The Canada Pension Plan (CPP) is a mandatory defined-contribution plan that provides all individuals working in Canada with pension income when they retire. Statistics Canada funds the CPP from the contributions of employees, employers, or those who are self-employed toward the CPP, as well as the interest it receives from investing those contributions. If you are self-employed, the rules of CPP are different than for those who pay their CPP contributions automatically through their employer. Below, we will discuss how a self-employed individual can make the most of the CPP.
How does the Canada Pension Plan work?
Any individual above 18 years of age, working in Canada and earning more than $3,500 a year, has to contribute a percentage of their income to the CPP.
The idea behind CPP is to help individuals replace some portion of their income when they retire. When you turn 18, Service Canada starts collecting CPP contributions on the annual income you earn above $3,500 and up to the maximum pensionable earnings limit. The government sets this limit every year, depending on the average income and inflation.
For salaried people, both the employer and employee contribute an equal amount towards CPP. But if you are self-employed, your CPP contribution will double, as you must pay both portions. After 65, you can choose to contribute till you turn 70, or you can opt to no longer contribute. To do this, you will be required to complete the section “CPP contributions on Self-Employment and Other Earnings” when you file your income tax returns.
You can choose to start receiving the fruits of your contribution once you turn 60, but the standard age to begin benefits is 65. One can also opt to delay benefits until age 70. The age when you begin receiving benefits will affect the amount; the earlier you begin, the smaller the amount will be. After your death, your family will be entitled to a one-time, lump-sum payment known as the “death benefit”, which at present is set at $2,500.
How much can a self-employed person contribute to the CPP?
As it is a defined-contribution plan, the more and longer you contribute, the higher your payout will be. The basic CPP contribution is 9.9% for the self-employed. In 2019, Statistics Canada started the CPP enhancement, under which it will modestly increase the CPP contribution over a seven-year period.
Every year in November, the Canadian government announces the next year’s maximum pensionable earnings and the contribution rate. For 2021, it has set the maximum pensionable earnings at $61,600 and the contribution rate at 10.9%.
As a self-employed individual, you will contribute 10.9% of your net business income above $3,500 and below $61,600. Your contribution towards CPP cannot exceed $6,332.90 for 2021. This business income excludes any other income you earned from investments.
For instance, let’s say that Jeremy runs a barbershop, and he earns $55,000 in business income in 2021. He will have to contribute 10.9% on $51,500 ($55,000-$3,500) towards CPP when he files his 2021 tax return. His CPP contribution will come to $5,613.
How much can you get from the CPP payout?
Now it’s time to reap the benefits. You can start collecting your CPP payout as early as age 60 or as late as age 70. You have to apply for the CPP with Service Canada. It will calculate your CPP payout depending on your average earnings in your working life, contributions to the CPP, and the age you decide to start your CPP payments.
In 2020, you can get a maximum payout of $1,175.83 if you start collecting your CPP payout at age 65, however, it is worth noting the average monthly payout as of June 2020 was $710.41. The CPP enhancement can increase your maximum payout by about 50%. Life events such as having children, or low income, or a disability, can also increase your payout.
As you get a tax break in CPP contributions, the payout will be taxable. There are ways you can minimize your taxes on CPP payout.
You can get an estimate of your monthly CPP retirement pension payments by logging into your My Service Canada Account.
If you don’t have an account, you can register for one. You will receive a personal access code to complete your registration.
How can you make the most of your CPP benefit?
You can make the most of your CPP by leveraging the tax benefit during your contribution years and maximizing your payouts. The trick is to assess your financial situation and work out the age when you should stop contributing and when you should start collecting the payout.
Going back to the previous example, Jeremy continues to work after age 65 and is at the peak of his earnings. In his scenario, he will benefit the most if he delays the CPP payout and continues to contribute to the CPP till he turns 70. This way, he will get a CPP contribution tax credit and a higher payout when he turns 70. When determining how to maximize your own CPP benefits, it is best to consult with a skilled accountant who will review your situation and advise you on the best path forward in your specific circumstances.
At Sloan Group LLP, our team of accounting professionals is dedicated to delivering reliable solutions to our clients and identifying the best solutions to mitigate tax obligations. If you would like to discuss how partnering with us could benefit you or your business, contact us to schedule a consultation. Please reach out to us online, or by phone at 416-665-7735.