The federal government, acting in concert with the provinces, has recently made a series of changes to incentives that seek to delay employees taking their CPP retirement pensions, until at least age 65. In part, these changes were brought on by government reaction to the economic and financial crises plaguing the world since the American housing bubble burst in 2008.
This article describes how these incentives affect employee CPP retirement pensions. These changes affect employees whose CPP retirement pensions commence on or after January 1, 2011. Employees who were already on CPP retirement benefits as of that date are mostly, but not completely, unaffected.
Before these changes, employees who applied for and received CPP retirement pensions no longer paid CPP contributions, as of the month a CPP retirement pension became payable. Starting in 2011, there is now a difference between employees aged 60 to 65 and those between 65 and 70. All employees aged 60 to 65 must now pay CPP contributions, the same as any other employees. By contrast, employees aged 65 to 70 now have the option to either continue CPP contributions or to stop paying them. The default is that CPP contributions continue after age 65. Employees between ages 65 and 70, who wish to stop CPP contributions have to explicitly apply. This application, filed with the employer, is made on form CPT30, Election to Stop Contributing to the Canada Pension Plan, or Revocation of a Prior Election. These two changes apply to all employees, even those whose CPP retirement pensions started prior to 2011.
Under the old rules, it was obviously an incentive to take your pension early, since this meant CPP contributions stopped. This incentive was particularly forceful for persons with self-employed income, on which the contribution rate is 9.9%. Under the new rules, for persons aged 60 to 65, this incentive has been removed.
As an added incentive, for employees aged 60 to 70, there is now a new element to CPP retirement pensions. This is called the post-retirement benefit and is payable to those aged 60 to 70, who continue CPP contributions. Under the old rules, the monthly pension payable was fixed, other than for yearly indexing based on the CPI, once retirement benefits began. The same is still true, for basic CPP retirement benefits, no matter what age employees are when they apply for CPP. However, under the new rules, CPP contributions between the ages 60 and 70 entitle employees to the new post-retirement benefit.
The post-retirement benefit is based on pensionable earnings for employees between age 60 and 70, who are being paid CPP and who continue making CPP contributions. As above, these contributions are now mandatory till at least age 65. The gist of it is that 0.625% of any such earnings are payable as a post-retirement benefit, starting in the year following. The actual calculation is also affected by changes in the Year’s Maximum Pensionable Earnings, as well as by earnings subject to both the CPP and the QPP. Since these are a little more complicated than can be explained here, what follows is an approximation of the actual calculations.
Example: Kate is aged 67 in 2012. She applied for and began receiving a CPP retirement pension, at age 63, in 2008. She has not filed a form CPT30 with her employer, so her pensionable earnings, up to the YMPE, are subject to CPP contributions. In 2011, Kate’s pensionable earnings were $35,000. Starting in January, 2012, Kate’s monthly CPP benefits increased by approximately $18.23 per month ($35,000 at 0.625%, divided by 12).
It’s important to point out that no additional CPP contributions are required in order to earn these post-retirement benefits. Only the normal CPP contributions are required, on pensionable earnings between the basic exemption and the YMPE. Further, once post-retirement benefits have been earned for a particular year, they continue year after year. So in the example above, if Kate had a further $35,000 in pensionable earnings in 2012, starting in 2013 her monthly benefits would grow again by roughly another $18.23 a month, meaning a monthly increase over her 2011 benefits by approximately $36.46, apart from any CPI related changes. Since, employee CPP contributions are made at 4.95%, and post-retirement benefits are payable at 0.625%, any CPP contributions after age 60 are fully recovered within approximately 8 years (4.95% divided by 0.625% is 7.92 years). In Kate’s example above, any CPP contributions made for 2011, will be fully recovered by the related post-retirement benefits received during the years 2012 to 2019, inclusive.
Other major changes are increased penalties for taking CPP before age 65 and increased rewards for delaying CPP until at least age 70. Before these changes, for every month prior to age 65, pension benefits were reduced by 0.5% per month. Similarly, for every month after age 65, and before age 70, that CPP was not taken, retirement benefits increased by the same half a percent. After these changes, these penalties are being increased from 0.5% to 0.6% and these rewards from 0.5% to 0.7%. The increased penalties are being phased in over a 5 year period, with the penalty rate increasing by 0.02% in each of these 5 years, from 2012 to 2016. The increased rewards are being phased in over a 3 year period, from 2011 to 2013.
Example: Mark plans to take his CPP retirement pension in 2012, starting the month he turns age 62. From that month there are a total of 37 months till an unadjusted CPP retirement pension becomes payable. It’s not 36 months, since the penalty for taking CPP early stops for pensions that start the month following the actual 65th birthday. In 2014, the penalty factor applied to each of these months is 0.56% (0.002% times the 3 years after 2011). At 37 months, the penalty applied to Mark’s CPP benefits is 20.72% (37 times 0.56%).
This penalty applies to Mark’s regular CPP retirement benefits, for each month these are payable. A similar penalty applies to post-retirement benefits. However, during the transition years 2012 to 2015, the penalty is calculated separately for post-retirement benefits becoming payable in each of those years. For example, if Mark qualified for post-retirement benefits, starting in 2015, based on his 2014 pensionable earnings, the penalty factor applied to the benefits starting in that year would be 0.58%. By contrast, the penalty factor applied to post-retirement benefits starting in 2016, based on pensionable earnings in 2015, would be 0.6%, for as long as those benefits are paid.
The last changes starting in 2011, deal with the number of months used to calculate regular CPP retirement benefits. These benefits are based on the number of months between the 18th birthday and the month a retirement pension becomes payable, termed the contributory period. For this purpose the actual month of the 18th birthday and the month a retirement pension becomes payable are both excluded. So, for example, there are 538 months in the contributory period of an employee whose CPP retirement benefits start the actual month of the 63rd birthday ([63 – 18] times 12, less 2). This is an approximation, since other factors are also at play, such as the person having being on CPP or QPP disability benefits. Don’t confuse this contributory period with the requirement to make CPP contributions. An employee can have started CPP retirement benefits, but still be required to make CPP contributions (see opting out above).
Prior to the 2011 changes, employees were allowed to drop 15% of this number from their contributory period. Under these old rules, CPP retirement benefits started at age 63, as above, would be based on 457 months (538 at 15%, rounded up to 81 whole months, subtracted from 538). Similarly, the pensionable earnings for this same number of months could be excluded, where these earnings were lower than other months in the contributory period.
This allows employees to drop out of the labour force for short periods of time or to have other periods of lower earnings, without affecting CPP retirement benefits. Regular CPP retirement benefits are based on monthly average earnings. Reducing the count of months in the contributory period denominator, while reducing equivalent low-income months from the earnings numerator increases the resulting monthly average.
The changes made, starting in 2011, allow employees to drop further low-income months from the average on which regular CPP retirement benefits are calculated. The percentage of low-income months excluded is 16% for CPP retirement benefits starting after 2011 and 17%, for those starting after 2013.
The last incentive for delaying CPP retirement benefits after age 65, has not been changed by these new rules. For every month, an employee delays taking a CPP retirement pension after age 65, an equivalent number of months can be dropped from the contributory period described above. This also means an equivalent number of months of low-income earnings can be dropped from the earnings used to calculate regular retirement benefits.