Is the CPP Program Just Another Tax?

A few weeks ago, I mentioned in one of my columns that the Canada Pension Program (CPP) could be considered as another government tax. A couple of people had trouble understanding this idea, so I thought I would elaborate.

The oxford dictionary defines tax as “a compulsory contribution to state revenue, levied by the government on workers’ income and business profits”. The CPP contributions that are being increased are certainly compulsory but are they contributed to state revenue? They’re not supposed to be but let’s take a look at the math.

In 2018, the maximum annual self-employed contribution is $5,187.60. The maximum that you can receive in benefits starting at age 65 is $1,134.17 per month. To keep things simple, we will exclude the increases to both amounts for now.

If you started contributing the maximum at age 25 and worked for 40 years, you would put a total of $207,504 into the CPP program. Assuming you live to age 90, you would then get $340,251 back out in retirement benefits. Sounds ok right? You’re getting all of your money back plus interest!

But wait, how much are you really getting back? If you were able to “opt out” of CPP and you instead invested the $5,187.60 each year and earned 6% per year in investment returns, you would have $864,139 in your account. If you took that amount and purchased a life annuity (even at today’s ultra-low annuity rates), you would get a guaranteed lifetime income amount of $4,384.65 per month! Or if you passed away prematurely, your named beneficiaries would get the full amount minus taxes owing.

When I run the math backwards using the CPP’s maximum of $1,134.17 per month, it shows that you’re effectively getting no interest on your money at all. It would take $213,000 put into an annuity to generate $1,134/month and the contributions you would have put in was $207,504. That means over 40 years, you would earn a total of $5,496 of interest! That equates to 0.13% per year of interest…

The above is based on a 6% annual return. According to the CPP investment board’s website, they have obtained an average annualized net return of 6.7% per year over the past 10 years (11.8% per year over the last 5 years). So where exactly are all of the returns that you’re earning on your CPP funds going? I for one would love to know…

Seems like there’s a big difference between what the CPP program gives back to you and what you would have if you invested the money on your own right? Where is all of your extra money going? They claim that the money is held separately and invested but when you read the fine print, they invest a lot of it in their own “infrastructure” plans. While much digging didn’t unearth much detail, the math simply doesn’t line up.

What happens if you put all your money into CPP and then pass away at age 64? Do your children get a cheque for $300,000 since it’s “your money” and not a tax? Nope, the government just keeps the whole thing!

So here’s the problem. The government is requiring you to pay into the CPP program but you’re not getting any interest on that money at all and missing out on 40 years of the power of compounding. Worse yet is that the new rules announced in December of 2016 are increasing compulsory contributions over the coming 7 years which means Canadians will be left with less money to take home after the mandatory deductions.

This will mean less money left to pay down the ultra-high household debt that exists and they will continue to incur huge interest on their debts while earning no interest on their forced “savings”. In the end, Canadians will simply end up further behind.