS and GIS.