Creating a retirement plan can be a really confusing and frustrating process. Many of us will arbitrarily save into a RRSP and hope that this will be adequate. However, the key to a successful retirement plan is to target just how much money you anticipate to need in retirement and to avoid the trap of saving too little or even too much money. One of the key steps in any retirement plan is to understand how much you will collect from the Canadian Pension Plan and this is exactly what we will be talking about today.
Please note, I’ll be hosting a retirement planning session on Saturday, February 6th, 2016 at the Green Beanery in Toronto. Limited spots are still available! Registration is available here.
The Basics of the Canadian Pension Plan
The Canadian Pension Plan (CPP) is one of those topics that most Canadians loathe to think about and even then, only when they need to. All the years that lead up to your retirement actually build your pension fund and some simple foresight can help you out immensely. I promise, your future self will thank you.
Understanding your Canadian Pension Plan is actually a lot easier than you may think. The general idea is that all Canadian workers, excluding those from Quebec, that are aged 18-65 are required to contribute a portion of their income to this pension. You are then normally able to withdraw these funds when you’re aged between 60 and 70. If you withdraw the funds before 65 then this will reduce your monthly payment and if you delay the use of the funds until after 65, then you get an increased payment.
How Much Do I Need to Pay Into the CPP?
So as mentioned, all Canadians between 18-65 are required to contribute to the Canadian Pension Plan. If you’re an employee of a company, you will contribute 4.95% of your pre-tax income that’s between $3,500 and $54,900. So therefore, the maximum amount that you’ll contribute in 2016 is $2,544.30. Please note that the “yearly maximum pensionable earnings” ($54,900) increases every year, while the exemption amount of $3,500 has been unchanged for several years.
An example of a typical annual CPP contribution calculation;
If you’re self-employed, you will need to contribute 9.9% of the yearly maximum pensionable earnings. This equates to an maximum annual amount of $5,088.60 in 2016.
So How Much Will You Get?
As mentioned, knowing your future Canadian Pension Plan payment is required to create a proper retirement plan. Of course, this number will be an estimate, but it can be updated as required. The amount that you get from your Canadian Pension Plan really depends on how much you have contributed towards it. Specifically, how many years you’ve contributed and how much you have contributed in comparison to the yearly maximum pensionable income.
To determine your monthly payment, we begin by looking at how many years you’ve contributed to the Canadian Pension Plan between the age of 18 to 65, which is a total of 47 years. Currently, the government lets you exclude 17% of your lowest income years, leaving us with a total 39 usable years. Thankfully, you can also apply to reduce the eligible years further for any years spent childbearing.
The next part of the equation is to determine what percentage of the yearly maximum pensionable earnings (YMPE – $54,900 in 2016) you’ve been contributing. For example, if you always earned 80% of the YMPE for all of the applicable years, then you will get 80% of the full CPP payment. So, your CPP payment will be in proportion to the amount of income you’ve earned compared to the YMPE.
Since determining how much you earned in comparison to the YMPE can be complicated, you can order a copy of your CPP statement of contributions to help make a forecast. You can receive a copy by phoning Service Canada at 1-800-277-9914.
The maximum monthly payment that you can receive in 2016 is $1,092.50, but the average amount that Canadians receive is $629.33. This monthly payment is fully taxable and will be taxed at your applicable tax bracket. As mentioned, this payment is determined by the amount of contribution years and your earnings compared to the YMPE.
You’re monthly payment will also fluctuate by when you decide to start receiving it. You can start receiving your CPP as early at 60 years old, but you’ll lose 0.6% for every month that you receive it earlier up to a max of 36%. However, you can delay withdrawals up until 70 years of age, with an extra 0.7% per delayed month to a maximum of 42%.
There’s also an assorted amount of extra payments that households can receive. While not going into depth here, there are extra benefits for disabled individuals, spouses with deceased significant others, and more. Your CPP can also be reduced if you separate or divorce from your significant other.
CPP payments can also be split between spouses and common-law partners. This strategy is effective if one partner can reduce their income taxes by transferring a portion of their pension to their significant other. This strategy doesn’t work for everyone, but it can be helpful.
So this is how the Canadian Pension Plan currently works. This information can be combined with other forecasted retirement income sources to determine if there is a gap between what you want to earn during retirement and what you’re currently forecasted to earn. You can then close this gap accordingly.
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