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By Julie Cazzin with Allan Norman
Q: I am 60 years old and have paid into the Canada Pension Plan (CPP) for the past 38 years, most of them at the maximum. I am now self-employed and working part time, making about $130,000 annually. Is there any advantage to me continuing to pay into the CPP for the next five years until I start drawing CPP? — Fareet in Toronto
FP Answers: Fareet, the simple answer is you don’t have a choice. If you’re under age 65 and earning an income, you must contribute to CPP. It’s only after age 65 that you can opt out of making CPP contributions. The problem is that you have almost contributed enough to qualify for the maximum CPP benefit, so any additional contributions won’t increase your base CPP pension. It is money wasted.
Even worse, you’re self-employed. You must make both the employee and employer’s contributions, for a total of $6,999.60 per year. You’ll be paying twice what an employed person will be paying. Plus, your CPP contributions will increase each year with the increase in the yearly maximum pension earnings (YMPE), and annual CPP contributions.
Now, to be fair, you will likely get a little increase in your CPP pension due to the CPP enhancements — that is, a larger pension — but not enough relative to what you’ll be contributing.
You also have the option of using your CPP contributions to fund the Post-Retirement Benefit (PRB) program. The program allows Canadians who are older than 60, receiving CPP but still working and contributing to CPP, to receive additional benefits for their contributions. The PRB is a smaller pension benefit equal to 1/40th of the CPP and it can’t be split with a spouse for tax purposes. Like the CPP, if you collect it before age 65, it is reduced by 0.6 per cent per month, and after age 65, it is increased by 0.7 per cent per month.
You qualify for the PRB when you are over age 60 and collecting your CPP pension. It will be added to your monthly CPP benefit, even if you are already receiving the maximum CPP retirement amount, and that will continue for the rest of your life. Each additional year that you continue working and contributing after you start collecting CPP will earn you a new PRB that will be added to your monthly CPP benefit the following year.
The benefit is paid in the year following your CPP contribution. Did you catch that? You can’t start collecting the PRB until you’re collecting your CPP.
This all sounds good, but there’s a catch. Starting your CPP early means a CPP reduction of 0.6 per cent for every month before you turn age 65, or a 36 per cent reduction if you start CPP at age 60.
The question becomes: If you take a reduced CPP pension, will the additional PRB make up for a reduced CPP? For most people, the answer is no. The PRB will not make up the cost of a reduced CPP by starting it early. However, there are a couple of things to think about.
The same two guiding principles used to decide when to start your CPP are also used to judge the value of PRB benefits. Those two principles are anticipated life expectancy and expected investment returns, both of which you have no control over, making decisions around CPP confusing.
If you have an anticipated short life expectancy, starting CPP early and collecting the PRB likely makes sense. The longer the anticipated life expectancy, the stronger the case for delaying CPP.
As for investment returns, if you’re able to save and invest the after-tax PRB in a tax-free savings account, and if you can earn seven to eight per cent on your investments, then taking CPP early and collecting the PRB may make sense, but those are two pretty big ifs.
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Fareet, my guess is you will be better off not starting your CPP early, which means you will still be contributing $6,999.60 to CPP and not getting much back for it.
But perhaps there is a better solution for the self-employed. I don’t know your full situation, but have you thought about incorporating your business? There are costs to incorporating, but once incorporated, you can pay yourself a dividend rather than a salary, and a dividend-only strategy is a way to opt out of CPP contributions at any age.
Having a corporation may also lead to some interesting tax planning, such as when to convert to a registered retirement income fund, paying dividends to a life partner once you turn age 65 and tax-efficient income-layering strategies.
It’s worth having a conversation about incorporating with your advisers. If incorporating doesn’t make sense and starting CPP early to earn the PRB doesn’t make sense, then you’re likely going to find yourself making CPP contributions with very little benefit to you.
Allan Norman provides certified financial planning services through Atlantis Financial Inc. Allan conducts securities related business through Aligned Capital Partners Inc. (ACPI). He can be reached at www.atlantisfinancial.ca or firstname.lastname@example.org
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