Canada Pension Plan: Be Prepared for a Monthly $500 Pay Cut in 2021
Service Canada is bringing changes to the Canada Pension Plan (CPP) in 2021. These changes could mean a $500 pay cut every month. The CPP is a mandatory pension plan, where your employer deducts your contribution as well as their contribution. What you get is the net income after these deductions.
As part of the CPP enhancement plan, Service Canada has increased the CPP contribution rate to 5.45% and maximum pensionable earnings to $61,600 for 2021. How will this impact your paycheck in 2021?
How will CPP impact your pay?
If your gross annual income is $61,600, your monthly salary comes to slightly above $5,100. Your employer will deduct both employer and employee contribution of 5.45% each towards CPP. This comes to $528 per month in total CPP contribution. In 2021, you will get $4,606 every month in salary.
Service Canada has increased the total annual CPP contribution of employer and employee combined by $537 to $6,333 in 2021 ($5,796 in 2020). This modest increase in contribution will go a long way. While it will reduce your current salary, it will give you a federal tax credit of around $409.86.
You will realize the CPP benefit when you turn 65. After 65, Service Canada will pay you a monthly pension equivalent to a third of your average work earnings you received post 2019.
How can you offset the $500 gap in your paycheck?
The many benefits of CPP outweigh the $500 pay cut every month. But pay cut does sting. You can fill the $500 monthly gap, or $6,000 annual gap, by claiming the various tax benefits the Canada Revenue Agency (CRA) offers. It has increased the basic personal amount tax credit by $174 in 2021 and has started a $250 Canada Training Credit. Moreover, Service Canada has increased the Registered Retirement Savings Plan (RRSP) contribution limit by $600. You can deduct this additional contribution from your 2021 taxable income.
The CPP enhancement will increase your contribution every year till 2025. This means you could see a higher pay cut every year. An effective way to deal with this pay cut is to fill the gap with passive income. One tax-efficient way to earn passive income is through a Tax-Free Savings Account (TFSA). The CRA allows the money you contribute to TFSA to grow tax-free, and you can withdraw this money without worrying about taxes.
Investors generally look for fixed-income securities to earn passive income. But the pandemic crisis has pulled down interest rates to near zero, making fixed-income securities unattractive. However, the pandemic has created some good dividend opportunities.
Dividend stocks are the new income source
Invest $6,000 of your TFSA contribution in RioCan REIT (TSX:REI.UN). The pandemic has increased its dividend yield to 7.95%. This yield is gradually reducing, as the stock price recovers from the March sell-off when the yield touched 10%.
RioCan develops stores in prime locations and pays dividends from the rental income it gets from retailers. When the pandemic-driven lockdown shut all non-essential stores, RioCan suffered from reduced rent collection, lower occupancy rate, and risk of default.
But the recovery has been fast, and its rent collection has normalized. The occupancy rate will take some time to return to the pre-pandemic level, but it won’t hurt the REIT’s dividend-paying capacity. A $6,000 investment in RioCan will fetch you $480 in annual dividend for a lifetime.
RioCan is on the road to recovery. The stock has already surged 23% so far this month. Those who invested in the stock before the start of November have already earned $1,200 in capital appreciation. The stock will return to the pre-pandemic level of $27 in two years. This means another $3,000 in capital appreciation plus $950 in dividend income. That will fill more than a 50% gap in the pay cut from CPP.
The post Canada Pension Plan: Be Prepared for a Monthly $500 Pay Cut in 2021 appeared first on The Motley Fool Canada.
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Fool contributor Puja Tayal has no position in any of the stocks mentioned.
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