CI Direct Investing’s All-in-One Guide to Understanding Retirement Savings Options: Part I
Making sense of retirement is the number one financial planning issue facing Canadians. Whether you are 20 or 60, there will be a point in your life when you won’t want to depend on your earned income for basic living needs. Many Canadians look for professional advice when it comes to retirement planning because of the complexities of understanding long-term finances, or figuring out what kind of income to expect when they retire.
But, before we delve into the details of how we can accumulate funds for our retirement income, let’s get some definitions out of the way. This will help us speak the same language.
YMPE: Yearly Maximum Pensionable Earnings. This is the amount of your salary on which you pay CPP premiums. In 2016, this amount is $54,900 and it is indexed with inflation.
RRSP contribution limit: This equates to 18% of your salaried (earned) income or a certain constant amount as defined by CRA. For each year after 2010, the limit is indexed for inflation using the Industrial Aggregate average wages and salaries in Canada.
Money Purchase Limit or RPP Limit: A money purchase limit is the same as a RRSP contribution limit, but offset by one year. RRSP limits lag behind RPP limits by one year because RRSP limits are based on prior-year earnings, and RPP limits are based on current-year earnings.
DPSP Limit: Deferred Profit Sharing Plan Limit. This is 50% of your Money Purchase Limit (or half of 18% of earned income for the year it applies). Bear in mind that Money Purchase limit is always slightly higher than RRSP limit because RRSP limit lags by one year.
Defined Benefit Pension Plan Limit: Defined Benefit Limit is not limited by your contributions, but rather by the benefit. The benefit amount per year of service is maxed by 11% of Money Purchase Limit for the year in which benefit was received.
Earned Income: All of the above are based on 18% of your earned income. For most people, earned income is equivalent to the salary you receive from your employer, but it also includes other sources of income. This includes:
- Income from office or employment reported on a T4 slip.
- Other employment income (line 104). This amount includes foreign employment income (assuming it is not deductible). Talk to a professional accountant if you think you may have a source of a foreign employment income.
- Income (less loss) from a business carried out by the taxpayer, either alone or as a partner actively engaged in the business.
- Income (less loss) from rental of real property.
- Royalty income regarding a work or invention of which the taxpayer was the author or inventor.
- Taxable support payments received.
- CPP or provincial disability pension income.
- Amounts received under a supplementary unemployment benefit plan (not federal Employment Insurance, less deductible support payments made)
Note: Dividends received from a personal corporation do not form earned income. Also, disability benefits from personal disability plans are not taxable and thus do not form earned income.
Need more info? The CRA provides a great summary of each of the above.
We’ll refer to these numbers as we explore the different ways we can save for retirement.
Primary Ways to Save for Retirement
Phew! Now that we have all those definitions out of the way, let’s explore how those limits fit into your retirement savings plan.
There are 3 major ways to save for retirement. I’ll give a quick upfront snapshot here, followed by a more detailed explanation on each below.
1) Mandated by the government: Commonly known as the CPP, this type of savings applies to all Canadians receiving earnings—whether as a salaried employee or self-employed business owner.
2) With the help of your employer: This type of savings is, for the most part, optional if your funds are involved. However, in cases where an employer’s contributions are your sole source of savings, participation is mandatory.
3) Your own individual savings: This includes any self-directed accounts or those being managed with the help of an advisor.
Seems pretty straightforward right? Now, let’s dive into each of the above in greater detail. We’ll start by looking at the types of savings mandated by the government. Detailed coverage of the other two savings types will be outlined in parts two and three of this series.
Savings Mandated by the Government
The Canada Pension Plan (CPP) is funded by contributions made by you and your employer during your working years and is managed by a team of professionals.
The CPP works like this: you contribute 4.95% of your salary and your employer contributes 4.95% on your behalf up to Yearly Maximum Pensionable Earnings (YMPE) amount. CPP contributions are never paid on the first $3,500 of your salary. They also stop being made after you reach the YMPE.
For anyone making $55,000 or more, you’ve likely noticed that at some point in the year your paycheque increases. The reason for this? You’ve reached the YMPE for that year (recall, it’s now set at $54,900). Once the YMPE is reached, CPP contributions are no longer drawn from your income, hence, the spike in your pay.
The good news is that your CPP contributions are not eating into your RRSP, or MPP limits, so they are extra savings. The funds are saved in your name (tracked by your Social Insurance Number) and managed by a team of professionals.
We believe that the CPP is a well-managed pension with a great benefit and high-level of sustainability for future generations. If you’re curious to see how much you’ve contributed to the CPP so far, head over to the My Services Canada website. To sign-in, you’ll need your SIN and a password. First-time access is a bit of a gauntlet but worth doing, especially if you’ve experienced a major salary change. Once logged in, you’ll be able to see all your contributions over the years and even submit corrections if something looks off.
Coming up next…
In Part II of our Understanding Retirement Savings Options series, we’ll take a deep dive into the layered world of employer savings plans. Stay tuned next week!
Can’t wait and want to get started on saving for retirement right away? Sign up for CI Direct Investing and create a financial plan with your dedicated financial advisor for free!