The CPP also allows parents to exclude low-income years while raising children under seven.Nikolay Amoseev/iStockPhoto / Getty Images
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This is the latest article in our series, Planning for the CPP, in which Globe Advisor explores the decisions behind when to take CPP benefits and reviews different aspects of the beloved and often-debated government-sponsored pension plan.
Canada Pension Plan (CPP) benefits play a big role in how soon – and how comfortably – many Canadians can retire. The amount received depends largely on a person’s lifetime CPP contributions and when they decide to start taking the pension. Then, it gets a little more nuanced.
CPP calculations also remove or “drop out” Canadians’ no- or low-income years, such as the start of their careers when salaries tend to be lower, time away from the workforce to raise kids, or time off due to a disability. CPP benefits are usually higher once these drop-out years are removed.
Understanding how drop-out years impact CPP benefits is critical for advisors when developing financial plans for clients.
General drop-out years
The most common CPP provision is the general drop-out years, says Matthew Castling, senior financial planner with the Bender, Bender, & Bortolotti team at PWL Capital Inc. in Vancouver.
When the CPP calculates the base component of a person’s pension, it drops out up to eight years (or 96 months) of their lowest earnings from age 18 to 65. That’s 17 per cent of those 47 years. Mr. Castling notes the 47-year maximum can be further reduced by child-rearing and disability drop-out years, which are done before the general drop-out calculations.
Also, the 17-per-cent drop-out provision is only applied if there are more than 10 years of earnings and after accounting for child-rearing and disability drop-out years.
A common scenario Mr. Castling comes across is people who retire before 65 and see their CPP reduced because of the number of zero-contribution years in their calculation. For example, someone who retires at 60 would make no contributions for the five years between 60 and 65. However, Mr. Castling says someone who has made maximum CPP contributions consistently throughout their working life may not be affected by retiring early due to the available drop-out provisions.
Some people who retire early may wish to delay starting their CPP as long as possible as it will result in a higher monthly payment, says Jason Heath, certified financial planner and managing director at Objective Financial Partners Inc. in Markham, Ont.
Mr. Heath says there can be a misconception that, by starting CPP at 60, someone can avoid being penalized by the no-income years from 60 to 65.
“It doesn’t work that way,” Mr. Heath says. “If you start taking your CPP benefits early, before 65, the reduction you get for starting early is bigger than the reduction you get for a single zero-income or low-income year. So, while no- or low-income years may reduce your CPP pension a little bit, starting earlier would reduce it even more.”
Child-rearing provisions
The CPP also allows parents to exclude low-income years while raising children under seven years of age. Mr. Heath notes these are accounted for before the general drop-out is calculated.
“It means you’re not penalized for having low-income years while your kids are young, and can potentially enhance your pension through that provision,” he says.
Mr. Heath notes that the government doesn’t calculate child-rearing years automatically like it does with general and disability drop-out years. Parents need to fill out a separate form to exclude their child-rearing years when applying to start their CPP benefits at age 60 or later.
If there are overlapping children in the child-rearing provision timeframe, the drop-out timeframe runs from the month after the first child is born to the month the youngest turns seven. Mr. Heath says the parent who claims the drop-out years is normally the same one who qualified under the previous family allowance or the current Canada Child Benefit.
Mr. Castling of PWL adds that there’s a new “drop-in” provision for child-rearing as part of the recently enhanced CPP that started in 2019. These credits are based on the qualifying parents’ average contributions for the five years before the child was born.
“In effect, your enhanced CPP average would remain unchanged, as if you had continued to work at the same contributory level during the child-rearing years,” Mr. Castling says.
The disability provision
Canadians can benefit from the disability drop-out provision if they’ve received CPP disability benefits during their career. Like the child-rearing provision, the disability provision removes years someone received a CPP disability pension from the base component of their CPP benefit.
“This will increase your CPP retirement pension and may help you qualify for other benefits,” Service Canada states on its website.
With the enhanced CPP that took effect in 2019, the CPP says it will “drop-in” credits for the time someone was disabled. According to Service Canada, the credits equal 70 per cent of someone’s average earnings covered under the CPP enhancement in the six years before they became disabled.
“This will increase your retirement pension as well as your spouse or common-law partner’s survivor’s pension,” Service Canada states, adding that it will do the calculation based on information it already has, which means people don’t need to apply.
Why CPP estimates are just estimates
Projecting CPP benefits can be a challenge for advisors because Service Canada doesn’t include all the drop-in and drop-out provisions in its estimates, Mr. Castling says.
“That means their estimates are usually lower than what someone would actually receive,” he says. “From a financial planning standpoint, that’s not ideal as we like to have as accurate information as possible when building people’s financial plans.”
CPP estimates also don’t include future inflation, Mr. Heath notes.
“So, if someone in their 50s has a projected pension of, say, $800 a month at 65, that doesn’t take the annual CPP inflation adjustment into account. So, it might underestimate your pension a little bit,” Mr. Heath says. “That might not be a bad thing.”
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