The ROI of your CPP contributions: is CPP worth it?

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What is CPP?

The Canada Pension Plan (CPP) is a mandatory, government-managed taxable benefit designed to replace part of your income when you retire. As of 2019, Canadian workers are required to contribute 4.95% of their earnings, up to a specified maximum, to the CPP. This contribution is matched by employers, although self-employed workers have to pay the full amount out of pocket.

I like to think of myself as a competent investor, so I’ve often wondered whether my CPP contributions are in good hands, or whether I’d be better off investing them myself. Although CPP contributions are mandatory, it’s still a fun question to dive into.

My approach to this problem is fairly straightforward:

  • What is the CPP benefit actually worth?
  • What would my CPP contributions be worth had I invested them myself?
  • Given the answer to these two questions, is CPP worth it?

If these questions interest you, read on!

The average return generated by the Canada Pension Plan Investment Board

CPP investments have been managed by the Canada Pension Plan Investment Board (CPPIB) since 1997. The CPPIB is a Crown corporation that manages over $400 billion in assets on behalf of the 20 million Canadians who contribute to the CPP.

We are independent of the Canada Pension Plan (CPP), operate at arm’s length from federal and provincial governments and are guided by an independent highly qualified, professional Board of Directors.

CPPIB website

Before taking a deeper dive into the ROI Canadians receive for their CPP contributions, I figured the first place to look for clues is the CPPIB’s financial statements. After all, if they aren’t generating a solid return there’s no way pensioners are either.

I went through the CPPIB’s annual statements for the last 20 years to quantify their performance, and to see how $100 under their management has grown over that time period. (The official financial statements of the CPPIB can be found here.)

The CPPIB’s principle performance metric is net nominal annual return. This is the rate of return before considering inflation, investment fees, and taxes. Since 1999, the CPPIB has achieved a net nominal compound annual return of 7.77%, with only three years in the red – 2003, 2008, and 2009.

In comparison, the S&P500 has achieved a compound annual growth rate (CAGR) of 5.92% over the same time period, with dividends reinvested. In that time, there were five years in the red – 2000, 2001, 2002, 2008, and 2018.

While the S&P500 may not be the ideal benchmark to compare the CPPIB’s performance to, as its entirely comprised of American companies, it does illustrate the point that they’ve performed very well over the last twenty years. They not only beat the index that is often viewed as a barometer for the global stock market, they did so with less volatility. In fact, the CPPIB’s annual returns had a standard deviation of 8.5%, compared to 17.5% for the S&P500.

I have to say, I was both surprised and impressed by these results. Management is clearly doing some right, and they seem to be benefiting from the investment opportunities that are available to such a large pool of capital. (For example, the CPPIB recently purchased Pattern Energy outright in a deal valued at US$2.6 billion.)

Net present value (NPV) analysis of the CPP benefit

As of 2019, the maximum CPP payout is $1,154.58 per month, or $13,854.96 annually. We can get a rough idea of how valuable this pension is by making a few assumptions and calculating the net present value.

The idea behind a NPV calculation is that $100 today is worth more than $100 in the future, as that capital can generate a return in the meantime. For example, if I’m sure that I can get a 7% return in the stock market, then a $100 payment a year from now is only worth $93 today. Similarly, a $100 payment 10 years from now is only worth about $51 today.

To value a recurring revenue stream, like the CPP benefit, we can apply this concept by assigning a discount rate to future payments, and summing those payments together. An obvious problem with this approach is that no one knows how many CPP payments they’ll actually collect – it goes without saying that CPP is more valuable for people who live longer.

I’ve used this technique to value the CPP benefit for a 65 year old. Since CPP payments are hedged to inflation, I’ve assumed that payments will grow at a rate of 2% annually in my analysis. For the sake of simplicity, I’ve ignored the CPP survivor benefit.

The following chart shows the present day value of the full CPP benefit for a 65 year old, depending on the chosen discount rate and whether that person will live to 75, 85, or 95.

Remember that the discount rate you choose is essentially the opportunity cost of not receiving your CPP payments immediately. If you’re a risk adverse investor who only invests in GICs, a discount rate of around 3% would be appropriate. If you’re an investment hotshot with consistently high returns, a 7% discount rate may be appropriate. In this case, the CPP benefit is far less valuable, as payments down the road are worth considerably less with each passing year.

This same results can be presented in a different manner by plotting NPV against age of death for a given discount rate. These results are shown in the following chart.

What would your CPP contributions be worth if you managed them yourself?

We’ve established that the CPPIB has achieved excellent annual returns over the last 20 years, and we’ve calculated the net present value (NPV) of the CPP benefit as a function of life expectancy and discount rate.

So how does this valuation compare to what your CPP contributions would be worth if you had invested them yourself? It’s a tricky question, as not everyone will contribute to the CPP every year, but I’ll consider two common cases.

Case 1: Worker who hits the CPP maximum contribution limit from age 21 to age 65

This chart shows the maximum annual and cumulative CPP contributions by year since 1975. Data was pulled from the CRA website here.

Someone in this situation will have contributed $55,240 to the CPP over the course of 44 years. Remember that this scenario is a bit contrived – most people do not pay the maximum CPP amount each year, and only 39 years of maximum payments are required to receive the full CPP benefit.

So what if these CPP contributions had been invested in the stock market instead? Here is what these contributions would be worth today for a given CAGR.

With a CAGR of 7%, CPP contributions since 1975 would be worth $173,000 today. In comparison, the NPV calculations in the previous section showed that for a 7% discount rate, a pensioner would need to live until at least age 82 for the NPV of the CPP benefit to be higher.

Case 2: Self-employed worker who hits the CPP maximum contribution limit from age 21 to age 65

Workers who are self-employed need to pay the full 9.9% CPP deduction themselves, meaning their annual and cumulative contributions are doubled.

Self-employed workers really get the short end of the stick here. At a 7% growth rate, the CPP benefit is never worth more than the value of the contributions had they been invested by the worker. At a 4% discount rate, the break-even age is 81.

One interesting thing to consider here is that the 4.95% employer match isn’t necessarily free money. It’s likely that salaries would be higher across the board if employers were not required to make these contributions.

Putting everything together: CPP vs. managing the money yourself

We’ve calculated the NPV of the CPP benefit as a function of age of death and discount rate, and we’ve calculated what CPP contributions would be worth had they been invested in the market instead.

Now we can determine how long you need to live for your money to be better off with the CPPIB than in your own investment account. The results are summarized in the following table.

Rate of return/discount rateMinimum age of death for CPP
to be preferable to self-directed investing
2.0%71
2.5%71
3.0%72
3.5%73
4.0%73
4.5%74
5.0%75
5.5%77
6.0%78
6.5%81
7.0%84
7.5%89
8.0%99

The better the returns you can generate on your own, the longer you need to live for CPP to be the better option. For someone achieving average market returns of around 7%, the age at which CPP and self-directed investing are of equal value is in your early eighties – which happens to be the average life expectancy for Canadians.

In general, we can see that risk adverse investors with lower annual returns benefit from CPP the most, while investors who achieve higher returns have a lower chance of CPP being a net benefit to them.

Should you take CPP early (or late)?

A common question among Canadians is “When should I start collecting CPP?” Retirees typically begin collecting CPP at age 65, however you can claim CPP as early as age 60 and as late as age 70.

Monthly CPP payments are reduced by 7.2% for each year CPP is claimed prior to age 65. Similarly, payments increase by 8.4% for each year you wait after turning 65.

In general, the longer you expect to live, the more it makes sense to delay your CPP payments. Healthy women in particular should consider waiting to claim their CPP benefit, as life expectancy pushes into the high eighties.

Conversely, if you expect to die young, it makes sense to collect CPP as soon as possible. Another argument for taking CPP early is that you can get more enjoyment out of your money when you are young, as you’ll be active enough to enjoy luxuries like travel. After all, what good is a higher CPP payment if you’re bedridden?

From a quantitative perspective, you can calculate the optimal age to collect CPP by estimating your life expectancy and assigning a discount rate to future payments. For example, the following chart shows the NPV of the CPP benefit for different ages of death, given a 5% discount rate.

From this chart, we can see that it makes sense for someone expecting to die before age 81 to claim CPP at age 60. Similarly, it only makes sense to delay payments until age 70 if you plan on living until age 97!

Again, this calculation will depend heavily on your chosen discount rate and will vary immensely from person to person.

Conclusion: Is CPP worth it?

In general, the answer is a resounding yes!

From a purely financial perspective, CPP contributions generate an ROI of around 7% for people with an average life expectancy. Most importantly, this return is guaranteed by the government, and hedged to inflation. Imagine the CPP benefit didn’t exist – would you invest a portion of your portfolio into an inflation-hedged annuity with a guaranteed 7% return? For most people, this would be an excellent investment.

But what this article didn’t discuss in detail is the immense social benefit of the CPP benefit. Even if you are an outlier that could get a better return by managing your CPP contributions yourself, it’s a fact that most people can’t. The people who benefit the most are those who never learned the importance of saving at a young age – people who would need to be supported by taxpayers in their old age anyway, if it weren’t for a forced savings vehicle like the CPP.

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