“Will the Canada Pension Plan (CPP) be there for me when I retire?”
It’s a question that many Canadians are asking themselves these days. Although experts generally consider the CPP plan sustainable, some worry that it isn’t.
The concerns are rooted in a time when the Federal Government was, in fact, messing with the CPP in a big way. In the 1990s, Federal Politicians were effectively raiding the CPP by borrowing money from it at below-market interest rates. This helped pay for the Federal budget, but it also left the CPP program in a precarious state. There was, at the time, a legitimate concern that politicians raiding the CPP to finance their personal projects would eventually bankrupt the program.
That was then, this is now. After a comprehensive set of reforms in 1996, the CPP board was established to manage Canadians’ money in an intelligent way. The CPP’s reforms included a shift away from a 100%-bond portfolio to modern portfolio management, as well as a new funding mechanism that prevented politicians from getting their hands on CPP funding. Since then, the CPP portfolio has earned satisfactory risk-adjusted returns. It is considered actuarially stable today.
Why some think the CPP won’t be there when you retire
When people claim that the CPP is unsustainable or a house of cards, they are basically echoing the then-legitimate criticisms of the 1990s. The CPP at that period followed an outrageously mindless investment strategy and was funded on a “pay-as-you-go model,” which contributed to the “raiding politician” issue mentioned earlier.
Today, Canadians hear about massive budget deficits and start to wonder whether the old CPP problems are rearing their ugly head again. The idea is something like, “With deficits as big as they are, it’s hard to believe that politicians aren’t raiding the CPP again.”
Why they’re probably wrong
People have their reasons for thinking that the CPP won’t be there when they retire. Fortunately, virtually all experts studying the matter agree that the CPP program is sound today. There are several reasons for this:
- The CPP investment board has earned good returns over the years.
- The new funding mechanism doesn’t allow for “loans” to the government.
- Contributions are high enough to make up for potential shortfalls.
Still, supplementing your CPP with investments couldn’t hurt
Despite the fact that the CPP program isn’t about to go broke, you still ought to supplement your future CPP with investments. By holding dividend stocks, exchange-traded funds, and bonds in a TFSA, you can enjoy tax-free returns, which means a higher actual return than in a taxable account.
We can look at Fortis (TSX: FTS) as an example of how the Tax-Free Savings Account (TFSA) boosts your returns. I am not “recommending” Fortis by highlighting it here, I’m just using it because it’s a relatively high dividend stock that illustrates how the TFSA’s tax shelter works on both dividends and capital gains.
Let’s imagine that you live in Ontario, hold $95,000 worth of FTS stock, and have a 50% marginal tax rate. Since Fortis has a 3.8% yield, you get $3,610 in taxable dividends per year on this position.
| COMPANY | RECENT PRICE | NUMBER OF SHARES | DIVIDEND | TOTAL PAYOUT | FREQUENCY |
| Fortis | $61.84 | 1,530 | $0.59 per share ($2.36 annually) | $902.70 quarterly ($3,610 annually) | Quarterly |
The way these $3,610 in dividends would be taxed follows below:
- The $3,610 in dividends is grossed up by 38% ($4,918.80).
- Your marginal tax rate yields a $2,459.40 tax
- A $747.30 federal credit is applied (calculated from the grossed-up amount and subtracted from taxes owed).
- A $491.88 provincial credit is applied.
- Your actual tax owing is $1,220.
The dividend tax credit definitely saves you some money here. However, if you hold the same $95,000 worth of FTS shares in a TFSA, you pay $0! So, investing in a TFSA is a great way to boost your returns. Dividends earned within one can even supplement your CPP payments — not that you have to worry about those going anywhere.
