The provincial and federal Ministers of Finance have jointly recommended changes to the Canada Pension Plan (CPP) that are intended to make the CPP fairer.

The proposed changes focus primarily on increasing contributory benefits and adjusting rates for early and postponed retirement. This Communiqué will be of interest to Canadian employers and their employees.

Contributions for working pensioners under age 65

Currently, employees under age 65 who work while receiving a CPP pension cannot contribute to the CPP. Under the proposed changes such employees will be required to make CPP contributions, as will their employers. In return, the employee will receive an additional CPP pension of up to 2.5% of the maximum CPP pension. This would represent, in current dollars, 2.5% of $10,905 or $273. The additional CPP pension “purchased” in any one year would commence in the immediately following year, subject to any applicable early retirement reduction. The effective date of this measure is 2011.

Elective contributions for working pensioners over age 65

Similarly, employees over age 65 who work while receiving a CPP pension cannot currently contribute to the CPP. Under the proposed rules, such employees may elect to make CPP contributions. If a pensioner elects to contribute, his or her employer will also be required to contribute. The additional benefit derived from such contributions will be determined in the same manner as for employees under age 65. The effective date of this measure is 2011.

Removal of work cessation test

Under the current rules, in order to qualify for a CPP benefit before age 65, an employee must not earn more than a certain amount in the month the CPP pension commences to be paid and the month before. Currently this amount is approximately $900. This earnings test is referred to by the government as the “Work Cessation Test”.

Under the proposed rules, the Work Cessation Test will be removed for employees who commence their CPP pension in 2012 and later. However, employees under the age of 65 will be required to contribute while working in return for an increased benefit, as explained earlier.

Increase in the General Low Earnings Drop-Out

Since the CPP is a career average plan it allows for certain years of low or no earnings to be disregarded in arriving at average earnings. Currently, 15% of an employee’s potential working career may be disregarded. Under the proposed rules, the drop-out percentage will be increased as follows:

• to 16%, in 2012. This would allow a maximum of 7.5 years to be dropped, based on a working career of 47 years (age 18 to 65).
• to 17% in 2014. This would allow a maximum of eight years to be dropped.

Change to Pension Adjustment Rates for Early and Late Retirement

Currently, if the employee’s CPP pension commences before age 65, the pension earned is reduced by 0.5% for each month preceding the individual’s 65th birthday. Accordingly, a 60-year old’s pension would suffer a 30% reduction. Similarly, an employee who commences his or her CPP pension after age 65 is entitled to an increase in the pension of 0.5% for each month after age 65 (but not beyond age 70). A CPP pension deferred to age 70, therefore, would be increased by 30%.

Commencing in 2012, and phased in over a period of five years, the 0.5% reduction percentage for early retirement would be increased to 0.6%. Commencing in 2011, to be phased in over a period of three years, the 0.5% increase percentage for postponed retirement would be increased to 0.7%. The government proposes to review these adjustments periodically.

These changes are intended to reflect shifts in the economic and demographic factors and seek to achieve an “actuarially fair” level for early and postponed retirement adjustments.

Effective date

If the proposed changes are approved by Parliament and the provincial governments they will come into force on the various dates indicated, but no earlier than 2011. The change to the Work Cessation Test will not apply to those who commenced receipt of a CPP pension before 2012 – all other changes will not apply to those who commenced receipt of a CPP pension before 2011.  Draft legislation has not been released at this stage and the precise mechanics of the new rules could differ from what is described in this Communiqué.

Comment

These modest measures are designed to improve the neutrality, flexibility and pension coverage of the CPP.

Workers under 65 in receipt of a CPP pension will receive additional benefits, although they and their employers will be required to pay for these benefits. Flexibility has been provided to permit employees over 65 in receipt of a CPP pension to elect to obtain additional contributory CPP pension. However, elections made by employees after age 65 to contribute will compel matching employer contributions.

The receipt of a CPP pension will no longer depend on work status at or near retirement. Phased retirement will thereby be facilitated.

The changes to the early and late retirement adjustment factors seek to achieve neutrality in the financial impact to the CPP irrespective of the time of retirement.

Unfortunately, employees wishing to gauge the precise impact of these new rules on their particular situation may be stymied by both the complexity of the calculations and the absence of data on their complete work history. Employers will no doubt be asked by continuing employees whether they should take a CPP pension or not.

It is unlikely that employers would be interested in paying for the tools to allow employees to make informed decisions. Even if employers would like to provide these tools it is unlikely that they will be able to obtain the required data. As a result, the government will face pressure to either develop tools or provide sufficient information to permit employees to determine the precise impact that the proposed changes will have on their CPP entitlements in order to permit employees to make informed CPP decisions.