Why the 17% drop-out rule is key to your CPP entitlement

Q. There are lots of articles on retiring early and whether or not to take CPP at age 60, but one small aspect that never seems to be covered is the impact of zero income years on the answer. CPP ignores eight zero-income years in calculating your benefit, doesn’t it? So there are really 34 years they’d count between 18 and 60.

So if someone already has several zero income years (i.e. from going to post-secondary school or travelling when they were young), wouldn’t delaying CPP reduce their payment by 1/34—or whatever—for each additional zero income year after 60? Or am I way off the mark? Can you explain this to me? Thanks for your time,

— Bob

A. Hi Bob. This is a great question, as it highlights how challenging it can be to understand how Canada Pension Plan retirement benefits are calculated. For many Canadians, the CPP retirement benefit is an important part of their income after they’ve stopped working. Even if you’re not near retirement yet, it’s worthwhile to delve into how your monthly CPP payment is determined.

Your question is about the CPP drop-out provisions which automatically remove no- and low-income months from the calculation of CPP retirement benefits. Because your CPP retirement benefit is based on your pensionable earnings from the age of 18 to when you take your CPP pension—called your “contributory period” in CPP lingo—dropping out these no- and low-income months can increase your monthly CPP retirement benefit, as the average income on which your retirement benefit is then based goes up.

Currently, the CPP program drops out the 17% of months in a person’s career period where he or she earned the least. Depending on how long your contributory period is, and whether other drop-out provisions also apply to your situation, this can allow up to eight years of your lowest earnings to be removed from the CPP retirement benefit calculation. Before 2012, this “general drop-out” provision was 15% of low earnings, in 2012 it increased to 16% and since 2014 it’s been 17%.

In addition to the low-income drop-out provisions, your CPP retirement benefit can also be impacted by the child-rearing drop-out provisions, which allow you to drop out low-income years during which you were raising children, or by any periods when you were receiving a CPP disability pension. The calculations for the child-rearing and disability drop-out periods take place first before the general low-income drop-out is calculated. Then, the 17% drop-out is only applied if, after applying the child-rearing and disability drop-outs, more than 120 months of earnings remain.

In the case of someone retiring and starting CPP at age 65, and assuming there is no period of disability or low- or no-income periods dropped out for child-rearing, the contributory period would run from age 18 to age 65, or 564 months; and 17% of the lowest-income months would automatically be dropped out. In this case, 17% of 564 months is 96 months, or eight years as identified in your question.

In contrast, someone retiring and starting CPP age 60 would have a shorter contributory period from age 18 to 60, or 504 months; and 17% of that total is 86 months, or 7.14 years which could be dropped out—not eight years as in the case of someone retiring at 65.

In fact, someone could retire at any point between ages 60 and 65, giving a range of contributory periods and corresponding maximum low-income drop-out months as follows:

Drop-out months by CPP starting age

*Assuming no child-rearing drop-out provisions and no periods of CPP disability income

Your question specifically asks about how the CPP retirement benefit is affected if someone stops working after the age of 60, but delays taking their CPP pension—thus adding low- or no-income years to their contributory period. Here’s the answer: the consequence of low- or no-income years after the age of 60 is no different from years before the age of 60, as those years still fall within your CPP contributory period.

What that means, in turn, is that whether or not years of low or no income after the age of 60 and before your CPP pension starts will impact your CPP benefit depends on how many years of low income you already have before the age of 60.

If, for example, someone has no or few years of low income before age 60, and then stops working for several years before starting their CPP retirement benefit, their CPP amount would not be impacted as those low-income years would be automatically dropped out from the CPP benefit calculation. Conversely, someone with many months of low income before the age of 60 who opts for a few additional years of low income during their CPP contributory period after age 60 might see an overall reduction in their CPP retirement benefit as a result.

At this point, you may be wondering how “low income” is calculated, as someone aged 60 now may have started working in the early 1970s, when salary amounts were much lower than they are today. (For example, the federal minimum wage in 1970 was just $1.65 per hour.) In order to calculate whether a month qualifies as a “low-income” month for the 17% drop-out calculation, all of your past earnings are updated to current values using what is known as the Yearly Maximum Pensionable Earnings, or YMPE. The YPME is the maximum amount of earnings covered by the CPP in any given year (for 2019, it’s $57,400). Essentially, each year of past earnings is calculated as a fraction of the YMPE in effect for that year, and then that ratio is updated to the current YMPE in order to determine which months are excluded in calculating your CPP retirement benefit.

Finally, you may also want to know if you can find out the amount of CPP you might receive in retirement—and the answer is yes. To check your expected CPP benefit, you can request a Statement of Contributions from Service Canada that shows your total CPP contributions for each year, the earnings on which your contributions are based, and an estimate of what your pension would be if you were eligible to receive it now. Requesting and reviewing your own Statement of Contributions can help you track and plan for your expected CPP income in retirement.

As this question and response shows, the CPP program is complex and can be hard to understand. Effective January 1, 2019, new changes to the CPP will start to be implemented, and with these changes, CPP will replace more of your working income in retirement. As a result, demystifying how CPP retirement benefits will fit into your retirement income picture will become even more important.

Alexandra Macqueen, with files from Lea Koiv of Lea Koiv & Associates.  Alexandra is a Certified Financial Planner and retirement expert providing advice through Pension Acuity Partners. 

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