CPP expansion: Legislative changes and chief actuary’s valuation
Following up on the finance ministers’ agreement to expand the Canada Pension Plan (CPP) on June 20, 2016 (see our Special Communiqué of June 2016), and the assent of all provinces other than Quebec, the federal government introduced Bill C-26 on October 6, 2016. Bill C-26 amends the Canada Pension Plan, the Canada Pension Plan Investment Board Act and the Income Tax Act (ITA) in order to provide for the agreed-upon CPP expansion to be implemented gradually from 2019 to 2025.
The current definition of the Year’s Maximum Pensionable Earnings (YMPE) will be retained. A new definition of Year’s Additional Maximum Pensionable Earnings (YAMPE) will be added to the CPP. The YAMPE will be 107% of the YMPE in 2024 and 114% of the YMPE thereafter.
This change is very significant. If the new, higher limit had been named the YMPE, then pension plans that are integrated with the CPP would have adjusted their benefits downward automatically. Instead, each plan will have to take action to make the change happen and to avoid providing overly generous benefits.
The new contribution levels will be termed “first additional contributions”, in respect of the increased contributions for earnings up to the YMPE, and “second additional contributions”, in respect of new contributions above the YMPE (collectively, the “additional contributions”).
Retirement, survivor and disability pensions will be increased as a result of the additional contributions, subject to the amount of additional contributions made and the number of years over which these additional contributions are made.
The additional contributions will be held within the CPP in a separate account named the Additional Canada Pension Plan Account. These will be accounted for and valued separately, although they will form a part of the CPP. Pursuant to the legislative requirement that benefit enhancements should be fully funded, the additional contributions are intended to be sufficient to fully fund the new tier of benefits. If the Chief Actuary reports a shortfall, the CPP provides required contributions may be increased or the inflation adjustments may be decreased. It remains to be seen what impact this objective will have on the investments of the Additional Canada Pension Plan Account.
As previously announced, the first and second additional contributions will be fully tax deductible for all employees. The current level of contributions will continue to be subject to a tax credit based on the lowest tax rate, instead of being deductible from income.
The amendments to the Income Tax Act also implement increases to the Working Income Tax Benefit (WITB) starting in 2019. The WITB is a refundable tax credit intended to provide tax relief for eligible low income workers. The expansion of the WITB is meant to help them offset the impact of increased CPP contributions.
Chief Actuary’s Report
On October 26, 2016, the Chief Actuary, Jean-Claude Menard, presented the 28th Actuarial Report on the CPP, concluding that the projected contributions are expected to be sufficient to sustain the expanded CPP. It is expected that a separate, slightly less risky investment policy will be developed for the new tier of the CPP. Due to the funding approach of the additional CPP tier, in the long term investment income will become the major source of funding for the additional CPP tier. There is a small buffer built into the contribution rates for the additional CPP tier.
It is interesting to note that, in the very long term, once the current generation of younger workers retires and receives the full impact of the gradual benefit phase-in, the assets of the additional CPP tier will exceed the assets in the base CPP. This is a result of the requirement that the additional CPP tier be fully funded, as opposed to partial funding of the base CPP.
Bill C-26 is expected to be passed by the federal government in the near term. In the meantime, the Quebec consultation on expanding the Quebec Pension Plan has been delayed and may take place next year.
The Chief Actuary’s report notes the importance of investment returns in ensuring the additional CPP tier is financially sustainable. This means that contribution rates for the additional CPP tier could be more sensitive to investment results. If the projected real rates of return are not achieved on the additional CPP tier assets, Canadians in the future might need to contribute more into the expanded CPP or receive less than full indexing on those benefits.