Canada pension plan (CPP) enhancement is a program that has the potential to massively increase the CPP benefits Canadians ultimately receive when they retire. It entails increasing CPP premiums today in order to increase benefits tomorrow. A classic “short-term pain for long-term gain” program, it has its pros and cons – particularly for younger Canadians who will be paying the higher premiums. In this article, I will examine CPP enhancement and argue that it is a double-edged sword for millennials and Gen Z.
CPP enhancement should eventually boost your benefits
The main benefit of CPP enhancement is that it should boost the benefits you receive from CPP. Currently, CPP aims to supplement one-quarter of your income. It doesn’t always work out that way, granted. For example, if you earned a very high income in the last two years of your career, you won’t have paid enough into the program over your career for CPP to pay you one-quarter of what you earned. However, the program works well enough that if your income has been below the maximum pensionable earnings threshold your entire career, you should get close to one-quarter of your income from CPP benefits.
CPP enhancement aims to take the percentage of your income covered by the benefits to one-third. So, if you earn $60,000 per year, you’d have gotten approximately $15,000 per year under the old system, but will receive $20,000 per year under the new one. Of course, this isn’t precise: it depends on how many years you paid premiums into either system, and many people’s careers will have straddled the transition from one to the other. This is especially the case for Millennials and Gen Z. But in theory, the aforementioned is the main benefit you should get from CPP enhancement.
But you have to pay more into the system
The downside of CPP enhancement is that you have to pay more into the system in order to get the higher benefits. Money isn’t free: in order for the government to give you $X, you or someone else will have to pay $X later. Now, because CPP premiums are paid in advance, and then invested, there’s a possibility that you’ll get more in benefits than you paid in extra premiums. But basically CPP premiums are going from 5.1% of your income to 5.9%, and the amount of income on which premiums is deducted is increasing. C’est la vie.
Investing: Better than relying on CPP?
If you aren’t convinced that CPP enhancement will deliver its promised benefits, now would be a good time to start investing. By investing prudently in dividend paying stocks, you can establish an income stream that doesn’t depend on government benefits.
Consider Fortis Inc (TSX:FTS), for example. Canada’s only “Dividend King” stock, it has raised its dividend every year for 50 consecutive years. If you purchased the stock 10 years ago and re-invested the dividends, you’d have realized an 11.8% return – much better than the TSX index would have given you.
How has Fortis been able to achieve this incredible track record?
It comes down to two things:
First, Fortis is a utility, and all utilities enjoy the benefit of fairly stable revenue. Heat and light are basic life essentials. People would rather sell their cars than go cold in the Winter.
Second, Fortis has invested in growth much more than the average utility has. It spent the last few decades buying up utilities all across Canada, the U.S., and the Caribbean. As a result, it has delivered better growth than most utilities. FTS stock has responded in kind.
