It is never too early to plan your retirement. At age 25, you enter the workforce, and your first paycheck deducts 5.95% as the Canada Pension Plan (CPP) contribution. It might be frustrating, as you have a lower amount to spend. But these contributions will compound to give you a monthly paycheck when you retire at age 65. The CPP enhancement program began in 2019 and will run through 2025 and will increase your CPP contribution every year in a phased manner. The program aims to give you the maximum CPP (33.3% of your average work earnings).
While it might look too early to discuss retirement, there is no harm in knowing more about your CPP deduction. It may hurt less when you know what the deduction can give you.
Working towards CPP maximization
The CPP is designed to cater to your retirement needs without hampering your youth. To earn the maximum CPP for your retirement, you have to contribute the maximum CPP for 40 years.
For 2023, the maximum CPP contribution is $3,754. How did the Canada Revenue Agency (CRA) arrive at this figure? Your CPP is 5.95% of your annual earnings above $3,500 and below the maximum pensionable earning (MPE) of $66,600. So, if your CPP contribution hits this mark, you have secured one point. Now, you have 39 more to go.
But this won’t be easy, as the CRA increases MPE annually. And for the next two years, it will accelerate MPE to an estimated $81,100 in 2025. So, unless you are sure of having an annual income of $81,100 by 2025, you might miss out on the full point for a few years.
So, what can you do? It’s time to upgrade your skills and increase your economic value. With a higher salary, you can maximize your retirement earnings in two ways:
- Maximum CPP contribution
- Longer CPP contribution
For instance, if there were a few years when you were out of the workforce or had a lower income, you can make up for it by delaying your CPP payout to age 70. For every month’s delay, the CRA increases your CPP payout by 0.7%/month.
How much would all this add up to your retirement income?
Suppose you worked 40 years, of which your earnings were low in four years due to personal issues. The CRA will calculate your average earnings, excluding those four years. (The CRA excludes up to eight years of your lowest earnings).
Those who retire in 2023 can get a maximum CPP payout of $15,678 (25% of $61,840 annual income) and an Old Age Pension (OAS) of $8,292. An annual retirement income of $23,970 makes up 36% of $66,600 MPE in 2023. As a thumb rule for retirement, you should ensure you have at least 70% of your pre-retirement income coming from passive sources.
The CPP enhancement will replace 33% of your pre-retirement income. Add OAS, and around 40% of your pre-retirement income is secure. For the remaining 30%, you can use a Tax-Free Savings Account (TFSA) for passive income.
TFSA passive income to secure your retirement
The TFSA allows you to grow and withdraw your investment tax free. You are still young and have 30-40 years before retirement. Taking out $250 from your monthly budget for the next five years can set you up for a long-term passive income.
Canada’s telecom giant BCE (TSX:BCE) is a Dividend Aristocrat with a strong history of paying regular quarterly dividends and growing them annually. There were a few years when BCE paused its growth, but it never cut them. You can use this quality of BCE to compound your dividends and build a strong passive-income source.
If you buy BCE shares at an average price of $60 for the next five years in tranches of $3,000 a year, you will own 250 shares. Opt for the dividend-reinvestment (DRIP) option. The DRIP will use the dividend income to buy more income-generating shares and grow your passive income.
A one-time investment of $2,500 in BCE’s DRIP in 2003 compounded to give you $804 in annual dividends. You can learn as you invest and build a passive-income pool equivalent to 30% of your paycheck.
