moneyFYI
Financial Freedom Is Merely Organized Common Sense
Canada Pension Plan (CPP) Value
The Canada Pension Plan began in 1966 for persons 18 or older. The plan provided a retirment income at age 65 equal to 25% of the average industrial wage over the past three years. ASs with other pension, deductions are made from the employee each pay. The maximum contributory amount is based on the average industrial wage. In 1966 the maximum contribution base was $4,400 and the contribution rate was 1.80%. The employer matched it. It has ggrown greatly since then.
The question: “Has it been a reasonable investment for the employees?”
Unpacking the CPP Package
Most people think of it as a retirement plan. It includes several other parts that would be expensive to replace They include:
- A flat rate death benefit. It was never material and has been frozen at $2,500 since 1998.
- A disability benefit that is meaningful. It would pay to the persona dn to his family members as well. It presently is made up of a flat rate portion of $511 plus a percentage of your retirement benefit. with a maximum of $1,413.66. An additional flat rate amount is payable to other dependents.
- There is a survivor benefit on death before retirement. Currently $650 a month. After retirement the survivor benefit is 60% of your retirement amount.
I don’t know how much those pieces are worth, but I do know the disability part would be expensive. Except it is very hard to qualify for it. The disability must be permanent.
For purposes of this piece, I will assume the total value of these ancillary parts is zero.
What did you buy?
Take someone born in 1947 and qualifying in 1966. Your total contributions began at $79.20 times two. We will assume they made at least the CPP maximum each year throughout their working life. The could retire at 60 with a 30% reduction in their income. I am assuming they work to 65. In 2012 they would pay 4.95% on $46,600, and the employer matched that.
By retirement each of you and your employer will have contributed $38,329.35.
If an employee kept the total amount and invested at 5%, at the time of retirement the fund would have become $155,516. Their pension was $986.67 monthly. The payments are tied loosely to inflation. We could work out what is reasonable on these amounts if we knew life expectancy and inflation. We would be using educated guesses to make our decision.
Reality check
A t the end of 2012, how much would it have cost to buy an annuity from a life insurance company that pays 986.67 per month plus an inflation increment and has a 60% survivor benefit? I don’t have a 2012 annuity table available, but from memory, that pension is about 20% higher than you could have expected to buy elsewhere.
The takeaway.
From the beginning to 2012, the plan provided reasonable pension value.
If you joined the plan later, the value is less because the contribution rate rose steadily from 1.8% to 5.45% now. It might still provide reasonable value given that annuities today pay very little because the bond market is quite low.
People live longer. More capital is needed to pay benefits longer.
The ancillary benefits are not valueless and they may be becoming more expensive.
I took a couple of actuarial courses back in the day. Trust me on this, pension actuarial calculations are among the most difficult. You cannot do this stuff on a napkin and get it right. All things in, it doesn’t look like a crazy way to invest some money. I wonder about the current contribution level though. It seems high for a promise of a 25% of income pension. But bond rates are near zero so maybe. Guarantees are expensive.
It takes a lot of capital to replace your cost of living. Pay attention to your savings and employer pensions.
I help people have more retirement income and larger, more liquid estates.
Call in Canada 705-927-4770, or email don@moneyfyi.com
moneyFYI 