Update: see previous posts – June 19/16 Canada: CPP Changes Being Discussed by Finance Ministers,June 18/16 Conservative Lisa Raitt Opposed to Larger CPP Payouts to Canadians,Jan.4/16 Ontario pension plan will launch in 2017 regardless of CPP changes, Kathleen Wynne says,Nov.11/16 Canada/Ontario Tackle CPP & Retirement Issues
Canada’s finance ministers reached an historic agreement in Vancouver on Monday: an expansion to the $44 billion-per-year Canada Pension Plan. The pressure had built for a deal in two ways. First, CPP expansion was a campaign commitment of the federal Liberal government. Second, Ontario had served notice it would forge ahead with its own provincial Ontario Retirement Pension Plan if the country’s finance ministers failed to reach quick agreement on a Canada Pension Plan expansion. Late Monday afternoon a deal was reached and some of the details began to emerge.
To understand what’s going on with the CPP, it’s easiest to start with how we got here, then assess where we are now, and finally look forward to what’s next.
How we got here
The Canada Pension Plan started operation 50 years ago in 1966 as a stand-alone program based on a federal-provincial partnership. It was introduced to build on the existing Old Age Security, but structured in a very different way. Whereas Old Age Security paid everyone the same amount per month, CPP was structured to depend on your earnings. If you earn more, you pay more into the CPP and you get a bigger pension when you retire.
By the 1980s, the CPP was running annual deficits. Payroll contribution rates were increased, but the deficits persisted into the 1990s. After a multi-year round of negotiations between the federal and provincial governments, a deal was reached to increase contributions still further, limit benefits, and accumulate a surplus to be invested in what is now the $280 billion Canada Pension Plan Investment Board. Through those efforts to fix the CPP, Canada found itself almost alone among advanced countries with a public pension system that was stable and mostly effective.
Over the past five years, analysts noticed that there were pockets of people who were still not doing well under the CPP. In particular, many middle earners without a workplace pension were falling into too-low income ranges after retirement. Low earners were fairly well-covered by other parts of the pension system, but too many current middle-earners were struggling—and future generations might be even worse off if workplace pension coverage continues to slip downward.
The 2015 federal election saw promises by the NDP and the Liberals to expand the CPP, leading Canada’s finance ministers to get back to work in examining CPP reform after the dust settled from the election.
Where we are now
Currently, the CPP covers earnings up to a cap at $54,900. For earnings up to the cap, the CPP aims to replace about 25 per cent of the income. So, the maximum pension comes in it at about $1,092 per month, or $13,100 per year. Contributions are 4.95 per cent for each of the employer and employee, up to the same cap.
The expanded CPP announced Monday is a new, separate tier. This new tier is added on top of the existing CPP. The new CPP tier does two things, phased in over the next nine years to 2025. First, it takes the replacement rate up to 33.3 per cent from the current 25 per cent. Second, it expands the upper earnings cap from today’s $54,900 up to $82,700. To pay for this, the Globe and Mail reports that the contribution rate will go up by 1 per cent for both employers and employees. These new contributions will be accounted for separately and will be deductible for tax purposes—unlike current CPP contributions which only get a non-refundable tax credit.
For low to middle earners who are currently at or under the earnings cap, this new CPP will boost their pension by about one third. Whereas the old CPP replaced just 25 per cent of their earnings, the new CPP will expand that up to 33.3 per cent. For those earning more than today’s $54,900 earnings cap, the upward expansion of the earnings cap toward $82,700 means they are now covered at 33.3 per cent over earnings in the $54,900 to $82,700 range that were previously not covered at all. Because of this extra coverage, middle-to-high earners will eventually see a substantial increase in their CPP cheques—paid for by much heftier CPP premiums when they are working.
This deal was signed by eight provinces—only Quebec and Manitoba withheld their signatures. For Quebec, they operate a separate-but-similar Quebec Pension Plan, so they may follow a different path for expanded pension coverage. The Globe and Mail reports that Manitoba’s signature may soon be added once the newly-elected Manitoba government has some more time to analyze the CPP expansion. With this broad support, the legislated double test (two-thirds of population and two-thirds of provinces) for CPP reform is met.
The political and legislative cards will be played quickly. The Canada Pension Plan Act says that once a sufficient number of provincial governments have indicated support, the federal government can move forward and lock in the reform with an Order in Council—no new Parliamentary debate or legislation is required. From that point forward, the expansion will be fixed in place unless amended through a subsequent agreement of two-thirds of provinces to reverse the expansion—which is very unlikely. So, the only way this CPP expansion can be held back now is if some of signing provinces decide to reverse their position in the next few weeks before indicating final support to the federal government. The federal and Ontario governments issued a joint press statement on Monday declaring that approval from provinces must occur by July 15th—less than a month from now.
The economic reaction will take longer to play out during the nine-year phase in period. As the payroll contributions increase after 2019 there may be some temporary downward pressure on wages or employment, but with the payroll contribution increase limited to 1 per cent for most workers, this pressure will be limited. The bigger move will be for those with existing workplace pension plans. In the past, CPP changes have resulted in offsetting changes by workplace pensions. For this CPP expansion, employers and employees may decide to shrink their workplace pensions over the earnings range where CPP is newly expanded so that workers are not ‘over’-covered. Those workplace adjustments will take some time to negotiate—but the slow phase-in of the CPP expansion will allow sufficient time for the adjustments to take place.
Over the next few weeks, we can expect a flurry of analysis and opinions on this CPP expansion. The analysis may show it falls short in some ways. For example, this expansion may not effectively target those middle-earners at the greatest risk of pension problems. However, we should keep in mind the difficulty of attaining the cross-Canada consensus necessary for CPP reform. If we miss this opportunity another generation may pass before the chance for CPP expansion arises again.