Whenever the Canada Pension Plan is amended, the chief actuary must prepare a supplementary actuarial report has to be prepared on it. That report, released late last month, contains several items of interest to most plan sponsors and participants.
Unless you read the legislation itself, this report may be the first time we see the use of the term year’s additional maximum pensionable earnings (YAMPE). The YAMPE is the new and higher earnings ceiling for the CPP and has been set at 14 per cent above the existing year’s maximum pensionable earnings (YMPE). The YAMPE is expected to be $82,700 by 2025, versus $72,500 for the YMPE. It could have been the other way around, with the YMPE being the higher number and a new name being given to the lower limit. This turns out to be important. If they had chosen the latter approach, earnings-related plans — like almost all public sector defined benefit pension plans — would have integrated automatically with the enhanced CPP.
As it is, the integration needs to be negotiated plan by plan and if an agreement cannot be reached, then pension benefits and contributions will increase significantly. This isn’t ideal since most public sector plans are already geared to provide a gross replacement rate (including old-age security benefits) of 80 per cent or so. A recent academic paper showed that 80 per cent of recent retirees who had a gross replacement rate of 65 to 75 per cent achieved a net replacement rate of at least 120 per cent.
Both the YMPE and YAMPE need to be maintained indefinitely, since the contributions on this tranche of earnings result in a tax deduction rather than a tax credit. This need to have two thresholds will complicate matters for employers since CPP contributions have to be broken up into two parts for remittance and reporting purposes.
The report confirms that the additional contribution required on the new tranche of pensionable earnings (the portion between the YMPE and YAMPE) will be four per cent on the part of both employees and employers. By comparison, the contribution rate on earnings up to the original YMPE will be 5.95 per cent. It will be interesting to see if the public eventually twigs to the fact that higher earners will be paying a substantially lower rate than low-income earners to earn the same benefit rate.
By legislation, the CPP enhancement must be fully funded, whereas the current CPP is only about 20 per cent funded. As the report explains, full funding could result in as much as four times the volatility as the existing CPP. This greatly increases the possibility of future cutbacks in benefits or increases in contributions in the event of adverse experience.
The higher funding volatility means that a different investment policy will be needed for the assets that are earmarked to fund the CPP enhancement. It will be a more conservative asset mix that is expected to result in a lower long-term return. The real return on the new tranche of assets is expected to average 3.55 per cent over the next 75 years, compared to 3.98 per cent on the original CPP fund. Even these return assumptions may seem optimistic in a scenario of prolonged low interest rates where risk-free real returns are less than one per cent.