Getting a grip of how calculations are affected by child-rearing or time off due to disability
Canada Pension Plan (CPP) benefits are crucial for many Canadians’ retirement plans, with the amount received largely dependent on one’s lifetime CPP contributions and the age at which one opts to start receiving the pension.
A nuanced aspect of how CPP benefits are calculated includes the exclusion or “dropping out” of no- or low-income years, such as early career years, periods of child-rearing, or times off due to disability. Once excluded, these “drop-out” years often result in higher CPP benefits.
Matthew Castling, a senior financial planner, explains that the CPP calculation for the base component of a pension omits up to eight years (or 96 months) of the lowest earnings between ages 18 and 65.
This amounts to 17 percent of those 47 years, which can be further adjusted for child-rearing and disability “drop-out” years before the general “drop-out” calculation. This provision requires more than ten years of earnings. It accounts for child-rearing and disability “drop-out” years before application.
Castling also points out that early retirement before age 65 could lead to reduced CPP due to zero-contribution years needing to be accounted for in the calculation.
However, for those with consistent maximum CPP contributions throughout their careers, the drop-out provisions may mitigate the impact of early retirement.
Jason Heath, a certified financial planner, highlights a common misconception that starting CPP benefits at 60 could avoid penalties for no-income years between 60 and 65. He clarifies that the early start reduction is more significant than the reduction for a single zero- or low-income year.
The CPP also includes provisions for child-rearing, allowing parents to exclude low-income years while raising children under seven. This provision is calculated before the general drop-out. Heath notes that parents must apply separately to exclude these years when starting their CPP benefits.
Moreover, the CPP’s enhanced plan, introduced in 2019, includes a “drop-in” provision for child-rearing, crediting parents based on their average contributions before the child’s birth.
Additionally, the CPP disability provision offers benefits for those who received CPP disability pensions, excluding these years from the base CPP calculation and potentially increasing retirement pensions.
Projecting CPP benefits can be complex. Service Canada’s estimates do not always incorporate all drop-in and drop-out provisions, leading to potentially lower estimates. Furthermore, CPP estimates do not account for future inflation, which could complicate accurate retirement financial planning.
