Are You a (CPP) Dropout?
When I was a teenager, some of my acquaintances dropped out of high school. In B.C., where I grew up, the rule was that you had to be at least 16 years old to make that choice. I suspect that far fewer make that choice to drop out these days. To my recollection, none of my children’s classmates dropped out of high school. Indeed, according to Statistics Canada, “the percentage of non-students aged 20 to 24 years who had not graduated from high school in 2016” was only 6%.
Given the increasing emphasis on post-secondary education, whether academic or technical/vocational, it is not surprising that dropping out is becoming a less likely option.
However, this is not a blog post about dropping out of high school. Rather, I am writing about the “dropout” provisions that are used to determine your payments from the Canada Pension Plan (CPP).
Toward Understanding the Canada Pension Plan (CPP) Dropout Provisions
The CPP is a reliable source of income in retirement. You may be surprised to learn that it was not established until 1966. Old Age Security (OAS) is the older of the two main government supports for retirees. While the latter comes from the general revenues of the government and is based on residency, CPP is based on your contributions. The amount you receive is determined by how much you have contributed, by how many years you have contributed, and by the age at which you begin to receive it.
CPP was never intended to cover the entirety of your employment earnings in retirement. For many years, the goal was to cover approximately 25 percent of a person’s earnings from employment, but beginning in 2019, payments have been gradually increasing to replace approximately one-third of earnings from employment. The longer you have to retire, the more closely that one-third of employment earnings coverage will apply to you.
You may be aware that contributions to CPP are made by both you and your employer. If you are self-employed, then you pay both the employee and the employer portions. As of 2022, the Maximum Annual Pensionable Earnings amount is $64,900, of which the first $3,500 is exempt. The contribution rate is 5.70% for each of the employee and the employer, which is maximized at $3,499.80 ([$64,900 – $3,500] x 5.70%) or at $6,999.60 for the self-employed. Not everyone will maximize their contributions, however, which is why, although the maximum pension a 65-year-old will receive in 2022 is $1,253.59 per month, the average as of January 2022 is only $779.32.
There are ways that you can enhance your retirement even if you are retiring now. The first way, which applies to all CPP contributors and is applied automatically, is the general dropout provision.
A Canadian resident’s contributory years begin at age 18. In your early years, you may be pursuing post-secondary education or working at a low-paying job. Either way, since you are not earning a lot, you can exclude them from the calculation of your CPP entitlement. In total, up to 17 percent of your eligible months can be excluded. If you begin receiving CPP at age 65, 17 percent works out to 96 months or 8 years. If, however, you retire earlier than age 65, then 17 percent is based on a shorter contributory period.
What about immigrants who arrive after age 18?
If you immigrated to Canada from another country with which Canada has a social security agreement, you may be able to qualify for pensions or benefits from Canada and/or the other country if you have worked in Canada and made at least one valid contribution to CPP and you also have valid contribution periods that count toward the national pension in that other country.
Note that, even with the agreements, your contributions to CPP are the only factor that will determine your payment amounts at retirement.
Other Dropout Situations
The Child-Rearing Provision
As many working-age people, mostly women, take time off work to care for their children, this is an important provision to be aware of. The child-rearing provision applies to the person who qualifies as the primary caregiver, defined as “the person who was most responsible for the day-to-day needs of the children for the specified periods.” The specified periods that are excluded from the calculation of your pension amount are when your children are under age 7. Let’s imagine you had a child born in March 1988, September 1989, and June 1991. Beginning in April 1988, that is, a month after the first child was born, and ending in June 1998, the month that the youngest child turned 7, these months can be excluded. In this particular example, that works out to 10 years and 3 months.
Note that these months are not automatically calculated. You need to apply for this benefit. You or your spouse must also have qualified for Family Allowance payments or more recently, the Canada Child Benefit (irrespective of whether you received the Benefit).
The Disability Provision
If you receive payments through the CPP Disability benefit, those months will also be excluded from the calculation of your CPP retirement pension. When you are receiving the CPP disability pension, you are not earning an income and therefore not contributing to CPP. These may or may not be tax-free years for you since the CPP disability payments are taxable, you may be receiving taxable income from a group disability plan for which your employer is paying the premiums (not the best arrangement in my opinion, but that’s another story), and you may have investment income from non-registered assets. Regardless, the important thing to note is that these years are excluded from consideration.
For calculations, the child-rearing and/or disability dropouts are applied to your contributory period first, and then the remaining months have the 17 percent dropout applied next, as long as more than 120 months of earnings remain.
Let’s imagine that a woman born on January 16, 1962 chose to retire this month (April 2022). Her contributory period would begin February 1, 1980 and would end this month. That is a total of 507 months or about 42 ¼ years. Using the example of the three children above, 10 years and 3 months or a total of 123 months could be excluded. Let’s further suppose that several years later she experienced a period of disability that qualified her for the CPP disability pension, which she received for two years or exactly 24 months before becoming well enough to return to work. Taking those two dropouts into account, her 507-month contributory period is reduced to 360 months (507 – 123 – 24). From 360, an additional 17% of low-earning months are removed, resulting in her highest-earning 299 months being the base from which her CPP payments are calculated.
As a consequence of the application of the child-rearing provision, the disability provision, and the general dropout provision, fully 41 percent of her contributory period was removed from the calculation of her CPP benefit. However, she does need to consider that she is beginning receipt of her CPP payments almost 5 years (57 months) earlier than the standard retirement age of 65. Consequently, even if all 299 of the remaining months met or exceeded the maximum pensionable earnings, she is still going to receive only 65.8 percent (100% – [57 months x 0.6%]) of the maximum, reducing her monthly payment to $824.86 per month.
The Canada Pension Plan is fairly simple in many ways. As an employed person it is taken off your paycheque automatically. The application process is fairly straightforward. However, the underlying calculations can be quite complex. If you are approaching retirement, arm yourself with this knowledge so that you can maximize the amount to which you are entitled.
This is the 144th blog post for Russ Writes, first published on 2022-04-18.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.