Return on CPP contributions still meagre after expansion

The expansion of the Canada Pension Plan (CPP), announced in June by Canada’s federal and provincial finance ministers, has sparked important questions about what the changes will mean for individual Canadians. And rightfully so given that the CPP is one of the key pillars of our country’s retirement system.

A particularly important question is: how will the expanded CPP impact the rate of return for Canadians contributing to the program? After all, some people have tried to justify expansion of the CPP on the grounds that it provides a competitive, even high rate of return for retired Canadians.

The available data do not support this claim. The rate of return that working Canadians—especially younger workers—can expect to receive on their CPP contributions is meagre under the current system and will remain so even after expansion.

A recent Fraser Institute study calculated the rate of return under the current, pre-expansion CPP system by analyzing the contributions of Canadians over their working lives and comparing them to the benefits received during retirement. It found that for Canadians born after 1956, the rate of return is a meagre three per cent or less (after inflation). The rate of return declines to 2.1 per cent for those born after 1971.

The rate of return will increase after the announced changes to the CPP are implemented, but only slightly.

Starting in 2019, workers will be required to pay more into the program in exchange for higher CPP retirement benefits. Once fully implemented in 2025, the total CPP contribution rate (which is split notionally in half between employees and employers) will increase from the current rate of 9.9 per cent to 11.9 per cent of eligible earnings up to a maximum of $72,500. In addition, earnings between $72,500 and $82,700 will also be subject to mandatory CPP contributions, albeit at a lower rate of 8 per cent.

While some technical issues on the changes to the CPP have not yet been clarified, we re-calculated the new rate of return that Canadians can expect based on the available details.

The results are not impressive. Canadians born in 1971 or after can now expect to receive a rate of return from their CPP contributions of between 2.3 per cent and 2.5 per cent (depending on their specific year of birth). In other words, there is only a small increase in the rate of return for younger Canadians under the expanded CPP—2.5 per cent or less after expansion versus 2.1 per cent before expansion.

People who believe the CPP offers a high rate of return often confuse the individual rate of return (again, just 2.5 per cent or less for Canadians born after 1971) with the 11.4 per cent average return earned over the past five years by the Canada Pension Plan Investment Board (CPPIB), which manages the investable funds of the CPP.

In reality, CPPIB returns have no direct effect on the benefits received by retirees. CPP retirement benefits are determined by the number of years a person works, their annual contributions (up to a maximum of $5,089 this year), and the age they retire—not CPPIB rates of return.

Notably, the CPPIB itself must generate a 4.0 per cent return (after inflation) simply to keep the program actuarially sound. In other words, Canadian workers born in 1971 or after are required to contribute to a fund that must generate a 4.0 per cent rate of return in order to sustainably provide recipients with a return that is 2.5 per cent or less.

The claim that the CPP provides Canadians with a strong rate of return does not withstand scrutiny. Younger Canadians will continue to receive a meagre return for their CPP contributions even after expansion.