The Self-Employed & CPP: A Pension or A Tax?

When a self-employed person collects personal income, they have to pay into the Canada Pension Plan (CPP). This can be avoided by incorporated professionals through paying themselves via dividends instead of using a salary. Generally, tax integration favours those earning a salary rather than flowing money through a corporation as dividends. However, some accountants and advisors consider the money paid into CPP as a tax. Hence, they recommend dividends only instead – to avoid it. This post will explore that argument in detail.

What is is the Canada Pension Plan?

Participation in the Canada Pension Plan is mandatory for those earning income through work in Canada. It is often referred to as a “payroll tax” because it is usually collected as part of the payroll. However, it differs from a tax because the amount you receive in benefits is proportional to what you contribute. In contrast, a tax is paid into the public pot and paid to those who use the services. With taxes, access based on need or political importance rather than contribution.

The CPP is actually a pension plan, as indicated by the name. There is a defined benefit related to your average income/contributions, and it is indexed to inflation. The kind of pension most people are jealous of. There are also some other benefits. The main limiter of the CPP is that it is relatively small in terms of contributions and benefits.

How much do you pay into CPP?

The employee pays into CPP at a rate of 5.7% of earnings up to the maximum pensionable earnings. The maximum earnings is $64900 for 2022 and increases each year tied to inflation. The percentage of earnings paid into CPP is also gradually increasing as “Enhanced CPP” is phased in. The enhanced CPP aims to pay out 33% of pensionable earnings as annual pension income rather than the 25% of the original CPP pension. So, it also has a higher contribution rate to meet that goal.

The employee payment is matched by the employer. That means that self-employed individuals or incorporated professionals who pay themselves a salary make both the employee and employer contributions (11.5% in 2022).

Is this a double payment for the self-employed and unfair?

If the employer payment is simply recognized as being part of the employee’s compensation package, then it is not unfair. If a business is looking to hire an employee, it will consider the total cost and benefit of the employee. That is a balance between what is required to attract and retain them versus excess cost to the business. So, an employee could conceivably get paid more if the employer wasn’t forced to pay into CPP and that was part of the competitive landscape. Essentially, CPP is a forced pension benefit for everyone. It just shifts this cost/benefit from “optional” to “mandatory” for all employees and employers.

How much can you expect to get from CPP?

The exact amount you would collect from CPP is actually complicated. It depends on how many years you contribute and how much. Pension plans are also designed around how long the average person will collect payments. So, how early you retire and how long you live in retirement to collect the benefits influences your payment. It takes 39 years of contribution at the maximal level to get the maximum CPP payment. You can also drop out 17% of the lowest earning years plus some lower earning years using the child-rearing provisions.

If you starting collection at age 65, the maximum benefit was $1204/month in 2021. However, the average monthly benefit actually paid was $714/month. The amount you get is scaled to the amount you contributed and most people don’t make 39 years of maximum CPP contributions.

When is CPP actually a tax?

If the contributions made to CPP do not result in a higher pay-out, then it is no longer like a pension where you get out something proportional to what you paid in. It is more like a tax. You pay, others benefit. There are a couple of situations when this can occur with CPP.

If you work & contribute too long, CPP becomes a tax.

If you have already contributed to CPP for 39 years, then the benefit becomes progressively less. You may still get some benefit as low-earning years are displaced by higher earning ones, but that is much less than straight-up additions to your life-time pensionable income. If you have already made 39 years of maximal CPP contributions, then contributing more does not result in a bigger benefit. It then becomes a full-on tax at that point. That is ~12%/yr of benevolence for the self-employed.

If incorporated and you work for multiple employers, CPP can become a tax.

If you have two employers, then they both pay the employer CPP contribution. You also pay employee contributions via the payroll at both companies. That is not an issue if your total T4 income is below the maximum pensionable income (~$65K). However, if you are over that, then you may contribute more than the maximum, yet still cannot collect more.

For the non-self-employed with more than one employer, that is not a big issue. At tax time, you can get refunded for the over-contribution. However, the companies do not get refunded for their over-contribution on your behalf. I will illustrate this with a typical example.

Dr. X is incorporated and works at an academic center. Their clinical and administrative work is paid to their professional corp. However, some of their teaching is considered employment by the University (on the advice from the University’s tax lawyers) and paid as T4 income. Dr. X Medicine Professional Corporation pays Dr. X a salary of $130K and they get $30K employment income from the University. Dr. X’s corporation also pays their spouse $20K/yr for administrative work for the corp. Their spouse also makes $60K/yr from their regular job. They are both over the maximum CCP contribution and some of the excess contribution from Dr. X Med Prof Corp doesn’t get refunded and doesn’t result in Dr. X and his wife getting more CCP payout.

Summary

The Canada Pension Plan is usually a defined benefit inflation-indexed pension. As it is intended to be. However, there are some times when the contributions are disproportionately more than the entitled benefit. That is effectively a tax.

CPP can become like a tax if:
  • Working a long high-income career (>39 years making over $65K/yr)
  • If incorporated and getting T4 income from your corporation and an external employer that totals more than $65K/yr
  • If incorporated and paying a spouse T4 income from your corporation and they also have outside income that pushes them over the maximum pensionable income.
CPP is usually not a tax, but is a pension for the self-employed if they are not in any of the above situations.

Why does it matter?

The question of whether CCP is a tax usually comes up during the debate of whether to draw income from your corporation as a salary or to pay dividends and keep more money invested in the corporation.

Even if CPP is not a tax, the other important question for self-employed professionals is whether CPP is a good investment compared to using dividends only and investing more through your corporation. I will explore that question in my next post.

4 comments

  1. Great points that I had not thought of.

    For salary paid to a spouse who is currently working with a large enough income and does not qualify for dividends (i.e., due to TOSI), it sounds like the CPP contribution tax is unavoidable.

    1. Hey TK,

      It probably is unavoidable for many people with a spouse working full-time outside the corp. However, it may partially be offset by the difference in tax brackets between the higher income and lower income spouse (the income splitting benefit of paying a spouse salary). It would be completely offset if the difference is >12%. For example, in Ontario if my spouse made $65K from her job and $20K from my corp and I took a salary of $160K to live on and contribute to our RRSP/TFSAs. The difference in our top tax brackets is >12% (barely) and the tax savings from that offsets the CPP “tax”. It may still be worth it to pay salary to my spouse though because it allows her to build her RRSP room more and for us to shunt more money from the corp to our RRSP/TFSAs which are more tax efficient in the long run. If our costs of living leave us with some extra money, it may also allow us to live off of my salary and invest more of hers in her own taxable account which can also be very handy and tax efficient.
      -LD

  2. Thanks ! Nice article.

    My wife and I are both seniors and semi-retired. So, taking money as dividends out of the corporation makes sense and not paying into C.P.P also had been a wise move. The question is what happens if we let our Medical Corp “expire”. i.e. when it becomes a Holding co. IF…not sure yet, if we decide to do part time work, we will have no choice to contribute to C.P.P.?
    I haven’t run this scenario through our accountant yet. Just thinking aloud.

    1. Hey Savlai,

      Great question. I would always run everything by an accountant. However, if your corp becomes a holdco, then you would likely need to pay into CPP as a self-employed person since your clinical income wouldn’t be channeled through a professional corp anymore. I would cling onto my professional corp until I stopped earning income completely and was sure I wasn’t going back. I don’t see a downside to doing that, other than an extra few hundred bucks a year in fees. By the time I was not earning any clinical income for a while, it may also be the time where keeping my license and maintenance of competence has dropped off anyway and made it hard to go back anyway.
      -LD

Leave a Reply

Your email address will not be published.