Budgeting and Cash Flow
What Is Your Income Available for Spending?
When people are asked how much money they make each year, the response is typically the gross salary that they earn. Is this the amount you should be using to calculate your budget? No, because there are various amounts that are taken from that salary that are beyond your control which would shrink the amount of money available for spending. There are 3 categories of such amounts. I call them mandatory deductions, optional deductions in that they are chosen by you, and fixed expenses where the parameters can be changed over multiple years. If you have business type revenue, there are some differences in these mandatory deductions which will be highlighted when they are relevant.
Mandatory Deductions
The easiest and best way to know what these deductions are is to look at a pay stub at the end of the year. You can also use a T4 Slip for income tax purposes or a Record of Employment (ROE) form if you have left a job, but these forms may not have all the deductions. What do you see? You will see various amounts taken from your salary like CPP contributions, EI payments, company pension contributions, union dues, health and life insurance premiums, worker benefits, and income taxes paid throughout the year. For more detail about how each deduction works, read the paragraphs below – otherwise you can skip to the section entitled Fixed Expenses.
CPP Deductions
Every employee or self-employed person between the ages of 18 and 65 must contribute to the Canada Pension Plan (CPP). These contributions are divided into an employer portion and an employee portion. The employer portion is paid by the company you work for and is not taken from your salary or visible on your pay stub. The exception is for a self-employed person who will pay the CPP employer portion out of their income and this would then be a budget item – more on this later in the document. The employee portion will come from your annual salary and would not be available for spending until you collect CPP. For the year 2021, the rate for the employee portion of CPP is 5.45%. This rate may change each year so you would have to check the government sources to obtain the current rates. To add another wrinkle to the calculation, the CPP contributions will apply to income ranging from $3500 per calendar year to the maximum annual pensionable earnings. The maximum annual pensionable earnings is fancy language for saying there is a maximum annual salary above which the CPP deductions stop. For 2020, this maximum amount is $61,600. If you make $80,000 in salary as an example, the contributions for CPP would cease once your salary reaches $61,600 at some point in the calendar year. For a sample calculation, if your income is $80,000 per year, the CPP contribution you would pay each year is equal to: ($61,600 – $3,500) x 5.45% = $3,166.45 per year. If you make $40,000 per year, contributions would be applied without a cap and be equal to: ($40,000 – $3500) x 5.45% = $1,989.25 per year.