Tax Tip Thursday

We get questions on the CPP enhancement that has been getting a lot of press lately.

How it’s going to work

By 2019, it became clear that many Canadians were not going to have sufficient savings or assets for their retirement. The government made a decision to essentially enhance the government benefits to make up for the lack of private benefits.

The CPP enhancement

Introduced in 2016 and begun in 2019, the CPP enhancement is a seven-year program designed to boost retirement pensions by increasing the amount of CPP contributions.

How CPP contributions are calculated

Since the CPP was introduced in 1965, Canadian workers have contributed by way of payroll deductions or, in the case of self-employed people, at tax time.

Each Canadian worker can earn up to $3,500 (the “basic exemption amount”) without paying into CPP.

Think of this as your personal base rate when you file your taxes. Any money you earn after that is subject to CPP deductions—up to the year’s maximum pensionable earnings (YMPE). The YMPE is also called an “earnings ceiling”—that is, anything earned above this amount will not be subject to additional CPP contributions.

In 2018, prior to the first enhancement, the rate for Canadian employees was 4.95% (with employers matching this contribution).

Self-employed Canadians paid double—or 9.9%—because for these purposes, they serve as both the employer and employee. So, with a YMPE of $55,900 in 2018, an employed person earning that much or more would pay 4.95% in CPP on $52,400 ($55,900 minus the basic exemption amount of $3,500), for a total of $2,593.80. A self-employed person making $55,900 or more would pay double, for a total of $5,187.60.

The first enhancement, CPP1, went into effect in 2019 with a YMPE of $57,400 and a CPP contribution rate of 5.1% (10.2% for self-employed people). Over the next five years, both the YMPE and the contributions rates increased marginally. In 2023, the YMPE was $66,600 with a contribution rate of 5.95% (11.9% for self-employed people).

The second enhancement (CPP2)

The final phase of the CPP enhancement starts in January 2024. Instead of raising the rates further, this phase adds a year’s additional maximum pensionable earnings (YAMPE), or second earnings ceiling, with a contribution amount of 4% for employees and 8% for freelancers and other self-employed Canadians. In other words, the second earnings ceiling is meant to capture a portion of the income of higher-earning Canadians.

To understand how the CPP enhancements work, let’s use an example of someone with an annual salary of $100,000, to make the math clear.

Jameela from Edmonton earns $100,000 annually as an employee. Under CPP1, with the 2023 rates of 5.95% and a YMPE of $66,600, she would owe $3,754.45, based on the following formula: ($66,600 minus the basic exemption amount of $3,500) x 5.95%. Jameela would pay nothing on any amount she makes over $66,600.

In 2024, with a YMPE of $68,500 and a YAMPE of $73,200, Jameela’s CPP contributions are a bit different. She will pay 5.95% on the first $68,500 (minus $3,500), for a total of $3,867.50. In addition, she owes 4% on the money she earns between the first and second earnings ceilings (or between the YMPE and YAMPE), which is: $73,200 – $68,500 = $4,700. Multiplied by 4%, that comes out to $188. Her contributions will total $4,055.50.

How much are CPP contributions going up in 2024?

As of 2024, the CPP contribution rates for employees and the self-employed are the same as in 2023: 5.95% and 11.9%, respectively, unless they make more than the YMPE, which is $68,500 in 2024 and an estimated $69,700 in 2025.

Workers who make more than the YMPE will contribute more—at a rate of 4% for employees and 8% for freelancers. This rate will only apply to the earnings between the first and second earnings ceilings.

The enhancement

Over time, these enhancements are expected to increase the income replacement rate from 25% to 33% of your average lifetime earnings, thus giving future retirees a more comfortable cushion to rely on.

Who it affects

Canadian retirees can take advantage of the CPP enhancement by simply enjoying the increased benefits that will roll in over time.

Essentially, the longer you stay in the workforce, even if it is part-time, the more you can benefit from these enhancements.

For those approaching retirement, it might be worth considering delaying your CPP benefits for a few extra months or years. Each year you delay taking your CPP, your payments increase by a certain percentage.

When should you take CPP

I get this question all the time.

First, before make any decision, you should arm yourself with the facts. Services Canada has all the information about your CPP eligibility and amounts. I believe you can get there from your MYCRA account and if not, you can set up an account directly with Services Canada. It will tell you what you are entitled to in terms of your CPP benefits.

Second, the amount you are entitled too, is determined by how long you contributed, how much you have contributed and when you start taking it.

The one thing you can know is that Your age affects your pension amount:

• If you start before age 65, payments will decrease by 0.6% each month (or by 7.2% per year), up to a maximum reduction of 36% if you start at age 60
• If you start after age 65, payments will increase by 0.7% each month (or by 8.4% per year), up to a maximum increase of 42% if you start at age 70 (or after).

Seek Help from a Professional

It can be challenging to make sure you’re collecting everything you’re entitled to without accidentally claiming too much, then finding yourself in a tricky situation with the CRA. The best thing you can do is book an appointment with us today so we can help you figure it out!

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.