How Do People Finance Their Retirement?
Many Canadians share the investment goal of having a comfortable retirement. To retire at our desired age, we must develop an investment strategy that will provide enough money at retirement to support the desired retirement lifestyle. Most of us expect to retire around the age of 65 with enough post-retirement income to maintain the standard of living we have enjoyed before leaving our jobs.
Graphically, a retirement strategy can include some of the following elements for retirement income benefits:
Government-Sponsored Retirement Programs
There are two main government-sponsored programs that can help finance retirement:
- Old Age Security (OAS)
- Canada Pension Plan (CPP)/Québec Pension Plan (QPP)
Old Age Security (OAS) Program
The Old Age Security program includes four public pension benefits:
- Old Age Security (OAS) pension
- Guaranteed Income Supplement (GIS)
- Allowance for the Survivor
The benefits paid by the federal government through each of these programs are funded by general tax revenues. In other words, there is no contribution requirement for individuals to qualify for OAS benefits. The only qualifying criteria are age and a residency requirement. OAS program benefits are indexed every quarter to address increases in the cost of living. OAS program benefits are not paid automatically to eligible recipients when they turn 65. Rather, the program requires that your eligible clients apply to begin receiving the OAS benefit.
All OAS program benefits are subject to a “means test”. If your client’s income exceeds a certain minimum, their OAS program benefits will be reduced, or “clawed back”.
Old Age Security (OAS) Pension
The OAS pension is a monthly pension payment payable to eligible individuals. OAS pension benefits are considered taxable income.
To be eligible for full payment, your client must:
- be 65 or older
- be a Canadian citizen or legal resident of Canada at the time of application approval
- if your client no longer lives in Canada (a non-resident), they were a Canadian citizen or legal resident of Canada on the day preceding the day of departure from Canada
- have lived in Canada for a minimum of 10 years (or 20 years for non-residents) after reaching age 18
Individuals who have lived in Canada for 40 years after the age of 18 are eligible for 100% of the OAS pension benefit.
Partial OAS pension benefit is available for those individuals who have lived in Canada for fewer than 40 years after age 18. A partial OAS pension is calculated at the rate of 1/40th of the full OAS pension for each complete year of residence in Canada after age 18. The following table summarizes the eligibility criteria:
Applying for OAS
Service Canada now has a process to automatically enroll seniors who are eligible to receive the OAS pension. If your client is eligible to be automatically enrolled, Service Canada will send them a notification letter the month after they turn 64.
If your client did not receive a letter from Service Canada informing you that they were selected for automatic enrolment, they must apply for the OAS pension.
In deciding when to apply for your OAS pension, consider your client’s personal financial situation.
As of July 2013, your client can defer receiving Old Age Security (OAS) pension for up to 60 months (5 years) after the date they become eligible for an OAS pension in exchange for a higher monthly amount. If your client delays receiving your OAS pension, the monthly pension payment will be increased by 0.6% for every month that they delay receiving it, up to a maximum of 36% at age 70. If your client chooses to defer receipt of OAS, they will not be eligible for Guaranteed Income Supplement (GIS) and their spouse or common-law will not be eligible for the Allowance benefit for the period that OAS is delayed.
OAS Pension Clawback
As mentioned earlier, the OAS pension benefit is subject to a “means test”. For example, at current 2019 rates, for every $1 of net income your client earns over $77,580, they lose $0.15. This reduction in benefits is commonly referred to as an OAS “clawback”. At an income level of $126,058, a recipient of the OAS pension benefit will have to repay the entire amount.
The threshold amount is updated every year. The chart below provides additional information for specific income years.
Guaranteed Income Supplement (GIS)
The Guaranteed Income Supplement (GIS) is available to low-income pensioners. This benefit is payable only to individuals who qualify for the OAS pension benefit. GIS is a tax-free benefit and is paid on top of the OAS pension. Individuals who have no sources of income other than the OAS pension benefit will receive 100% of the GIS. If your client defers his or her OAS pension benefit, the GIS benefit is also deferred for the same period of time. There are four criteria used to determine your client’s payment amount, as well as the maximum income threshold where they are no longer eligible:
- if your client is single, widowed or divorced;
- if your client’s spouse/common-law receives full OAS;
- if your client’s spouse/common-law does not receive full OAS or allowance
- if your client’s a spouse/common-law partner receives the allowance
GIS benefits are “means-tested”. For the most part, GIS payments are reduced by $1 for every $2 of base income, excluding OAS pension income. However, the actual amount is determined using a set of complex tables.
Applying for GIS
In December 2017, Service Canada implemented a process to automatically enroll seniors who are eligible to receive the GIS. If you can be automatically enrolled, Service Canada will send you a notification letter the month after you turn 64.
If you did not receive a letter from Service Canada informing you that you were selected for automatic enrolment, and you wish to start receiving your OAS pension and the GIS at age 65, you should apply for them right away.
The Allowance is a benefit available to low-income individuals aged 60 to 64 who are the spouse or common-law partner of a Guaranteed Income Supplement (GIS) recipient.
To qualify for the Allowance, an individual must meet all of the following conditions:
- is aged 60 to 64 (includes the month of your 65th birthday);
- has a spouse or common-law partner that receives an Old Age Security pension (OAS) and is eligible for the GIS;
- is a Canadian citizen or a legal resident;
- resides in Canada and has resided in Canada for at least 10 years since the age of 18; and
- the annual combined income of both the GIS recipient and their spouse or common-law partner is less than the maximum allowable annual threshold.
Other situations where individuals might qualify for the Allowance:
The Allowance for Survivor provides money for low-income seniors who meet the following criteria:
- if the individual meets all the above eligibility conditions, but their spouse or common-law partner does not receive the OAS pension or the GIS because they are incarcerated
- if the individual has not resided in Canada for at least 10 years since they turned 18, but they have resided or worked in a country that has a social security agreement with Canada, they may still qualify for a partial benefit. For the list of countries with which Canada has established a social security agreement, refer to the Canada Revenue Agency for Lived or living outside Canada.
Individuals are reviewed every year to determine whether they continue to be eligible for the Allowance.
The Allowance stops the month after your 65th birthday, when you may become eligible for the OAS pension and possibly the GIS.
Applying for the Allowance
|Your client should apply for the Allowance 6 to 11 months before their 60th birthday. Applications must be made in writing using the appropriate Allowance for Survivor forms and including certified true copies of the required documentation.|
Allowance for the Survivor
The Allowance for Survivor is a benefit available to low-income seniors who meet the following criteria:
- has a spouse or common law partner that has died and the person has not remarried or entered into a common-law partnership
- is aged 60 to 64 (includes the month of your 65th birthday);
- is a Canadian citizen or a legal resident at the time the Allowance for survivor was approved, or the last time they lived in Canada;
- has lived in Canada for at least 10 years after reaching the age of 18.
Currently, the maximum allowance for a survivor is $1,388.92 per month, tax-free. The allowance for survivor stops being paid in the following situations:
- the individual has not filed an individual Income Tax and Benefit Return with the CRA by April 30th, or if, by the end of June each year, CRA has not received the information about the net income for the previous year;
- the individual leaves Canada for more than six consecutive months;
- the individual’s net income is above the maximum annual threshold of $25,056.00
- the individual is incarcerated in a federal penitentiary because of a sentence of two years or longer;
- the individual has reached the age of 65 (payment stop the month after your 65th birthday when you become eligible for the Old Age Security)
- the individual remarries or lives in a common-law relationship for more than 12 months; or
- the individual dies
Canada Pension Plan (CPP)
The Canada Pension Plan (CPP) is a federally-administered program designed to provide the following:
- retirement benefits
- survivor benefits
- disability benefits
- death benefits
The benefits paid through each of these programs are funded using individual contributions. In other words, an individual (or his or her family) is not eligible to receive CPP program benefits unless they have made contributions to the program. CPP program benefits, except for the death benefit, are indexed annually for increases in the cost of living. In order to receive CPP program benefits, eligible individuals must apply. Benefits are not automatically paid once someone reaches the age of eligibility. Applications are accepted via two methods; online through the My Service Canada Account, or via paper forms mailed to the applicable Provincial CPP office.
The CPP program is designed to replace about 25% of a person’s pre-retirement earnings.
CPP is payable to all eligible Canadians except those who worked in Québec. Benefits received under the Canada Pension Plan are taxable.
Québec Pension Plan (QPP)
The Québec Pension Plan (QPP), sponsored by the Québec provincial government, provides benefits similar to those offered by the Canada Pension Plan (CPP) to workers in Québec. (The CPP does not apply in Québec.) The federal government and the Québec provincial government closely coordinate the CPP and QPP.
Benefits received under the Québec Pension Plan are taxable
Who Contributes to CPP/QPP?
An individual must contribute to the CPP/QPP if they do the following:
- work in Canada
- are over 18 years of age and have pensionable employment income exceeding the year’s basic exemption (YBE) of $3,500
Payments into the CPP/QPP are tax-deductible for employers and a tax credit for individuals. Since 2001, self-employed individuals can deduct half of their contributions and claim a tax credit for the other half. Individuals do not make contributions if they are collecting CPP/QPP disability benefits, they are not in the workforce, or they reach age 70.
Making CPP/QPP Contributions
CPP/QPP payments are based on mandatory contributions made by workers and their employers. Self-employed individuals are required to make both the employee and the employer portions of the contribution. Contributions are calculated based on a percentage of a person’s annual earnings between a minimum, known as the year’s basic exemption, or YBE; and a maximum, known as the year’s maximum pensionable earnings, or YMPE. Effective 2020, the YMPE is $58,700 and the contribution rates are 5.25% for both the employee and employer portions of the contribution. For the QPP, the contribution rates are 5.4% for both the employee and employer portions of the contribution. Contribution rates and contribution limits are set to increase each year until 2023:
Additional Maximum Pensionable Earnings
Starting in 2024, a second, higher limit will be introduced, allowing your client to invest an additional portion of their earnings to the CPP. This new limit, known as the year’s additional maximum pensionable earnings, will not replace the first earnings ceiling. Instead, it will subject their earnings to two earnings limits. This limit is referred to as the second earnings ceiling.
This new range of earnings covered by the Plan will start at the first earnings ceiling (estimated to be $69,700 in 2025) and go to the second earnings ceiling which will be 14% higher by 2025 (estimated to be $79,400). Like the first earnings ceiling, the second will increase each year to reflect wage growth.
Early Collection of CPP/QPP Retirement Pension Benefits
As a dealing representative, you may need to help your clients determine when to begin collecting CPP/QPP retirement pension benefits, as part of their overall financial and retirement planning. An individual may choose to collect CPP/QPP retirement pension benefits at any time between the ages of 60 and 70. It is not necessary to stop working to receive a retirement pension. Under the CPP/QPP, normal retirement is considered to begin at age 65.
If an individual chooses to start collecting their pension prior to age 65, the CPP/QPP pension benefit is decreased. The table below provides the reduced CPP amounts.
Late Collection of CPP/QPP Retirement Pension Benefits
|If an individual chooses to start collecting CPP/QPP pension benefits after age 65, the pension benefit is increased. Currently, the amount of the retirement pension is increased by 0.7% for every month after a person’s 65th birthday until age 70. This represents a maximum increase of 42%.|
|Aurora, age 65, is eligible to receive the full CPP pension. However, she has decided to delay her pension until she is age 70. Based on current figures, Aurora will receive a monthly pension of $1,669.78, calculated as $1,175.83 x 142%.|
CPP Disability, Survivor and Death Benefits
Disability benefits are payable to eligible CPP contributors who are no longer able to work at any job on a regular basis. The disability must be long-lasting or likely to result in death. There is also a children’s benefit available for the children of individuals who receive the CPP disability benefit. Survivor benefits are paid to the estate, surviving spouse or common-law partner, and dependent children of a deceased contributor. In addition to survivor benefits, a lump sum death benefit is payable to the estate of a deceased contributor.
For individuals receiving the CPP Disability benefit, when they turn 65 the benefit is automatically converted to a retirement pension. They do not need to apply.
Employer-Sponsored Registered Pension Plans (RPPs)
In order to provide employees with an additional incentive to remain with the company, many employers provide benefits designed to provide employees with a pension at retirement. Registered pension plans are registered in accordance with the pension legislation of the jurisdiction, federal or provincial, in which the plan is offered. In addition, registered pension plans must meet certain registration requirements under the Income Tax Act, which is administered by the Canada Revenue Agency.
There are three basic types of registered pension plans:
- defined benefit pension plans
- defined contribution pension plans
- pooled registered pension plans
Employers generally sponsor pension plans, although in some cases unions may sponsor them. As the Pension Administrator, the plan sponsor has the responsibility for funding the plan. An employer may make all of the contributions to a registered pension plan; although employees are often required to make contributions as well.
Investment earnings on deposits within the plan grow tax-free; however, retirement benefits are taxable to the employee when they begin to withdraw money from the plan. Employee and employer contributions are tax deductible. Registered pension plan benefits are also creditor-proof, so employees cannot lose their pension benefits if they are bankrupt.
As a dealing representative, it is essential to understand employer-sponsored pension plans. Along with government pensions, these will form the foundation of a client’s retirement income. You must be able to advise clients on how their pensions operate and how they will affect them in the future. Understanding their pensions will allow you to advise on what they must do personally to supplement their retirement incomes using RRSPs, TFSAs and other investment vehicles available to them.
Defined Benefit Pension Plans (DBPPs)
|A DBPP defines the benefit that an individual will receive at retirement. The benefit is known and guaranteed and is calculated based on the type of plan. The pension plan can use the employee’s average pensionable earnings to calculate the benefit. Employees’ average pensionable earnings will be based on one of the following:• their earnings throughout their career with the employer• their earnings over their final years with the employer, usually 3 or 5 years• their best earning years with the employer, usually 3 or 5 years this formula is used to calculate the benefit.|
|average pensionable earnings x accrual rate x years of service|
|The accrual rate is the percentage specified by the plan sponsor used to calculate the benefit entitlement. It is usually between 1% and 2% and is applied to an individual’s average pensionable earnings as determined above. The last part of the calculation refers to the number of years of credited service. The pension can also be based on a flat monthly amount. In this case, the plan would use the following calculation to determine an employee’s benefit.|
|(flat monthly benefit amount x 12) x years of service|
Defined Contribution Pension Plans (DCPPs)
A DCPP, also known as a money purchase plan, defines the contribution that an individual and his or her employer will make each year before the employee’s retirement. The amount that the employee will receive at retirement is not guaranteed and there is no retirement formula. Since the amount that the person will have at retirement depends on how well the investments are managed, the employee is often provided with the option to choose their investments from a pre-determined list of investment options.
NOTE: The current trend among employers has been to move away from DBPPs to DCPPs, since DCPPs present less risk to corporations.
Pooled Registered Pension Plans (PRPPs)
A PRPP is a retirement savings option for individuals, including self-employed individuals. It enables its members to benefit from lower administration costs that result from participating in a large, pooled pension plan. It’s also portable, so it moves with its members from job to job.
To be eligible, an individual must:
- have a valid Canadian social insurance number (SIN)
- work in a federally regulated business or industry for an employer who chooses to participate in a PRPP
- be employed or self-employed in Yukon, Northwest Territories and Nunavut or live in a province that has the required provincial standards legislation in place.
An individual can be enrolled into a PRPP by either:
- their employer (if the employer chooses to participate in a PRPP), or
- a PRPP administrator (such as a bank or insurance company)
The investment options within a PRPP are like those for other registered pension plans. As a result, its members can benefit from greater flexibility in managing their savings and meeting their retirement objectives.
Individual Pension Plans (IPPs)
An IPP is a maximum funded defined benefit pension plan usually set up by incorporated professionals, such as dentists, or by profitable corporations for their senior executives. A maximum funded IPP is one where the accrual rate is 2%. IPPs are ideally suited for individuals who are over the age of 40 and earn more than $100,000 per year. There are several advantages to these types of plans, including:
- annual contribution limits are higher than for other registered savings plans
- contributions are tax deductible to the corporation
- contributions can be made based on past service retroactive to 1991
- retirement benefit is known and guaranteed
- additional contributions are allowed if investment performs poorly
- investment growth is not taxed until withdrawals are made from the plan
- pension benefits are creditor proof
Deferred Profit Sharing Plans (DPSPs)
A DPSP is a plan in which an employer sets aside a portion of its profits for the benefit of some or all of its employees. Only the employer may make contributions to a DPSP. The plan can be set up such that contributions are only made when the company has a profitable year. Unlike registered pension plans, the employer is not obligated to make plan contributions every year. In addition, employer contributions are tax deductible. The employee benefits from a DPSP since the plan may be set up in addition to other registered savings plans provided by the employer. As a registered savings plan, any investment growth is tax-sheltered until the employee withdraws money from the plan. Most plans have a vesting period which is an amount of time that must transpire before benefits in the retirement plan are unconditionally owned by the individual.
Pension Adjustment (PA)
In order to maintain fairness in Canada’s retirement income system, employees who belong to a registered pension plan or a DPSP are restricted in their ability to contribute to individual registered retirement savings plans (RRSPs). In Canada, approximately 40% of employees are covered by a registered pension plan; the remainder must rely on RRSP contributions to save for their retirement.
If any of your clients participate in their employer’s registered pension plan or DPSP, their current RRSP contribution limits are reduced by a pension adjustment (PA). The pension adjustment reflects the amounts contributed by the client and his or her employer to a DBPP, DCPP, or a DPSP in the previous year.
Pension Adjustment (PA) Calculation
The amount of the PA depends on the type of registered plan in which the employee is participating. In general, the PA represents the amount contributed, or deemed to have been contributed, by the employee or employer. The table below highlights how the annual PA is determined for each plan type.
Past Service Pension Adjustment and Pension Adjustment Reversal
A past service pension adjustment (PSPA) occurs when the benefits of a DBPP are increased or upgraded. Similar to a pension adjustment (PA), a PSPA will decrease an individual’s current RRSP contribution limit by the amount of the PSPA. Whereas a PA occurs in each year that someone is a member of a registered pension plan, a PSPA occurs much less frequently.
A pension adjustment reversal (PAR) occurs when the benefits to be received by a DBPP member are reduced or terminated. Typically, a PAR occurs when a pension plan member leaves the employer before they reach retirement age. Similarly, a PAR can occur when non-vested DPSP contributions are returned to the employer in the subsequent year(s) after when the contributions were made. The effect of a PAR is to increase the RRSP contribution limit (in other words, give the RRSP contribution room back from previous years).
Pension Income Splitting
Certain pension income, referred to as eligible pension income, may be split between a pensioner and their spouse or common-law partner. The advantage of pension income splitting is that 1/2 of the pension income that would have been taxed in the hands of the pensioner can be taxed in the hands of the spouse or common-law partner. If the spouse or common-law partner is in a lower tax bracket, the couple will save on taxes.
Some of the types of income that a pensioner can split when the pensioner is 65 years of age or older include:
- the taxable portion of life annuity payments
- a pension income from a DBPP or DCPP
- DPSP income
- RRSP income
- RRIF income
- regular annuity payments
When a pensioner is less than 65 years of age, these amounts can only be split with a spouse or common-law partner if received directly from a pension plan or if they were received as a result of the death of a spouse or common-law partner.
Non-Registered Savings Plans
Employers may offer various types of non-registered savings plans within the group plan. Some of the types of non-registered savings plans are:
- Non-Registered Savings Plan
- Employer Profit-Sharing Plan
- After-Tax Savings Vehicle
- Savings Plans
Money that is deposited into non-registered savings plans has already been taxed. As such, withdrawals will not be subject to tax, as taxes were already withheld. If there is any growth on the invested assets, the growth may be subject to investment income tax, dividends tax, and/or capital gains or losses tax.
|Employment and Social Development Canada: Retirement Pensions||https://www.canada.ca/en/employment-social-development/programs/pension-plan.html|
|Québec Pension Plan||https://www.rrq.gouv.qc.ca/en/programmes/regime_rentes/Pages/regime_rentes.aspx|
|Canada Revenue Agency||https://www.canada.ca/en/revenue-agency.html|
|Old Age Security||https://www.canada.ca/en/services/benefits/publicpensions/cpp/old-age-security/apply.html|
|My Service Canada Account (MSCA)||https://www.canada.ca/en/employment-social-development/services/my-account.html|
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