CPP: “How Long Is A Piece of String?”
June 22nd, 2011
At a recent meeting of the Retirement Planners Association of Canada (RPAC), Willie Jack and I were challenged to calculate the effective rate of return on contributions made to the Canada Pension Plan (CPP). Interestingly, we used quite different approaches but came up with similar results. They must be right!
Willie considered an individual born on January 1, 1965 who started contributing to the CPP at age 18 and always earned at or above the Years’ Maximum Pensionable Earnings (YMPE). For the period from 1983 to 2011 he used actual contribution rates. For the future he assumed:
- Future increases in the Consumer Price Index of 3% per year
- Future increases in the YMPE of 4% per year
- A continuation of the present 9.9% employer / employee contribution rate
- A retirement age of 65
His calculations showed that:
- Based on employee contributions only, the effective rate of return is 6.5%, if the individual lives to age 84
- Based on combined employer and employee contributions (which would apply to a self-employed person), the effective rate of return is 4%, if the individual lives to age 83.
For my calculations I used an individual aged 25 in 2011, who is just starting to contribute to the CPP and will retire at age 65. I adopted similar assumptions about the future to those used by Willie and just looked at the situation of a self-employed person. I know that the CPP is a great deal for those of us who are employed!
My calculations showed that:
- If the individual lives to age 90, the return on his combined employer and employee contributions will be 5%
- If the individual lives to age 80, the return on his combined employer and employee contributions will be 3.5%
These results are surprisingly similar to Willie’s, given that:
- He used actual historic data and I used a prospective method
- He used a full 47 year contribution history and I used just 40 years (which should still be sufficient to generate a maximum CPP pension)
One of our friends described this whole process as “fractious and distasteful”. We can understand why he would say this. The CPP is not an investment program; it is a part of Canada’s retirement income system, rated as one of the finest in the world. Our calculations have ignored the disability, survivor and children’s benefits which may also be payable under the Plan. And everyone’s experience under the CPP is different, depending on their contribution history and their personal circumstances.
But next time somebody tells you that the CPP is a terrible program, and that you would be much better off investing the money yourself, you can tell them they’re wrong!
Patrick Longhurst
Tags: Canada Pension Plan, finance, investment
Email This Post
Spending your money!
May 23rd, 2011Shortly before I left for vacation, William Jack and I were meeting with a client for whom we had just prepared a financial model. Given the client’s goal of not wanting to leave a significant estate, our advice was,” you can afford to spend more”. Noting that the client enjoyed travelling, we suggested that he [...]
Read more »Canada Pension Plan Changes Start This Year
May 18th, 2011The CPP was designed in the early to mid 60’s. Fifty years later, Canadians are healthier, better educated and living longer. In particular, Canadians are working later in life and deferring retirement. As well, the retirement experience is changing from a single event, usually at 65, to a process that can extend over many years. The critical demographic development is the “age wave” of the boomers moving past their 65th birthdays. This wave starts to build in 2011 and will not crest until 20 years from now. It is important to address any imbalances and inequities in the design of the CPP sooner rather than later.
Read more »Starting the Transition: Managing Risk
April 11th, 2011I turned 65 in February and wife Mary is about the same age. In common with many people our age, we are at the start of a transition from accumulating retirement savings to converting those assets into an income stream that supports our lifestyle and our vision of retirement. We have spent considerable amount of time addressing these challenges which we will discuss in later articles. As Mary and I begin this “assets to income” conversion, we have been very careful to identify and plan for the risks to our retirement income. The following list developed by Peter Drake, Vice President, Retirement and Economic Research, Fidelity Investments Canada provides a good overview of things you should consider.
Read more »A “Just in Case File”
February 3rd, 2011In January, 2009, Good Times magazine printed an article written by Lillian Newberry, titled “Your Just in Case File”. The article talks about her husband’s sudden death and a binder that he had put together in the event that something like this happened. This article, click here, has been reprinted with permission from Good Times.
The [...]
Downsizing (Part Two)
January 21st, 2011My wife and I continue our discussions about our next move. What is of major importance to us, is to be able to lock the door and leave for months at a time with a minimum of inconvenience, such as meeting house insurance occupancy rules. We have satisfied ourselves that either an apartment or a [...]
Read more »Our Shopping List
January 4th, 2011After looking at several condos and townhouses in the city, Mary and I decided that it would be a good idea to put together a list of the attributes and features of a desirable location. There are several reasons to do this. The first is to start our negotiations long before we plunge into the [...]
Read more »Defining Benefits
December 14th, 2010In the 1980s I was helping a friend who had just been terminated by a major private sector employer at age 50. Despite recent events he was pretty positive, and told me that the pension plan would allow him to retire at age 55 with an unreduced pension. Unfortunately, I had to tell him that [...]
Read more »Retirement STEW
November 18th, 2010Our colleague Av Lieberman, President of the Retirement Education Centre, frequently provides retirement education sessions to groups of employees of his various clients. In his presentation, Av has come up with an answer to the often-asked question – if my financial projections don’t work out, what can I do? The answer is STEW
Read more »“For Everything There is a Season”
August 25th, 2010The core of our practice has been using mathematical models to help people make financial decisions such as whether to take a commuted value or a deferred annuity when leaving a defined benefit pension plan or deciding whether to buy back eligible past service. We now find ourselves helping different groups of people facing major but predictable transitions in their lives. We help them sort out the both the financial and the lifestyle issues to enable them to make the most appropriate decisions in the circumstances.
Read more »