Canada Pension Plan is one of the cornerstones of the Canadian retirement benefits. Everyone that works must contribute to CPP and as a result everyone is eligible to receive a retirement benefit from CPP.
How much you get in benefit depends on how much you put into CPP. For more details on how much you will get from CPP, check out one of my previous articles HOW MUCH WILL YOU GET FROM CANADA PENSION PLAN?
Lately there is lots of talk about enhancing CPP because of the serious retirement gap. Is this really a good deal? Let’s take a look at the current CPP system and see if Canadians are getting value for their contributions.
Going back 40 years
Let's say Bill started working 40 years ago. Back then he only contributed 1.8% of your pay to a maximum of $135.00. From this point, every year his contribution amount would have gone up because of inflation adjustments and increases to the contribution rate. Over the course of 40 years, he would have contributed $44,692.80. Bill's employer would have also matched his contributions. Today, 40 years later, Bill would be eligible for a CPP retirement benefit of $1092.50 per month or $13,110 per year. Is that good or bad?
If we look at it from the perspective of how much money would we need today as a lump sum to generate an annual income of $13,110 per year, we can estimate that we would need somewhere between $230,000 and $330,000. Let's say Bill could have taken his CPP contributions along with the employer contributions and invested it himself he would need to earn somewhere between 6.5% and 8.8% to achieve the $230,000 to $330,000. If Bill did not have the employer contributions, it would be very difficult to replicate a pension of $1092.50 per month.
Related article: How to calculate your CPP retirement pension?
Based on this math, CPP is a pretty good deal for employees. Especially if you add in the fact that the pension is indexed and that CPP is not only a retirement pension but a disability plan as well as a life insurance benefit.
What about the next 39 years?
Today, employees contribute 4.95% of their income up to a maximum of $2,544.30 per year (2016). This is figure is based on the yearly YMPE which is $54,900 for 2016. The YMPE goes up a little each year as a result of being adjusted for inflation.
In addition to the employee contribution, the employer also contributes $2544.30 per year making the total annual contribution $5088.60.
Let's say inflation runs at 1% per year for the next 39 years. That means your contributions to CPP will increase every but so will the monthly CPP retirement benefit. Based on these assumptions, your total contributions over the next 39 years would total $120,631. Your monthly CPP retirement benefit will be projected to be $1599 per month or $19,188 per year.
If we use the same math as we did in Bill's example, we would need somewhere between $320,000 and $480,000 to generate that income. If we were able to take our CPP contributions along with the matching employer contributions and invest that money ourselves, we would only need 2% to 3.5% to grow it to the $320,000 to $480,000. I know a lot of people would look at this and suggest they had a good shot at making more than 2% to 3.5%.
Because of higher contribution rate, the math of CPP is not as attractive as it was for the past 40 years. Regardless of the math, we can't opt out of CPP anyway as it is a mandatory plan. The math does suggest that moving forward CPP an OK deal. You can argue the pros and cons either way.
More than just math
The best part of CPP is your employer is required to match your contribution. If you were to invest only your portion, it would be very difficult to match the CPP retirement pension. For self-employed people like me, we pay both the employer and the employee contributions and if I I were to invest that money I would not need a very high return to equal what I will get from CPP 40 years later. One can argue that the CPP program is not great for self-employed people that pay both the employee and employer contributions.
Remember that CPP is a guaranteed lifetime pension. You get a cheque for as long as you live. And if you have a spouse, your spouse may get part or all of your CPP in the future.
Lastly, CPP is an indexed pension which is very hard for any of us to replicate on our own. The math I have given here largely ignores that which means the numbers argue more in favour of the CPP program.
The bottom line
Like any workplace savings program, if the employer is going to make contributions on your behalf, then you can’t go wrong.
With regards to CPP, the employer‘s matching contribution make CPP a wonderful program and every employee should vote to enhance CPP.
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The employers perspective is a little different.
Enhancing CPP means employer contributions will go up as well. This can have an effect on business. I work primarily with companies and organizations that have pension plans or Group RRSP plans with some form of employer matching or contributions. These companies are already doing their part helping employees with their retirement savings. If the government enhances CPP, maybe they should give employers with a pension plan the option to opt out of increased CPP costs. Or better yet, maybe the government should reward, encourage or help companies to put more Group RRSPs or pensions with employer matching. My guess is many companies would prefer that over being mandated to enhanced CPP.
What do you think?