Monday, May 11, 2020

How Much of Your CPP Contributions are Really a Tax?

A simple view of the Canada Pension Plan (CPP) is that it takes contributions from your paycheque, invests your money until you retire, and then pays the money back to you as a pension. However, reality is more complicated. CPP rules result in some people getting more out of CPP than they put in, and some get less. This splits your contributions into part savings plan and part tax.

Your first thought might be that the amount we get from CPP depends on how long we live. However, this is actually a good thing. I’m happy to have an income stream that reduces my longevity risk. I benefit today from the fact that once I start collecting CPP, it will last as long as I live. So, when I say we don’t all get out what we put in, I’m not talking about how long we live.

To get an idea of what I do mean, it helps to look at the short summary in CPP’s 2018 annual report. CPP paid benefits of $44.5 billion, but only $34.6 billion of this went to CPP retirement pensioners. The remaining $9.9 billion went to surviving spouses, people with disabilities, death benefits, and other amounts.

Imagine a Canadian with no spouse who worked steadily from age 18 to 65. This Canadian only has access to his or her share of the $34.6 billion for regular benefits plus the $368 million in death benefits. This is a total of about $35 billion out of the $44.5 billion paid from CPP. This person gets no share of the remaining $9.5 billion that is a collection of extra social programs baked into CPP.

To be clear, I’m not opposed to having these extra programs in CPP. We need to take care of those in need. I just think of paying for these extras as a form of tax rather than a form of forced saving for retirement, because one person’s CPP contributions get redistributed to other people.

These extra programs aren’t the end of the redistribution. When you calculate how much you’ll get in CPP benefits, you get certain “dropouts,” which means you don’t have to count some contribution months where your contribution was low. After using your dropouts, you get to use the average of your good contribution months to determine your CPP benefits.

Everyone gets to drop out 17% of their low contribution months. Primary caregivers can drop out any low contribution months while one of their children is under 7. People collecting CPP disability pensions can drop out months while they collect this pension.

It’s time for some estimates. Let’s say that about 40% of Canadians get 10 years of dropouts for children under 7. This is an extra 4 years of dropouts, on average. Out of the 47 working years from 18 to 65, this represents 4/47=8.5% more dropouts. We’re up to 17%+8.5%=25.5% dropouts.

The 2018 CPP report says that there are 338,000 beneficiaries with disabilities, which is about 1.7% of Canada’s workforce. These people get to drop out contribution months while they collect their disability benefits. This brings the total dropouts to about 27%.

Let’s guess that the average dropped out month has 60% of the CPP contributions of the remaining 73% of months used to calculate CPP benefits. So, if the dropouts didn’t exist, regular CPP benefits would drop to 73%+(60%)27%=89% of their current level.

So without dropouts, there would be a 11% drop in the $34.6 billion paid to CPP retirement pensioners, a drop of $3.8 billion. Add in the $9.5 billion in extra social programs baked into CPP, and we get a total of $13.3 billion in CPP benefits not available to our hypothetical Canadian with no spouse who worked steadily from age 18 to 65. This is about 30% of the total paid out by CPP ($44.5 billion) in the 2018 fiscal year.

So, as a rough estimate, 70% of your CPP contributions are your savings, and the remaining 30% is more tax-like. But that doesn’t mean you won’t get a slice of the 30%. All this money gets paid out. If your CPP contributions fluctuated at all over the years, or you’re married, or you have kids, or you become disabled, you’ll get some of this 30% in CPP benefits. Some people will get more than the 30% back and some less. That’s the nature of redistributing wealth through taxes.

I’ve seen analyses showing CPP giving poor investment returns for a Canadian who contributes the maximum to CPP each year. This is because these analyses assume that this Canadian gets none of the 30% of contributions that get redistributed. Another factor is that because CPP benefits are indexed to inflation, the claimed investment returns on our CPP contributions are a “real” return. This means we get this return plus the amount of inflation.

I’m quite happy with the extra programs built into CPP. I benefit a little from the 17% dropout everyone gets. My wife and I will likely benefit somewhat from the CPP survivor benefit, and our heirs will get the death benefits. Overall, we’re unlikely to get all of our 30% back; some of it will go to people with greater need.

One concern I have with CPP is that its costs are too high. Too much of CPP assets go to administration and investment management. But these costs are lower than the investment fees Canadians pay on their own savings. Another concern I have with CPP is that too many people start benefits at age 60 when they’d be better off waiting until 65 or 70 to get larger payments.

CPP is a good program. Its forced savings and redistributions to the needy do a good job of reducing the number of seniors who end up being a burden on taxpayers. Few Canadians can invest with returns as high as CPP gives. I have some concerns about this program, but I’m not concerned that about 30% of CPP contributions are effectively a form of tax.


  1. A question:
    If a person has paid into CPP for the required 39 years (or more) and has also just met the required yearly levels (YMPE) to get the maximum benefit @ 65, (but continues to work for a few more years) must they continue to pay into CPP? Your just overpaying at that point for no further benefit, no?

    1. Hi Paul,

      I suggest reading a post by Doug Runchie on Retire Happy:

      He says there is a post-retirement benefit (PRB) in addition to regular CPP under certain circumstances. CPP certainly has its complexities.

    2. Hi Michael. Thank you for the response.
      I've seen that one before, it doesn't address for example someone being 58 or 59 now and working having already the required 39 "M's on their "CPP statement of contributions". This really isn't hard to do. It wasn't that long ago $44K was all you required to get an "M" for the year on your statement.
      They seem to assume the example person is already 65 and wants to continue working. I thought maybe it would be a good discussion point for your blog here to make people aware if one could opt out, if they met the requirements prior to 65 and were still working and having the CPP deduction automatically made via payroll deduction.

    3. Hi Paul,

      As far as I can tell, even once you have your 39 years of max contributions, you still have to keep paying into CPP (if you're still working and under 65). That would be part of the 30% of contributions that are really a tax and will be distributed to someone else).

  2. Hi Michael,
    I believe you incorporate in your portofolio the NPV of estimated CPP payments. Your article got me thinking, do you discount your CPP payments net of estimated income taxes, just like you do with your RRSPs?

    1. Hi Ferd,

      Yes I do discount my future CPP and OAS payments for expected income taxes before taking the NPV to add to my (after-tax) portfolio value.

  3. I'm single and i have to say i have mixed feelings about the survivor benefits. It seems to me if it were equitable we wouldn't have them. After all single people have to save more so why shouldn't married people have to save more to accommodate one spouse living longer?

    1. Hi Christina,

      I'm guessing the origin of the surviving spouse benefit was a time when the husband worked, and the wife stayed home. In this scenario, after the husband dies, the wife has no CPP at all. So, the survivor benefit is intended to prevent having large numbers of surviving spouses in poverty. We can see this thinking in all the rules that reduce the survivor benefit when the surviving souse has his or her own CPP. So, the survivor benefit wasn't created out of a sense of fairness; rather it was compassion or not wanting taxpayers to have to support large numbers of old people in poverty.

  4. Thanks for that explanation. I didn't think of that being the origin. However i still think in retirement planning the couple should plan for one spouse living longer.

  5. I can only imagine the squawk if they tried to take away survivor benefits! I guess they would be less now with the formula used to calculate them. At least my parents will benefit as my mom was a stay at home mom.