How much is one year of maximum CPP contributions worth?
I’ve had a number of clients recently who wanted to know how their future CPP contributions would affect their retirement pension. After seeing a range of impacts for this group of clients, it struck me that the issue would be a good subject for this month’s article.
You may have heard me say previously that each year of maximum CPP contributions is worth about $25.00 towards an age-65 retirement pension. That used to be quite valid, but now the actual amount is over $30.00, even without considering the “enhanced CPP” component.
A more accurate answer can be calculated by dividing the maximum CPP retirement pension amount ($1,175.83 for 2020) by 39 years. If we do this, we find out that one year of maximum contributions is worth $30.15.
Where does the 39 years come from? The maximum CPP contributory period is from age 18 to 65, which is 47 years. The general dropout is 17%. What’s left is 83% of 47 years, which is 39 years.
But even this answer is true only in the following situation:
- The contributor starts receiving the retirement pension at exactly age 65, and
- The contributor doesn’t already have 39 years of CPP contributions, and
- The contributor has never been in receipt of a CPP disability pension, and
- The contributor isn’t eligible to drop out any years under the child-rearing provision (CRP), and
- The contributor doesn’t have any earnings in 2019 or later (enhanced CPP).
How does this value change if the contributor starts taking the retirement pension earlier or later than age 65?
If the contributor starts receiving a retirement pension earlier than age 65, each year of earnings will be averaged over a shorter time period (making each year of maximum contributions more valuable), but the retirement pension is reduced by an age-adjustment factor (making each year of maximum contributions less valuable).
For example, someone starting their CPP at age 60 will have their earnings averaged for their best 34.86 years (83% of 42 years), making each year of maximum contributions worth $33.73 ($1,175.83/34.86 years) towards their “calculated retirement pension.” However, when this calculated amount is reduced by the age-adjustment factor for starting it early (0.6% for every month for 2020), we find that each year of maximum contributions is worth only $21.59 towards an age-60 retirement pension.
Related article: How to apply for CPP early?
For someone starting their CPP after age 65, their earnings are averaged for their best 39 years, the same as for an age-65 pension, but the age-adjustment factor makes the one year of maximum earnings worth more. For example, at age 70, one year of maximum earnings could be worth $42.81 ($30.15, as in the calculation at age 65, x 142% for the age-adjustment factor at 70).
How does this value change if the contributor already has 39 years of CPP contributions?
As mentioned previously, an age-65 CPP retirement pension is averaged over your best 39 years of contributions. If you already have 39 years of contributions, the next year of maximum earnings will replace one of those years. If all 39 years of prior contributions are at maximum, you won’t gain anything at all by adding another year of maximum earnings, so the value is $0.00 (except for the enhanced portion in 2019 or later years).
However, if the least valuable of those 39 years was less than maximum, adding a year of maximum earnings would increase your age-65 retirement pension. For example, if the least valuable of those 39 years was at 25% of maximum, adding a year of maximum earnings would increase your age-65 retirement pension by about $22.61 (75% of $30.15).
Related article: How to calculate your CPP Post Retirement Benefit (PRB)
How does this value change if the contributor was in receipt of a CPP disability pension?
If someone receives a CPP disability pension, that period of time is excluded from their contributory period. That means that when their retirement pension is calculated, their earnings will be averaged over fewer than 39 years.
For example, someone who is permanently disabled at age 35 would have only 17 years in their contributory period (from age 18 to 35), and their age-65 retirement pension would be averaged over their best 14.1 years (83% of 17 years). This means that each year of maximum earnings that they had could be worth $83.39 towards an age-65 retirement pension ($1,175.83/14.1).
Related article: CPP disability benefit vs early retirement
How does this value change if the contributor is eligible to use the child-rearing provision (CRP)?
Similar to receiving a CPP disability pension as described above, if someone is eligible to drop out years under the CRP, their earnings will be averaged over fewer than 39 years, making each year of maximum earnings more valuable.
For example, someone who can drop out 10 years under the CRP would have their earnings averaged for their best 30.7 years (83% of the 37 years remaining in their contributory period after the 10 years of CRP are dropped out). This means that each year of maximum earnings that they had could be worth $38.30 ($1,175.83/30.7) towards an age-65 retirement pension.
How does this value change if the contributor has earnings in 2019 or later years, under the “enhanced CPP”?
Beginning with 2019 and for at least the next 40 years, adding one year of maximum earnings will always increase the amount of a CPP retirement pension, even if you already have 39 years of maximum earnings/contributions and even if you’re eligible for the advertised maximum of $1,175.83. That is because the maximum of $1,175.83 is just the base portion of the CPP, and earnings/contributions in 2019 or later years include an enhanced contribution which creates an enhanced component to the retirement pension calculation.
Related article: Understanding Enhanced CPP
The enhanced component to the retirement pension calculation actually contains two portions, known as the first additional portion and the second additional portion.
The first additional portion will replace 8.33% of the contributor’s first additional earnings, averaged over his best 40 years. This means that the first additional portion will one day be as much as $391.79 per month ($56,440 x 8.33% / 12 months), and each year of maximum enhanced earnings would therefore be worth $9.79 towards this first additional portion. Because the enhanced CPP is being phased-in over five years though, the actual value is lower for the years 2019 through 2023.
The second additional portion doesn’t take effect until 2024, and details on its value will be included in this article at some later date.
As you can see, the value of each year of maximum earnings depends on several factors and it can be as low as zero (prior to 2019 and the enhanced CPP changes).