CPP: Why You May Get Less Than You Expect
The Canada Pension Plan (CPP) is a secure foundation of income for many retirees. It provides a steady stream of payments which increases each year along with inflation. Knowing how much you will receive is a crucial part of retirement planning. However, many new retirees are surprised to learn that they won't receive the maximum benefit. This can be the case even after years of earning a high salary. In this article, we'll look at factors that can lead to a reduction in your CPP retirement benefit.
Understanding CPP Retirement Benefits
The 2023 maximum monthly CPP benefit (at age 65) is $1,306.57. The average benefit is much lower, however, being $772.71 as of June 2023.
To understand why you may receive less than full CPP, it's helpful to know a few details about how it's calculated.
The Canada Pension Plan is a retirement program that is based on contributions. Starting when you turn 18, you are required to make contributions based on your earned income. Employees make half of the contributions while your employer pays the other half. Those who are self-employed pay both portions.
Contributions are made each year up to the annual income limit. This is called the year's maximum pensionable earnings (YMPE). For 2023, the YMPE is $66,600. Since no contributions are made past this level, no further CPP benefits are gained for those with very high incomes.
Let's look at situations which may lead to lower retirement benefits:
Periods of Low Income
Your 20s may seem like ancient history, but they still have an impact on your future CPP retirement income. Your benefits are based on your entire work history, so these early years matter just as much as later years.
Many people have periods of low or no contributions during their 20s while a student or starting their career. These years can bring down your average CPP contributions. To find out if you had periods of low income, you can create an account on Service Canada's website and find your contribution history.
Retiring Early
Even if you've had a consistent employment history so far, if you retire early you may still have a reduction. The years without income during the CPP contributory period could reduce your average contributions. When reviewing your estimated CPP in your My Service Canada Account, be aware that it is based on your history so far. If you retire early, the years between retirement and the start of your CPP can count against you.
Marital Split
Separation or divorce can also affect your CPP payments. Contributions that you and your spouse or common-law partner made during the time you lived together can be equally divided. This is called CPP credit splitting. The impact this has on you will depend on the amount of time you lived together and if there was a difference in your incomes. If your prior partner earned less than you while you were together, your CPP credits may be adjusted downwards after the split.
Starting CPP Early
The age you start receiving CPP has a major impact on the benefits you receive. You can begin CPP as early as age 60, but your benefit will be reduced. For each year you choose to start before your 65th birthday, your benefits will be permanently reduced by 7.2%. If you start at age 60, that means a 36% reduction.
Starting early can be appealing if you need the income immediately, but the benefits of waiting are great. Each year you wait to start CPP after age 65 increases your benefits by 8.4%. This builds up to a total of a 42% increase at the maximum deferral age of 70.
Avoiding the Reductions
Despite these factors that can reduce your CPP benefits, there is a provision that can prevent the reduction. This is known as the "drop-out provision." It allows for the lowest-earning years in your working life to be excluded from the calculation of your CPP benefits.
The general drop-out provision excludes 17% of your lowest-earning years from the benefit calculation. For those retiring at age 65, this usually means that up to eight years of your lowest-earning working years are not counted.
Additionally, there are specific drop-out provisions for child-rearing and disability. The child-rearing provision can exclude low-earning years spent caring for children under the age of seven. The disability drop-out provision is for periods when you received CPP disability benefits.
Knowing your level of pension income
In summary, various elements can influence the size of your CPP retirement benefit. However, provisions like the drop-out rule are designed to compensate for times of low or no earnings. If you have many years of low earnings, you still may be subject to a reduction.
Even if your CPP pension is lower than you expected, it may still be possible to build it up with the CPP Post-Retirement Benefit.
If you’re feeling overwhelmed by all the work needed to create your retirement plan, you can book a free introductory meeting with me.
