Business owners often have reservations about paying into the Canada Pension Plan (CPP). Many think they’re getting a bad deal by paying both the employer and the employee portion of the contribution, but can they do better by paying themselves dividends? In the last two episodes, we did an extensive review of how you can compensate yourself as a business owner through a private corporation. Today, we take a deeper look at two of the payroll expense aspects that often come up in discussions with financial planners: CPP and Employment Insurance (EI). If you are self-employed, there are a few things you need to consider, including your decision to pay yourself a salary or take dividends. We discuss that in this episode, as well as whether self-employed business owners are really getting the short end of the stick when it comes to CPP and EI contributions. Tuning in today, you’ll learn about some of the unique features of CPP, how it’s calculated, and the three major risks it offers protection against, plus we walk you through various models to illustrate the consequences of paying yourself dividends versus salary. We also delve into EI for self-employed business owners, the special benefits thereof, models that consider different amounts of income and consumption, and much more. For a comprehensive guide to CPP and EI for self-employed business owners, don’t miss this episode of Money Scope with Benjamin Felix and Dr. Mark Soth!
[0:00:02] BF: Welcome to the Money Scope Podcast, shining a light deep inside personal
finance for Canadian professionals. We are hosted by me, Benjamin Felix, Portfolio Manager
and Head of Research at PWL Capital, and Dr. Mark Soth, AKA the Loonie Doctor.
[0:00:17] BF: Welcome to episode 14 of the Money Scope Podcast.
[0:00:20] MS: Yeah, in the last two episodes, we did a comprehensive review of how you can
compensate yourself as a business owner through a private corporation, so you can choose a
salary and dividend mix each year to optimally do that over time, as the mix of current taxes and
future taxes and tax planning also enters into that equation. Today, we’re going to take a deeper
look into two of the payroll expense aspects that pretty much always come up in discussions
with your accountant, my accountant, too, the Canada Pension Plan, or CPP and Employment
Insurance, or EI.
[0:00:51] BF: As we mentioned in previous episodes, corporate business owners have the
option of avoiding salary and contributing to CPP by not paying themselves a salary. But salary
has a lot of advantages, and the costs and potential advantages are actually much more
complicated under the service than what people see at first glance when they see how much it
costs to contribute to CPP.
[0:01:12] MS: Yeah, we really discovered that. In writing those episodes, we found it was hard
to find a really good analysis of the potential cost benefit of CPP and the newer enhanced CPP
for business owners from a really practical standpoint. I had taken a crack at it a couple of years
ago, but there’s challenges trying to find an apples-to-apples comparison, because CPP is a
different type of product completely. When we were talking about it, I think Ben got pretty
excited, because he went away and came back with this model accounting for some more of the
nuances. As we discussed that further, we pretty much found all sorts of other things that we
really needed to look at when we’re thinking about this, so quickly morphed into a larger project.
[0:01:48] BF: CPP is complex to model because there are tax credits and deductions that
reduce the current cost after taxes. Then the other thing is that paying dividends to avoid CPP
suffers from tax integration and efficiency. We talked about dividends being slightly less
favoured by integration relative to salary. In addition to that, the return on CPP is not like a
regular investment. It’s not like a stock or a bond, because it hedges risks that other
investments simply cannot hedge. I think it has to be looked at differently from just comparing
the rate of return, for example. We’re going to try and unpack that today.
We do want to acknowledge Aravind Sithamparapillai from Ironwood Wealth Management,
who’s done some great analysis on CPP and on EI, both the topics we’re going to talk about
today. He helped us out just giving feedback and ideas, and then I’m working on some analysis
with him on the side as well. I also want to mention Jason Watt. He’s one of the country’s top
CFP curriculum instructors. He does some really good thinking on EI and his thinking on this
nudged us in the directions that we took our research and thinking. As always, despite those
acknowledgments, any errors are our own. We’re the ones talking about it today, but those guys
did bring us some great perspectives.
[0:02:55] MS: Yeah. Honestly, building this episode today changed my perspective on EI. The
knee-jerk response for most of us is to not opt in, and it was for me. I can tell you that right up
front. However, it could actually make sense when you put together a bunch of different factors
that are involved. Again, with both of these topics, it is important to discuss your plans for your
specific situation with your tax specialist.
However, as we’ve alluded to, this is not a widely discussed analysis, so it’s a blend of current
year costs, the bigger picture long-term. Coming to the table armed with the information that
we’re going to discuss today could actually change that conversation substantially. With that
preamble, let’s just dive right in.
[0:03:31] BF: As we discussed in episode 12, payments into CPP are part of the overall
equation. When you decide to pay salary from your corporation as compensation, they’re
mandatory payments, and you have to pay both the employer and employee sides of the CPP
contributions. That leaves less money to invest in the corporation relative to paying dividends.
Those are the commonly cited reasons to avoid using salary, and sometimes a gut feeling that
CPP is a bad deal for self-employed business owners, which we’re going to dig more into. We
don’t think that’s the case, that it’s a bad deal, and we’re going to address each of those issues
and explain why we don’t necessarily agree with them.
[0:04:04] MS: Okay. Let’s start off with what you pay and what you get. CPP contribution is an
amount, I mean, the process of rolling out the enhancements that are just coming out will be
implemented by 2025. The enhancements are funded by higher contributions that will eventually
result in a 33% income replacement rate compared to the current 25% base CPP replacement
rate. There’s also, along with that, a higher earning ceiling for enhanced CPP, so you can pay a
little bit more and get a little bit more, and that’s important.
The enhanced contributions are being phased in now, but the enhanced benefits will start
phasing in moving forward. As we pay more an hour, expect more down the road. The full 33%
replacement rate will be for people taking the benefit about 40 years from now. Between now
and then, it’s not like it’s money lost. People will get some combination of basic and enhanced
CPP, depending on how much they actually contributed in to each parts of the plan. Again, what
you get is related to what you paid. Those getting a larger income stream will have paid more
into the pension.
[0:05:08] BF: The maximum combined employer and employee contribution for 2025 is
expected to be $8,848. That’s a big headline number, and we’re going to dig more into that in a
bit. It is important to keep in perspective that that’s a significant number for a business owner
with a moderate income. For any Canadian, that’s a big amount of forced savings. For someone
with a very high income and a high savings rate, it’s a smaller proportion of the overall mix of
money that they’re putting away, but it’s still not insignificant.
Salary also goes hand in hand, we have to keep in mind, with other options for your longer-term
tax planning, like RRSPs and IPPs. We talk about CPP with respect to paying salary, even if
someone thinks that CPP is a downside, which we’re going to continue to dig into. But even if
you had that belief, foregoing salary also means foregoing RRSPs and IPPs.
[0:05:56] MS: Yeah. Those being tax shelters, that’s giving up something important. The
question always comes up, do business owners get a bad deal with CPP? Part of what I think
gets people piqued about CPP is the fact that it’s mandatory and that self-employed people also
get a raw deal, because they contribute double what a regular employee sees deducted from
their paycheck. You have to pay both the employer and employee sides of the payment. Part of
the confusion lies in that CPP was previously underfunded and not managed in a sustainable
way as a pension. That happened previously, and I think left a bad taste in people’s mouths.
That did change with reforms back in the 1990s, and now CPP is managed like a pension, and
it’s separate from the federal government. Pensions are managed in a different way. Pensions
are managed to ensure that they have the funds to cover their future payment obligations.
That’s really the bar that they’re trying to achieve. The CPP is actually really well managed as a
pension by using that type of measurement. Its most recent report showed that the pension
obligations are met out past 2057 and are well-funded.1 As a pension, it’s much better managed
than when it was originally rolled out.
[0:07:06] BF: CPP has an incredible global reputation. It is a really good plan. It’s still not fully
funded. The enhanced CPP that’s rolling out now is designed to be fully funded. Base CPP is
partially funded, so it’s when people get CPP payments, some of those come from new
contributions from other members, and some of them come from investment returns from this
endowment fund that they’re creating. It’s on a path to be fully funded. It’s a very well-designed,
run pension plan.
Business owners, I think, often feel like they’re getting a bad deal with CPP, because they’re
required to pay both the employer and the employee portion of the contribution, which is true.
An employee just pays the employee side, but it doesn’t tell the whole story. When the labour
market sets wages for employees, employers are at least somewhat taking the cost of employer
CPP contributions into account. If I’m hiring someone and I’m deciding how much I want to pay
them in salary, I’m not just ignoring the fact that I have to pay into CPP, as part of deciding how
much I can afford to pay them as an employee.
In other words, business owners, self-employed people are explicitly paying both sides of CPP
contributions. Employees of arm’s length corporations that they’re not closely related to are
implicitly paying both sides of CPP through lower wages. Even though you’re not as an
employee, seeing it on your tax return, I guess, that you paid both sides. In reality, you got paid
slightly less from your employer for the work that you did, and that’s how you ended up paying
at least a portion of the employer half of CPP as an employee. Empirically, and there has been
some work done on this, that equilibrium is imperfect, and employees in practice empirically
seem to bear somewhere between two-thirds and 90% of social contributions like CPP.2
[0:08:48] MS: Yeah. That data point is really important. People don’t believe you when I say that
CPP is wrapped in someone’s compensation package. They just don’t believe it. As self-
employed companies paying ourselves, we just see that transparently, but it’s still buried in there
for everyone else. It’s not like people get a free ride. You can just expand a little bit more on that
data where it comes from, just so lends it to some more background.
[0:09:09] BF: That statement that employees end up absorbing the majority of social benefits
contributions is based on a meta-analysis of studies looking at countries around the world. The
meta-analysis finds that the costs of Social Security, or CPP in Canada, contributions are largely
passed through to employees, mostly through reduced wages, rather than reduced work hours.
The $1 of increased cost to the company for social contributions like this flowed through a 66 to
90 cents less wages for the employees.
I think the notion that the employer contribution is this like freebie that comes out of thin air for
employees and effectively a penalty for the self-employed, it doesn’t really hold up empirically. I
don’t think it really holds up logically either, but the empirical part is what matters. In any case,
as we discuss CPP throughout this episode, we are going to view it through the lens of paying
both the employer and employee contribution. That’s how I’ve done all of my analysis on this.
But even still, every time I post something about it, I get a lot of comments saying, “You must
only be looking at the employee portion.” Actually –
[0:10:10] MS: No, no.
[0:10:11] BF: Probably one of the most common comments that I’ve gotten. I posted about this
on YouTube. I posted about it on Twitter. At least a few people every time I posted about it say
like, “Great analysis. But too bad it doesn’t apply for self-employed people.” Actually, it does.
The other thing I want to mention here is the academic research, when you look at published
papers, usually in journals in Canada, looking at CPP, they model total contributions from
employees and employers when they’re looking at things like the rate of return on contributions.
There’s also a paper from the Fraser Institute on CPP. This one many times has been sent to
me saying, “You must be doing the math wrong, because look at this paper, they found a 2%
internal rate of return for an employee.”
I think that the language in that paper might just be confusing, because they specified that
they’re looking at an employee, which leads people to believe that it’s a different result than
what you get if you look at a self-employed person. When you dig into that paper, they follow the
methodology of a published academic paper, and that published academic paper, if you go
through their methodology, they’re looking at both the employee-run, employee contribution as
the cost of CPP.3 All of those industry reports, or whatever you call Fraser Institute think-tank
reports out there and academic papers, they all use the same approach and come to similar
results, which we’ll mention later. We’re going to take the same approach here. We’re going to
think about the cost of CPP, regardless of whether you’re self-employed or an employee. The
cost of CPP is the employer and employee combined contribution. That’s just the right way to
think about it, I think.
[0:11:34] MS: Yeah, I agree. The other issue is people think of CPP as a tax, when really, you
get what you get out of it as related to what you paid into it, which whereas with taxes, you pay
into the pot and it gets redistributed based on the government’s decisions about how they want
to redistribute it, rather than being directly tied to your contributions. CPP is different in that what
you pay in is what you get. But it is important before we leave that topic to talk about a couple of
times where it is actually a wasted premium, which functionally is like a tax in the sense that
you’re paying extra in, but you’re not going to get that out.
There are a couple of times when that can happen that it’s usually a minor impact, but it could
be important for some people. If you have income from an external employer in addition to your
own corporation, it is possible to contribute more than your annual maximum to CPP. When that
happens, you can get your employee side over-contributions back on your personal taxes.
However, the over-contribution made by your corporation and the external employer, if that goes
over the amount, then that extra part doesn’t get recouped. If you have a case of multiple
employers, you could end up paying a little bit more from your corporation for the same benefits.
Similarly, if you have already reached the maximum CPP benefit based on past contributions, it
actually takes quite a while at maximum contributions to do that. Very few people actually ever
get there. But if that was your situation for their contributions wouldn’t come with additional
associated benefits.
The other thing to be aware of is that during years that you’re raising children, the CPP benefit
calculation allows you to draw up low years of low income due to raising a child under the age of
seven, they can be excluded. That may mean, depending on your situation, making CPP
contributions in those years, if they’re not adding to the benefit, they’re not going to improve
your situation, despite some money paid into it. In those situations, actually paying dividends
may look more favourable if you’re doing one of those parental leaves instead, just to avoid that
situation. Although, very few of us are going to hit the maximum amount. Those situations, the
ways the contributions are a bit tax-like and that you’re paying a bit more, but you’re not getting
more back for doing that.
[0:13:41] BF: I want to keep going on the CPP as tax for an asset. Because if you think about it
as a tax, if you think about CPP as a cost, then paying dividends can look a lot more attractive
than salary, because CPP, if we view it as a tax, effectively increases the tax rate on salary. Not
an insignificant amount, but I’m going to argue, we’re going to argue that’s probably not the best
way to think about CPP. Because when you make CPP contributions, they build entitlement to
an inflation index annuity, proportional to what you put in, like you said earlier, Mark. That’s not
only an asset that’s proportional to what you put into it, which makes it less like a tax, it’s also a
really valuable asset in its own rate4, because an inflation index annuity is not something that you
can buy if you want to.
If you have a pension, a defined benefit pension plan for an employer that has an inflation index
benefit, that’s one source, most people don’t have that. If you work for the federal government,
that’s another source. Most people don’t work for the federal government, although more and
more people are.
[0:14:36] MS: Yeah, apparently. No one else is willing to take on the risk, because basically,
you’re moving the risk from you and it’s being moved on to someone else. No insurance
company is going to want to do that. No employer is going to want to do that, unless, perhaps,
the government where they can change how much they collect in revenue to cover unexpected
liabilities. But no other employer wants to do this. So, it’s, as you mentioned, basically
impossible, or very difficult to get access to this type of asset.
[0:15:02] BF: Yeah. CPP is not the government, but they have a massive base that covers all of
Canada. One of the reasons that the government can take on real liabilities is because they
have the most diversified revenue stream in the tax base of anybody. Nobody has a diversified
revenue stream like the government does. Now, again, CPP is not the government, but they
have a very diversified base of contributors who are required to contribute into CPP. They also
have a time horizon that is effectively, at least theoretically, infinite. Which again, that’s unlike
any corporation, unlike any individual. They’re just in a different position in terms of being able to
provide a real return to contributors.
Anyway, that’s valuable. You can buy annuities in Canada. I know I got some pushback on this
when I said the same thing on Twitter. Somebody said, “No, you can buy inflation index
annuities in Canada.” I dug into that. I talked to people who worked for insurance companies. I
have to be proven wrong on this. I would love to get the data because then we could have
pricing for what does it cost to buy this in the private sector, but I’m pretty sure it doesn’t exist. I
did quite a bit of digging on it.
What I’m trying to say is you can buy fixed indexing annuities in Canada, so you can get a 2%
index annuity, but it’s fixed at 2%. Inflation is not fixed at 2%, even if it’s been 2% for a long time.
That doesn’t account for if you have an 8% inflation year. A 2% index annuity does not respond
to that. Why is an inflation index annuity important? It is the risk-free asset for a long-term
investor. Cash is super risky for a long-term investor. It’s not a risk-free asset. An inflation index
annuity is the risk-free asset. That’s worth something.
Outside those special situations that you just mentioned, Mark, where CPP contributions are
wasted and they’re more tax-like, every contribution is going toward buying this really valuable,
useful retirement asset.
[0:16:41] MS: Yeah. CPP is more of an asset than a tax. Not only that, it’s actually a desirable
and hard-to-come-by asset. However, the other criticism that comes up is from people who feel
that they don’t need risk mitigation. They want to take as much risk as possible and putting
money towards CPP takes it away from other riskier investments. They don’t need any safety
net. How does CPP stack up as an investment in terms of risk and return? That’s an important
question for that crowd.
[0:17:09] BF: That’s the other common pushback. I could do better on my own. That’s a
common way to think about CPP is look at the rate of return you get on CPP and look what I
could have gotten investing in NVIDIA, which is a terrible comparison, but that’s one stock.
[0:17:21] MS: Yeah. Or you could have invested in Ark funds.
[0:17:22] BF: Could have invested in Ark. That worked for a while, but not so well. We will talk
about that. We will talk about the rate of return on CPP, because as much as that’s not, I don’t
think the best way to evaluate it, I think it is still one way to look at it. I think it’s important to talk
somewhat more qualitatively though about the unique features and benefits of CPP, because
risk and return aren’t just about investment risk. We can’t just look at a rate of return and a
standard deviation and say that assesses all facets of risk. That’s just not the way that the world
works.
CPP offers protection against three risks. That individuals are unable, or it would be very hard
for them to hedge on their own. It protects against longevity risk. The risk of living longer than
expected. I had a risk of living too long in my notes, but that sounds bad. People want to live
long. The risk is living longer than you planned to live for and then you’re in a position where you
may run out of the ability to fund your lifestyle. That’s one. Protects against longevity risk.
Protects against inflation risk, and that’s the risk of high inflation diminishing the purchasing
power of your assets. And it protects against sequence of return risk. That’s the risk of repeated
poor returns, particularly early on in retirement, doing a lot of damage to your long-term
spending outcomes. Those are three big risks for retirees and CPP protects against all of them,
which is valuable.
On longevity risk, again, it’s funny to refer to this as a risk, because people want to live long
lives, long, healthy lives, hopefully. The financial reality is that the longer we live, the more we
need to have saved to have a successful retirement. Nobody wants to run out of money and eat
cat food.5
[0:18:50] MS: No, exactly. Longevity risk. The risk of living longer than expected, or living longer
and running out of money before you run out of taste buds.
[0:18:58] BF: If you run out of taste buds, then eating cat food is not so bad, I guess. That’s
good. For longevity risk, or palate risk, pooled pensions like CPP, or annuities like CPP, they
deal with longevity in a different way than an individual can. It’s a bit grim to think about, but
instead of every individual needing to save more to fund a longer life, CPP lets people who die
earlier than expected fund people who live longer than expected. That’s called mortality pooling.
Again, I know that’s grim and it’s also something people don’t like about this. I don’t want to die
early and help somebody else. But if you live long, then someone else helps you. That’s just the
way that these things work.
It’s very efficient. Doing it this way is much more efficient than everyone having to save more.
On average, dying with a big pile of money left over. That’s mortality pooling. It’s very efficient
and useful. Nobody can do that on their own. Any individual can’t hedge longevity in the same
way on their own. Because of the mortality credits, CPP will look increasingly attractive at longer
life expectancies and we’ll talk about some of the numbers around that later.
[0:19:57] MS: This gets back to some of the things we’ve talked about right at the beginning of
this whole podcast series. Investing some time and money into good nutrition, exercise and
other things that benefit your longevity might actually get you mortality credits, too, when it
comes to CPP. Eventually, so you’re paid out of CPP, or if you’re able to obtain your own
insurance, you might make a profit from that, I guess, by beating the odds.
[0:20:19] BF: Yeah. CPP doesn’t take mortality expectations into account. They do when they
price the whole plan, but for any individual, they don’t. For private annuities, they do look at your
health and stuff like that. I think the only thing you can get is a higher payout annuity, if you can
prove that you have a shortened life expectancy. I don’t think I’ve ever seen a smaller pay-out
annuity. Nobody would ask for that. But there’s asymmetric information with annuities, so the
insurance company doesn’t know how healthy you are.
Anyway, this is off-script and a little bit off-topic, but there’s potential for arbitrage and risk-free
profit. If someone knows that they’re very healthy for their age and knows that they have high
longevity, they can choose – that person specifically can choose to go and buy an annuity,
because the insurance company is not going to assess their relative level of health. There’s a
concept of biological age, someone who’s biologically younger, and then their time-based age
would, at least statistically, be better off buying an annuity.6
[0:21:09] MS: That’s good to know. My government says, I’m six or seven years younger than I
really am, so.
[0:21:14] BF: Yeah, so you’re a good annuity candidate. I guess, the other thing there is that if
people are really upset about CPP, it’s an incentive to improve their biological age, get healthier,
so they can get more out of it.
[0:21:25] MS: Financially motivating.
[0:21:26] BF: Those types of lifestyle choices and other factors like that, they do impact
mortality and they do figure into the return on investment when we’re talking about this stuff.
This is particularly relevant, and this one doesn’t feel great to talk about, but it’s true. It’s in the
data. High-income professionals with higher levels of education and socioeconomic status tend
to live longer, so they’ve got more longevity risk.
[0:21:48] MS: If anything, it makes CPP a better investment for us, because of that statistic.
[0:21:52] BF: Yeah. Again, it feels gross to talk about it, but it’s there in the data, and the
numbers are not small. People with more education, higher incomes, live meaningfully longer,
so that’s important. The other thing that’s worth mentioning is that asymmetric information that I
mentioned about purchasing an annuity privately, that’s cool if you can arbitrage it. But while
annuity companies aren’t able to assess your biological age when they sell you an annuity, they
do know. They know that people who have higher longevity are going to be the ones that buy
annuities.
When the insurance company prices their annuity product, they do take that into account. They
do take it like an adverse selection problem, where people who expect to live long are going to
be the ones to buy annuities, and so annuity providers have to charge more for their product.
CPP, though, because everybody has to pay into it, there’s no adverse selection, it doesn’t have
that same problem.
[0:22:44] MS: The insurance companies, they’re smart when they price their products. They
look at all sorts of factors to make sure that they’re going to end up making the profits and not
paying for more things than they expected to. It’s what they do as a business. We can buy
insurance products to help mitigate longevity risks. We’ve talked about annuities. However, it’s
much riskier for an insurance company to take that on.
Plus, it’ll also take on the inflation risk goes with that. If they were to try to do that, the price
would be astronomical to account for them taking on that risk. Attempting to maintain our buying
power over long periods of time is part of why you invest in stocks, actually. Risky assets like
stocks and to lesser extent, bonds, may provide sufficient long-term returns that outpace
inflation in the long run. Unfortunately, though, they still do not offer a direct inflation hedge is
the best we can do, but it’s not a direct inflation hedge.
When I say that, I mean that they do not necessarily increase when inflation rises at the exact
same time. That could be a big problem for retirees. A little-known fact is that the worst time to
retire in US stock market history was actually not 1929. That’s what a lot of people would think.
That was the period just before the massive market crash in the Great Depression. It was
actually in 1968, and that was a period with reasonable market returns, but it was also
persistently high inflation. If you earn a 7% market return on your investments, but inflation is
running 8%, you’ve actually lost money in real terms.
The thing about this, inflation also tends to have catastrophic effects on long-term real returns of
bonds and cash. Those assets are typically thought of being as safe.7 As people think, I want to
mitigate my risk of running out of money, or having a bad sequence of return, I’m going to use
lots of bonds and cash, but they’re not safe when it comes to inflation. They’re particularly
vulnerable. The CPP benefit offers this indexing to inflation. Each year, the benefit of those
receiving CPP has increased based on the CPI, all items indexed.
Like longevity risk, inflation risk is extremely difficult for any individual investor to try to hedge
with their investments8, but CPP is in a much better position to deal with that. Since it’s funded by
many contributions and it has an extremely long time horizon to realize those investment turns,
they can smooth it out so they don’t have to worry about all these little bumps along the way,
which are little bumps for a pension with an infinite horizon, but they could be huge for someone
who’s facing 10 years of inflation or something.
[0:25:14] BF: They can invest in other stuff. There’s a paper from Sebastien Betermier, who’s a
professor at McGill. He was on our Rational Reminder Podcast a while ago. He’s got a relatively
recent paper out looking at not CPP specifically. He looked at three Canadian pension funds,
CPP being one of them, CPP Investments. But he looks at examples where they were able to
purchase, I think, entire companies and then through their abilities as a massive asset manager,
they were able to add significant value to that business for their pension investors. If that’s the
thing that a person just can’t do, I think there’s something in there, too.
Another under-appreciated fact is that CPP contributions are increasing with wage growth,
which is historically outpaced inflation. We’re talking about contributions going into CPP being
one of the reasons that it’s able to withstand inflationary pressure. That’s one of them. To the
extent that wages are going to at least keep pace with inflation, they’ve historically outpaced it,
that definitely helps. Then CPP Investments, which is this ground corporation that exists at
arm’s length from the government, but it invests the funds held by CPP. It can do the stuff that I
mentioned a second ago. It can invest in these long-term illiquid assets, which an individual just
doesn’t have the capacities to do.9
The other thing in there is that the investment management model employed by CPP
Investments has been very successful at hedging its real long-term liabilities.10 There’s often
criticism, pretty casual criticism. The cost of CPP are 1%, I think, which I think they are, which is
a lot, because it’s a massive fund. Then people will say like, they could have done better
investing in index funds, which is – I don’t even know if that’s true right now, because the returns
have actually been pretty good. Even if they’re same, match the returns of index funds.
That’s not really the right way to assess the performance of a pension fund, because the job of
a pension fund is not to earn the highest rate of return possible. It’s to hedge its real liabilities.
There’s another paper that looks at that. They look at how well has CPP, or how well have
Canadian pension funds in general hedged their real long-term liabilities. Using the model that
they do for investment management, they have been very successful. I think that’s another thing
that’s worth mentioning there. There’s links to a lot of this stuff in the footnotes. Papers backing
up most of the stuff we’re saying here.
The other thing is sequence of returns risk, so that an individual investor gets one investment
lifetime. The specific sequence of returns that they get can matter a lot. You could have two
people who get the same average return throughout their retirement, but the sequence in which
they earn those returns can have a material impact on their ability to spend in retirement.
Someone who gets bad returns early on in retirement can be in a much worse position than
somebody who gets strong returns early on in retirement. That can come from bad market
returns, like from the 1929 example.
It can also come from high inflation, which – I love that example, 1968 in the US market
example, that’s historically the worst time, worse than the big market crash to retire, or
realistically some combination of bad returns and high inflation. Those can cause sequence of
return risk. But with CPP, the guaranteed income stream plays a role in reducing those
challenges of sequence of returns, because it provides this baseline level of guaranteed income
through bad market returns and high inflation.11
[0:28:11] MS: Yeah. That put another way is that CPP can smooth the returns of many
investors’ lifetimes. Instead of having that one sequence that you’ve got, you have no single
sequence. A whole bunch of people are contributing and retiring at different times. Then you
spread out all of your sequence risk across all of those different sequences across this big pool
of participants. It reduces that impact on CPP as a whole. The other effect of a guaranteed
income stream, though, is that allows individuals to take more risks with their other investments.
If you are concerned about your risk in your return, you have this relatively safe stream, then
you could possibly afford to take some more risk with your other investments, without increasing
your risk of financial ruin for doing that.12
Now, before we leave the topic of how CPP helps us with risk, I just want to make one more
comment about a couple of other risks. Investors, they can theoretically control them, but it’s
challenging in real life. One of those is behavioural risks. People think, “Yeah, I can do it way
better than CPP.”
It’s different when you manage your own investments. We know there’s that behavioural gap
that’s there. We talked about that in episode seven, where we’re wired to buy and sell things at
bad times, and that average is 1% or 2% a year over our lifetime that could add up to a lot of
money, depending on how you’re investing. The other thing is CPP mitigates that behaviour,
because you don’t get to touch the investments. It forces you to invest regularly, not just when
you feel like it’s a good time to put money into the market. It has to be a regular thing. You can’t
touch the investments on your own. It really eliminates that problem for us.
The other risk that I’ve come to appreciate really as I interact with more people in retirement and
even looking at our own spending is sometimes if you have a lot of assets and you’re going to
be fine, still have a failure to spend. It’s hard for people to sell investments, but it’s relatively
easy for them to spend income. You see it come in there. You spend it, especially if you’re
someone who’s a bit of a saver. Those are the people likely to have big piles of assets. They
have a hard time spending them down. Of course, that means they’re giving up the use of that
during their lifetime.
Whereas, having this regular income stream that provides this safe floor may help you to spend
some money with more confidence from a behavioural standpoint. The amount of it, CPP could
be meaningful money in terms of people, some more than others. Even if it’s a smaller amount
of money relative to your overall portfolio, I think the psychological impact of that can be
disproportionate, just because it’s coming in there regularly into your account. You see it and
you’ve paid tax on it. You might as well spend it.
[0:30:42] BF: The numbers are getting big. I’m about to do some math on the fly, which is never
a good idea when you’re doing a podcast. The new earnings ceiling is higher. Then you’re
getting 33% of that as a potential future benefit. If you’ve run quick numbers on that and I’m not
going to do the math, because that’s never a good idea, like I said, on a podcast. But if you do
33% of the new higher earnings ceiling and then take into account the fact that you can get a
bonus for deferring CPP, and we’ll talk about that in our episode on retirement planning. If wage
growth continues to be 1% above inflation, like it has historically, because the initial CPP benefit
when you start taking it is affected by wage growth. When you take all into account, it’s a 49.2, I
believe, percent higher benefit if you defer from age 65 to age 70. When you add all that up for
a couple, could be really big numbers.
[0:31:28] MS: Could be a decent amount of money to live on.
[0:31:31] BF: For people with the enhanced benefits. That’s for people retiring 40 years from
now.
[0:31:34] MS: Yeah. Way in the future.
[0:31:36] BF: For now, it’s relatively small. But in the long-term, distant future, for people who
are saving today, the combined CPP benefit is going to be material for households, but less so
now. Still meaningful, but –
[0:31:47] MS: From a society standpoint, to force that savings is going to be important, because
otherwise, people fail to do it. If they fail to do it, then society is going to have to try to support
them the best they can. It’s for everyone’s benefit, really.
[0:32:02] BF: This is one of the debates I’ve had about CPP is that some people say that
because of that, because of what you just said, Mark, it’s a tax. It’s like, both things can be true.
CPP is good at the individual level and it is good for society. It doesn’t have to be one or the
other. But I tweeted a while ago, as it’s somewhat of a joke, but also a lot of truth behind it. I
can’t remember exactly what I said, but something about how everyone says that it’d be better if
they didn’t have to pay into CPP. Then I showed this statistic on how much people have on
average saved for retirement. It was some tiny amount. To your point, it’s good for everybody to
have stable, secure retirements.
To your point about spending, I can definitely tell you anecdotally that for retired clients having
guaranteed income streams, like CPP and old age security and guaranteed income supplement,
if it’s applicable, they definitely punch above their weight. They punch above the weight of their
economic benefits when it comes to improving infectious psychology with market returns, but
also comfort with spending. People don’t like to spend from their assets. But from an income
stream, it’s just psychologically different.
We’ve talked about qualitatively the unique attributes that CPP has. With that in mind, I think the
important question for an incorporated professional to ask is whether CPP is a good investment
compared to the alternative of paying themselves the dividends and investing what would have
gone to CPP in their corporation. Now, if CPP is deemed a good investment, in that case, then
paying into CPP is probably not such a bad thing. Definitely not a tax and probably not a reason
to avoid salary. That can materially affect the salary versus dividends decision. Because as
we’ve mentioned, dividends avoid CPP contributions altogether and leave more money in the
corporation to be invested. I’ve heard this. It’s not uncommon to hear people recommend the
dividends only approach with a sole intent of avoiding CPP.
[0:33:48] MS: Yeah. Build a bigger corporation, because you control everything.
[0:33:52] BF: When we’re making this comparison between paying the CPP and investing in a
corporation, it’s important, but not super easy to compare apples to apples. We’re going to do
our best here. If you compare paying into CPP to investing in an all-equity portfolio in isolation in
a corporation and assume a guaranteed 7% return every year in your corporation, like
clockwork, then you would expect a model to show that investing in your corporation is superior
to CPP. That’s the argument that I see all the time. It comes back to, I could do better on my
own. Why would I want to be forced to own this low-risk thing, which is CPP, when I could invest
in stocks and make more money overall?
I think there are some major issues that this entirely misses and it can lead to some bad
decisions. The first big one is that with stocks, yes, they have higher expected returns, but
you’re taking way more risk on multiple accounts. Probably more than is often appreciated by
investors. The real long-term outcome of stocks is uncertain. There’s lots of upside, yes. But
historically, domestic stocks have around a 13% chance of losing purchasing power at a 30-year
horizon. International stocks have around a 4% chance.13 Not immaterial at all. If you start adding
bonds into the mix there, the probability of losing purchasing power is even higher.
CPP has no upside. The market goes crazy and does really well, you’re not going to participate
in that with your CPP contributions. Not directly anyway. It’ll help fund future benefits. But the
downside of risk of CPP in real terms is pretty much non-existent. Assuming CPP remains
solvent and all that stuff, which is a whole other rabbit hole that we’re not going to go down right
now. I think it’s fine. But CPP is there. Because it’s an inflation-indexed annuity, it is, I mentioned
this earlier, it is the risk-free asset for a long-term investor.
If we get a period of high inflation, cash and bonds, like you mentioned earlier, Mark, they’ll tend
to perform really poorly. Again, the CPP benefit is indexed to Canadian inflation and is in a
position to weather the storm in those scenarios. When you consider CPP as an asset, it’s about
as close to a risk-free asset as you can get in terms of risk-adjusted real returns.
The second big variable that impacts how well the CPP benefit does for you as an investment
depends on when you take the benefits. Alluded to this earlier. You take them earlier than 65,
you get a penalty effectively. There’s a maximum 36% reduction in your CPP benefit, statutory
reduction. There’s some interactions with wage growth in there, too, that can actually increase it
more, but we’ll leave that alone for now. Then, likewise, if you take it after age 65, there’s a
bonus. That’s up to a statutory 42% increase. Again, if you account for the effects of wage
growth, it’s actually can be a higher than 42% increase for deferring when you start your CPP
benefit. Those are big variables.
Then how long you live for, or what your life expectancy is, another big one. Then how high
inflation is is also going to affect how well CPP performs as an investment. I’m saying as an
investment, if we’re just comparing the rate of return, which again, that’s only one lens to think
about this. If you defer the benefit to age 70 as long as you can, live a long life, and have high
inflation during your retirement, CPP will be the best-performing asset you could have. On the
other hand, if you take benefits early, or don’t live that long, or don’t experience high inflation, or
maybe market returns are really high during your retirement, CPP can look lousy on a relative
basis. It’s a totally different
On the CPP side, it’s an actuarial risk of how well your life lines up compared to the variables
used to price CPP. Totally different from financial market risk, which is a good thing. You want to
have different types of risks.
[0:37:16] MS: Diversification.
[0:37:18] BF: Totally. It pays off in scenarios where other stuff won’t. Other stuff pays off in
scenarios where CPP won’t relatively. The third issue, we talked about this in previous episodes,
is that paying dividends to avoid paying into CPP has other tax planning consequences, a
couple of them. Salary comes with some tax credits that reduce the effective current cost of
CPP. Plus, salary, and this is a big one. Salary opens the door to RRSP and IPP usage. You
only get room contributed to the RRSP and the IPP if you’ve paid yourself salary in the past.
There are also some nuances with tax integration for salary versus dividends that vary. We’ll talk
more about that at the end of the segment, because context there is important. We’ll talk
through some scenarios with numbers later. First, we need to touch on that relationship between
CPP and tax integration.
[0:38:04] MS: Yeah, and this is really interesting. It’s something that’s not well understood when
you’re considering the return on the investment of CPP is how much you’re actually putting in to
contribute to CPP. As we mentioned earlier, the total maximum CPP contribution in 2025 will be
around $8,848. This does not mean that you will save $8,848 by paying yourself dividends
instead. This isn’t intuitive to people. There’s two reasons why that is. One is that CPP
contributions result in a combination of tax deductions and credits. We mentioned that a bit
earlier that tax integration also favours salary over dividends. Those factors together make the
effect of cost of that actual decision of one versus the other using CPP and salary, versus
dividends only, not a one-to-one difference.
The 4.95% base CPP contribution results in a tax credit personally, which is worth the base
credit rate. In Ontario, that’s about 20% of base CPP. The additional CPP contribution is a tax
deduction at the personal level. The value of that actually depends on your tax bracket. For
example, in the top Ontario tax bracket, that deduction is worth 53.53%. You can imagine those
credits and deductions reduce the actual cost that you’re paying to contribute to CPP.
Now, on the corporate side, the employer CPP contributions are a deduction to the corporation,
meaning that their value depends on the corporate tax rate, because you’re not going to be
paying taxes on it. They’re not taxable to the corporation, not taxable to the employee. This
reduces the after-tax cost of the employer contribution and the employee contribution when you
put them together. This is similar to other pensions. The employer contributions are pre-taxed.
The personal contributions are only partially taxed. That’s not fully pre-taxed like an RRSP, or a
regular pension, but it’s not terrible either. With this tax deferral, that you defer that tax by not
paying it now, and then you’ll pay tax in the future when you get your benefits.
[0:40:09] BF: Some of the personal contributions are pre-taxed, that base CPP is a credit, it’s a
partial offset, but new enhancements to additional contributions, those are a deduction. Overall,
it’s partially pre-taxed, but some of the newer ones are fully deductible, which is nice, and it
means that it interacts with your tax rate in terms of how costly it is to contribute to CPP. The
imperfect tax integration inefficiency thing with dividends should also be, I think, considered one
of the costs of avoiding paying into CPP. This is the thing that Aravind Sithamparapillai really
uncovered and got me looking into. Him and I are looking at this together. It’s a really good
perspective.
When you add up all of those credits and deductions, not even counting RRSP and CPP room
as a benefit, but you just take the benefits and deductions of contributing to CPP, hack on the
imperfect tax integration, where you’re paying a little bit more tax for paying yourself dividends
than salary, the net cost of contributing to CPP is a lot lower than the headline number makes it
seem than the 8,848 makes it seem. Or an alternative perspective is that the net cost of taking
dividends to avoid CPP is a lot higher than I think people realize.
To prepare for this episode, we modelled a scenario where someone has a fixed amount of
personal spending to fund. This person’s lifestyle costs this much. I don’t remember what the
number was, but their lifestyle costs this much no matter what. They’re deciding whether to fund
that after-tax living expense using salary, or dividends. In the salary scenario, they have to make
their CPP contributions. In the dividend scenario, they retain the leftover earnings in their
corporation relative to the scenario where they pay themselves a salary. The salary at the
overall cost is a little bit higher, because of the CPP contribution. But in the dividend scenario,
they retain the leftovers in the corporation. This model really lets us see holding personal
consumption needs constant. How much gets left in the corporation by paying dividends to
avoid CPP? Which is the question.
The result, in our example, and I think we had a high personal tax right here, the result was just
under $6,000. The punchline, and this is important, is that while CPP is expected to cost that
$8,848 number in 2025, someone in the highest tax bracket in Ontario, so what’s the highest tax
bracket? They would only be able to retain about $6,000 in their corporation by avoiding paying
into CPP, using dividends to fund their personal consumption. That $6,000 is before personal
taxes, too. It’s $6,000 left in the corporation.
The explanation for that, why is it $6,000 that you save by avoiding CPP, instead of $8,848? It’s
because tax integrations slightly favours salary, and there are deductions and credits related to
CPP contributions.
[0:42:48] MS: Yeah. Basically, the bottom line there is that the cost of salary in CPP is less than
appears on the surface. Now, looking at the other side of the question is the return on
investment for CPP is actually often much better than what people think as well. I took a stab at
that previously, and then you’ve modelled it as well in a lot of detail here.
[0:43:06] BF: Yeah, I modelled the going in in a lot of detail that coming out is a little messier,
but still gets us to a useful place. We modelled that scenario. CPP versus dividends. We did a
time series of that. Side by side, over time, where do you end up with CPP in terms of
accumulating the benefit in there, versus where do you end up by retaining money in the
corporation? Now, it’s not going to be an apples-to-apples comparison. The reason being, what
we’ve talked about, CPP is an inflation index annuity. An investment portfolio in the corporation
is not an inflation index annuity, and we can’t buy one to make the comparison really apples to
apples. It’s a little bit rough.
One approach is to look at the internal rate of return on CPP contributions. That’s the number
that sets the present value of contributions and benefits equal. A higher IRR is going to suggest
a better outcome for CPP. Starting with a case that’s representative of the average Canadian,
the real IRR on base and additional CPP is around 2.1%. That assumes taking the benefit at 65,
living to age 85. That 2.1% is a real return that’s important.14 That’s after inflation. You tack on
inflation, it’s a bit higher. That number is not controversial. That’s what the Fraser Institute finds
in their modelling. There’s another academic paper that found the same thing.15 The Fraser
Institute and that paper followed the same methodology. It makes sense that the results are very
similar.
OSFI, the Office of the Superintendent of Financial Institutions, I did go into the Internet Archive
to find this one. It’s not on the Internet anymore. I love the Internet Archive for stuff like that.
They had a report a while ago, and they also found a 2% real IRR as the expectation for the
average Canadian paying into CPP. Anyway, all that to say that 2% baseline return for paying
into CPP, baseline real IRR is not controversial. It’s not bad. It’s not amazing. Not the expected
return of a stock, or of a diversified stock portfolio, but it’s not bad.
It’s about the same as what government bonds have historically returned in Canada, but
keeping in mind that CPP protects against high inflation and longevity, which government bonds
do not protect against. That’s a base case. If we model deferring the benefits to age 70, which
like we talked about earlier, it’s statistically likely to result in better outcomes16, especially for
people with high incomes and advanced education, because those are factors related to longer
life expectancy.17 We assume living to age 95, which is on the longer end of life expectancy, even
for someone with those demographic characteristics, but just to illustrate the point. In that case,
the real IRR and CPP is 3.11%.
Not bad. In that case, actually closer to the expected return on a 60% stock, 40% bond
investment portfolio. Investing in a higher stock allocation would have a higher expected return
and might be more tax efficient, but it’s also more risky.
[0:45:41] MS: If you live that long and are fortunate that way, you’re making a really great return
relative to a portfolio with much more risk. Without that risk, so risk adjusted return would be
fantastic.
[0:45:54] BF: Yeah, exactly. The other thing, and I think we might have mentioned this earlier,
but having CPP there lets you take more risk with your other investments.18 There’s research on
this. We’ll have this in the footnotes, too. Comparing stocks to an annuity doesn’t really make
sense, because there’s actually an optimal combination, theoretically, of stocks and annuities
that gives you a better-expected outcome than stocks alone. To look at just an annuity versus
just stocks doesn’t make a whole lot of sense. The real comparison should be some
combination of stocks and annuities compared to stocks, or compared to stocks and bonds.
What the research tends to show on that is that because the annuities hedging other risks that
stocks can’t hedge, you get a better-expected outcome by combining the two.
[0:46:37] MS: Yeah, it’s pretty cool. I mean, that’s one way of looking at it with those rates on
return. The other way is, how could I try to get as close to a risk-free asset like CPP as
possible? You could try to invest the retained corporate earnings of government bonds during
accumulation years and then buy an index annuity at the age that you’d collect. CPP is an
approximation. That’s how I tried to estimate it. I came up with 2% as well, so we came up with
exactly the same area.
[0:47:01] BF: Your post on this was good. It was a good way to think about it. You can’t buy an
inflation index annuity. You can buy an indexed annuity, which are more expensive than non-
indexed annuities, but an index is indexed to a fixed percent, not inflation. It’s not really an
inflation hedge. With all that said, if we had invested retained earnings in the corporation and
purchased an annuity with 2% indexing at age 70, the real interest rate required during
accumulation to match the IRR of CPP would be way higher than what bonds have actually
returned historically.
I took CPP. Then beside that, I took retaining the amount, the thing we talked with earlier with if
you pay yourself dividends, the $6,000, or whatever number that ends up being left over,
retaining that in the corporation and investing it. Then we go forward in time to age 65. On one
side, we can start CPP. On the other side, we have a pot of money and we’re going to buy an
annuity. I took annuity pricing for a 2% index annuity, which again, that’s fixed indexing, not
actual inflation indexing. If it were inflation index, it would be a lot more expensive to buy. I took
the pricing of that annuity and then solved for the interest rate that you would have had to earn
in the corporation in order to fund that annuity. It was that. I don’t remember what the number
was, but it was much higher than the return on bonds.
I thought that was a good indication that CPP is not really a bad deal. If you try and make a
somewhat risk-appropriate comparison, if I put stocks in there, which are more tax efficient than
IRR expected return, then again, we get back to maybe you could, yes, do better without CPP,
but that doesn’t mean that you’re better off without CPP, just because you could do better,
potentially.
One thing I do want to acknowledge, and this comes up a lot, is that it is true that paying into
CPP and dying early results in a bad financial outcome. You could have made your heirs better
off, or your surviving spouse better off, depending on the situation if you had all of that money in
a bank account, or in a corporation invested. That is true. The death benefit is $2,500. It’s not
indexed to inflation. It hasn’t changed. That’s not great. That’s completely true.
There are spousal survivor benefits. They vary though, depending on when death happens and
what the spouse’s own CPP situation is. There can be cases where the survivor benefits are
pretty good. There can be cases where they’re really not great.
[0:49:16] MS: Those benefits may seem small, but I can tell you from personal experience that
the impact may be more than what you think. It’s like insurance seems like an expense, until
you need it unexpectedly. For example, if the main breadwinner dies very young and there’s a
young child in the mix there, the CPP child benefit kicks in really quickly. That regular income
stream, when the surviving parent is trying to find their feet again amongst all the turmoil, can
really actually have an outsized impact.
[0:49:43] BF: Yeah, that’s a good point. There are disability benefits, too. There’s a bunch of
stuff with CPP that I don’t think gets enough credit. Overall, pretty good program. The whole
point of this is, should you avoid paying salary to avoid CPP? I think the answer is probably no.
Some people do worry about CPP getting raided by the government, or ungoggled like we see
with other government spending initiatives. But CPP Investments is run as an arm’s length
entity, that’s arm length from the government’s account corporation. The government can
legislate changes to CPP, so it’s not like they’re completely hands off, but there’s some
separation there.
As of the last report, which was September 2023 from the Office of the Chief Actuary, the
pension CPP is well funded and it’s projected to fund 75 years of its future obligations in its
current steady state.19 Meaning, the current level of contributions and stuff like that are in a goo
position to keep this thing going the way it’s set up right now. I think the management of CPP
Investments has been pretty good. I think that the current legislative setup for it is pretty good,
as the actuary reports tend to show, so the main threat could be maybe political interference.
Some of the stuff we’re seeing with Alberta, stuff like that.
[0:50:50] MS: Stuff could happen. It’s a pretty tough role for a politician to hold, though, to start
touching things like CPP benefits. It’s going to be big voter blocks that are going to be affected
by that, if they try to do anything. There’d be a lot of political motivation to make it work out well.
[0:51:05] BF: Yeah, I agree with that. Another important point in our modelling is that we did
assume all refundable tax was recoverable. If RDTOH is not recoverable, because of corporate
bloat, the retained earnings strategy would be less attractive than – I didn’t give any numbers
there a minute ago, but it would look worse than in my example that I talked through. Whether
that’s going to be an issue or not depends on your province and your longer-term plan. Mark, I
know you’ve done some modelling with that aspect, meshing CPP and with other corporate and
personal investment options.
[0:51:36] MS: Yeah, I think you have to look together with the whole plan with everything else
that we’ve talked about. When I look at this, really what you’re asking the question is about is
paying dividends only to avoid CPP as an investment and invest that money corporately
instead. You have to put that into the context of the longer-term planning that goes on. The
basic question is whether the difference between CPP return, versus, let’s say, all equity
investments in a corporation, is that larger than the impact of the loss of those other planning
benefits?
Even if CPP in an all-equity portfolio were an apples-to-apples comparison, does a few
percentage points more return on 6K per year retained in the corporation make up for a lower
return on 9K roughly invested via CPP? Also, does that corporate investment and corporate tax
deferral make up for the tax deferral and tax sheltering of using RRSPs, which if you’re going to
be paying yourself salary, you would likely be using that as well as part of your plan.
Then there’s also the issue of tax integration, which you mentioned about, how does that play
out if it’s tens, or hundreds of thousands of dollars of active business income that’s being
subjected to the issues of tax integration, not just a few dollars flowing through. Then how does
that change over time when you’re trying to pay money out of the corporation to fund your
consumption?
I did take a look at this and I used our optimal compensation algorithm, which we spent the last
episode talking about in detail about how we work that out. It’s very similar to what Ben and
Braden did in the IPP paper. The main difference is that I used RRSPs, rather than IPPs and I
used a DIY ETF low-cost portfolio, rather than looking at the fees, assuming that they’d be the
same to run an IPP. I used those low-cost DIY strategies. One of the features of our dynamic
salary strategy is that you usually start with mostly salary, and then you shift over to dividends
as the corporate passive income starts to become large, because you’re trying to clear all of
those notional accounts, like your RDTOH as things grow.
It becomes important as to when, or if that happens and that depends on your income and your
consumption because that’ll affect how much you’re saving in the corporation. It usually
translates into you not contributing to CPP for your full career. You contribute during those
salary years and then gradually over time, move over to dividends, and then at the end, you’re
left with some income stream that’s from CPP, which would be smaller, but it’s still proportional
to however much money you put into it.
The way that I tried to handle that in my modelling is I treated CPP as an account, a pension
account essentially, and tried to factor in its value into the comparison. I plugged in the CPP
internal rate of return of about 2% a year as the base case, which is as we’ve just finished
talking about, seems to be pretty reasonable. It’s going to depend on when you die. It could be
higher if you live a long time. It could be lower if you die younger. But that’s the so-called
average Canadian that’s been studied a bunch of times.
For the money invested personally or in the corporation, I used a globally diversified ETF
portfolio with a 7% per year nominal return. That’s about a 5% real return after inflation of 2%,
which is how I modelled it. That’s roughly the historical market returns over the past 100 years
when you look around the globe, including the US market, which does dominate data sets.20 I
also tested it in different provinces and at different income and consumption levels. I think that’s
important. You can’t just look at everything at the top tax bracket in Ontario. I did it in different
provinces, different consumption levels, which means you’re going to be having different tax
brackets playing into the equation.
In doing that, there was really one obviously important factor. That’s that in Ontario, New
Brunswick, there’s that anomaly in the tax integration, where making too much passive income
in a corporation as actually a good thing, as long as you’re spending the money to keep the
notional accounts flowing out of it. It bumps part of the taxes up to that higher general corporate
tax rate, but not all of it. Yet, you get to pay eligible dividends as if the corporation had paid more
tax, so it ends up being more efficient.
When that happens, it does benefit a dividend-only strategy more, because that what happens
is you’re ended up retaining more money in the corporation. It exceeds that 50K limit faster.
Then you end up taking advantage of that tax anomaly faster. For example, an Ontario
corporation that makes $500,000 a year before owner salaries, a dividend-only strategy could
come out ahead over the 35-year time period that I was studying.
However, that does require that the government doesn’t close that integration anomaly in the
future. That seems pretty unlikely to me, especially over a 35-year time period. I wouldn’t be
betting my plan based on tax anomaly. The other thing I would say, it also requires that you’re
spending about $150,000 a year or more. The intent of the passive income limits was to
penalize people keeping a bunch of money in their corporation and not spending it. Even though
there is that tax anomaly, it still actually accomplishes that objective, because if you aren’t
paying money at your corporation, then it is actually a very big penalty. But if you do pay the
money at your corporation, it’s using a carrot instead of a stick.
Now, I did look at this also in other provinces, which don’t have that broken tax integration. They
all show pretty much the same results. If they don’t have that break in tax integration, or even at
more modest consumption levels in Ontario and New Brunswick, the benefits of using an RRSP
and the tax integration benefits of salary overpowered the lower return of CP period compared
to equity investing via corporations. Yes, the return on CPP would be less, but because of all
those other tax sheltering benefits and the cost of it being relatively less than what you think,
that’s more important than trying to avoid paying into CPP by avoiding salary. That’s the bottom
line.
Now, when I looked at more moderate income levels of corporations, like say, $300,000 a year
of income, if you hit really high spending levels with that, like a $150,000 of personal spending,
it could be possible for a dividend-only strategy to come out and hit them under that
circumstances. But when you’re getting into that close of an amount between the corporate
income and the personal spending, it’s actually questionable whether you should be
incorporated at all, because really, you could just be using your registered accounts. You’re not
actually saving much money in the corporation, so you have to really manipulate it to come out
that way.
What I would say overall is if you live longer than that, so I did do some sensitivity testing as
well. If you live longer than that, then any of those advantages of trying to avoid CPP disappear,
because the internal rate of return of CPP then goes up because you lived longer and it wipes
out those benefits of using dividend-only strategies in those very specific cases. Again, I would
say, this highlights the apples-to-oranges comparison, because equity investing is going to be
much more investment risk involved, whereas CPP is this risk that’s based on your longevity
more so than the investment returns. It’s how long you live.
That’s important to look at it the other way, too. The other thing I did to do as a sensitivity test is
let’s say, I assume that you died at age 65. Without collecting CPP, you have no survivor to
benefit from your pensions. Basically, you’ve contributed into CPP and you get no return on
those contributions at all. While the magnitude of the benefit of using salary was less, it still
came out ahead because of the tax integration benefits, and being able to use your RRSP
compared to just using a dividend-only strategy.
[0:59:19] BF: That’s a big finding.
[0:59:20] MS: Yeah. I think it’s important, because I think what happens is people look at one
year of taxes. They look at one year of taxes, plus CPP. How many dollars do you have left
compared to if you just paid dividends only? It comes out, well, dividends only, you pay less tax
in CPP now, so you have more money now to invest, but it’s partially taxed and it’s not tax
sheltered. Whereas, the RRSP is tax-sheltered growth. When you look at that over a longer
period of time, that’s more powerful than a small amount of money difference right now.
[0:59:50] BF: That’s super interesting. I like that.
[0:59:53] MS: Yeah, I thought it was pretty cool.
[0:59:54] BF: All right, so the take-home message is that CPP is not an investment with lots of
Also, the dollar amount is often not high compared to the rest of your retirement drawdown
plant. I wouldn’t let CPP payments dissuade you from using salary. As Mark mentioned, the
other benefits of salary are usually larger than the difference between CPP and equity returns,
even if it were an apples-to-apples risk comparison. Let that sink in. That’s such a cool finding
that we talked earlier about how, yes, it looks like you could do better with stocks. But when you
take into account the fact that paying salary also gives you RRSP room, which you could fund
with investments, that actually offsets that advantage. Even if there is a higher return, the after-
tax return, maybe not so much.
With the possible exception of when taking advantage of a few tax integration anomalies in
Ontario and New Brunswick, but betting on those persisting for long enough to say that avoiding
salary is a good idea is probably unwise.
[1:01:08] MS: I think the other thing that I didn’t mention with my modelling that’s important is
Let’s move on to employment insurance. This is something I thought was going to be boring and
not really tell us much, but it actually is really interesting and there’s some really important
actionable bottom lines to this section.
[1:02:00] BF: I went into this similar to you, having written EI off, but I think there’s some, like
you said, some really interesting stuff in here. Employment insurance is optional for self-
employed people. When an employee controls more than 40% of a corporation’s voting shares,
or if the employee is a family member of someone in that situation, their earnings are not
insurable under the EI program. However, self-employed workers in these situations can choose
to opt into the EI program with the caveat that they do not qualify for regular EI benefits. What
does that mean? Regular benefits are for people who lose their jobs through no fault of their
own, like due to shortages of work, or seasonal layoffs, and are available for and able to work,
but can’t find a job.
That’s when you look on Reddit and stuff, like that’s what people are usually asking about when
they ask about EI. They got laid off or something like that. Not having access to those regular
benefits makes EI seem somewhat less appealing for self-employed individuals, and it leads to
the common advice to simply not opt in, which both of us thought before we dug into this. But
there are multiple special benefits that self-employed people who opt into the program are able
to access. The other interesting thing is that self-employed workers do not have to pay the
employer’s portion of EI premiums. Unlike CPP where you pay both sides, with EI you don’t.
The employer premium for EI is actually 1.4 times the employee premium. As a self-employed
individual, you just pay the employee premium. That reduces the total cost of participating by
more than 50%. Now the catch, we’ll take in the sort of in a sec. The catch is that once a self-
employed person has opted in and used one of the benefits, they’re then required to continue
paying EI premiums when they take salary as compensation forever. That’s, again, we’re going
to come back to that later.
[1:03:38] MS: Yeah. I think a common point of confusion with that is if you make a claim as an
employee prior to being self-employed. If that happens, that actually doesn’t count. For
example, if you took an EI-supported parental leave while you’re an employee, such as for the
common situation I’d encounter as resident physician, then when you later on become self-
employed, you’re starting fresh. At that point when you’re self-employed, you can choose to opt
in or not. It’s not that you because you took a leave as an employee that you’re now committed.
Now, let’s talk a little bit about how much you actually pay. EI premiums are payable on
shareable earnings based on a contribution rate that is set by the office of the chief actuary
each year. In 2024, the rate is 1.66%. The average rate for the last 20 years is 1.75%, so it’s
very similar. The 2024 shareable earnings are $63,200. Meaning, that above that income level
doesn’t require you to pay more EI and premiums on top of that. In dollar terms, the maximum
employee contribution in 2024 is $1,049. That’s the maximum that you can be expected to pay.
Again, that’s much less than what someone who has to also pay the employer contribution
would have to pay. We don’t have to pay that as self-employed people.
EI insurance earnings are tied to wage growth and that was mentioned previously that wage
growth has historically outpaced inflation. It’s not that it’s indexed to inflation. It’s probably 1%
per year higher than that annually if you look historically. The premium the benefit could outstrip
inflation slightly over time. The effective cost of the EI premium, like how we talked about with
CPP is reduced, actually. It’s not even that $1,049. It’s going to be less because it also creates a
basic tax credit. Again, that’s worth about 20% of the premium paid in Ontario and reduces the
net amount by that amount. Instead of $1,049, it’s effectively closer to $850 when you account
for the fact there’s a tax credit that comes with it?
[1:05:38] BF: We mentioned earlier that as a self-employed person, you’re not eligible for
regular EI benefits. But let’s talk about the EI special benefits that self-employed people do have
access to. There are six special benefits that self-employed people can access. They include
maternity benefits. That’s for people who are away from work, because they are pregnant, or
have recently given birth. Parental benefits, which is distinct from maternity. Parental benefits for
parents who are away from work to care for their newborn, or a newly adopted child. Those two,
maternity and parental can be combined.
Sickness benefits are for people who can’t work for medical reasons. The family caregiver
benefit for children covers people who provide care or support to a critically ill or injured person
under the age of 18. The family caregiver benefit for adults, similar, covers people who provide
care, or support to critically ill, or injured person over the age of 18. Then the last one is the
compassionate care benefit, which is for people who provide care, or support to a person who
requires end-of-life care.
A whole bunch of different programs that people have access to. The benefits are based on
55% of insurable earnings and the maximum number of weeks for each special benefit varies.
To receive benefits, the amount of time you spend on your business has to have decreased by
more than 40% for at least one week, and you have to have been registered in the self-
employment program for at least 12 months, and you have to have earned a minimum amount
of net self-employment earnings between January 1st and December 31st of the year before you
apply for benefits. For example, to be eligible for benefits between January 1st, 2024 and
December 31st, 2024, you need to have made at least $8,492 in net self-employment earnings
in 2023.21
[1:07:15] MS: Yeah. The question then is, when does it actually make sense to opt into EI?
Since it’s optional and you can choose to opt in at some point, this potential to get access to that
variety of benefits beyond what we’d usually think about. For a self-employed person, these
would be the main potential attraction. However, the benefits can come at the cost of paying
those EI premiums on salary. Once you’ve opted in and used any of the benefits, you’re
required to continue paying premiums when using salary. You have to look at the net between
the cost and the benefit and when would that make sense.
[1:07:49] BF: I think an interesting thing about EIs that you only have to be registered in the
program for 12 months before taking benefits. You’ve got to pay your premiums for 12 months
before taking benefits. That means you could pay the premiums for a year, so that’s the
$1,049.24 and then receive full benefits for maternity and parental leave the following year.22 We
looked at a case with one year of maxed-out employee EI premiums, followed by 50 weeks of
maternity and parental leave benefits at 55% of the maximum insurable earnings, and then
followed by 38 years of maximum EI contributions.
After that, which are, like we mentioned, once you’ve taken the benefit, you have to pay those
premiums going forward. We compared this to not opting into EI and paying a dividend out of
the corporation to match the after-tax income of the EI benefit in the year when the leave is
taken. That also means in the dividend case, no future EI premiums. Taking the benefits later is
less compelling than this example because, in this example, we’re paying premiums for a year
and then taking benefits right as soon as possible. I think someone planning to have children
could opt into EI a year in advance of starting to take the benefits, rather than starting to pay
premiums earlier, and then using the benefits much later.
Then the other thing is every additional child, so we’re talking about taking one leave, one
parental and maternity leave, every additional child makes opting in look better. Then also, it’s
not just about maternity and parental leave. There’s also all the other benefits. Having more
than one child and using the leave, or having other leaves for other reasons makes all of the
math look much, much better very quickly. We’re really just talking about one leave right now.
Taking benefits early in life also has a larger impact on the benefit, because of when the cash
flows happen.
For example, if you pay $1,000 into EI and then collect 34,000 the next year, that’s a massive
upfront return on your investment. In the alternative scenario of funding the leave with
dividends, there’s a huge opportunity cost on the money used to pay the dividend. That’s
whatever it is, 34,000 lost dollars that you could have left to invest in your corporation, take
advantage of tax deferral and growth in the corporation. With EI you then repay over time with
future premiums, but that ends up being less costly than the opportunity cost of having paid that
big upfront dividend, like getting an upfront lower no interest loan and then repaying it slowly
over decades. How beneficial it is to have the money saved and invested in the corporation by
using the EI benefit is going to be in the end, a function of the after-tax expected return of funds
left in the corporation.
[1:10:13] MS: Yeah. We’ll come back to that some more. But I would just to say in my case,
personally, I actually didn’t opt into EI. I took short, unpaid parental leaves. My wife took two
maternity and parental leaves as she was employed outside of our corporation and she also had
an employer top up. The reason why I’m mentioning this is because everyone’s situation is
going to be different. It’s also something that you should explicitly talk about as a couple, rather
than assuming it’s going to be this, or that. Maternity benefits are only available to the person
who gives birth, and parental benefits are additive to that and they can be shared between the
parents.
A birthing female, for example, may decide to collect maternity benefits, but if her partner has a
lower income, or maybe even a top-up from work, it could make the most sense financially for
their partner to take parental leave funded by EI following that. In the case of physicians, there
are also some other interactions that could happen, because there’s other programs that are
potentially available. For example, in Ontario there is a pregnancy and parental leave benefit
program for up to 17 weeks.23 Taking federal EI would actually subtract from that, so that enters
into the equation. That applies even if it’s taken before, or after that provincial benefit.
On contrast, a non-physician partner may not face that issue. A physician on the provincial
program, they can make some income, they can do some light work and earn up to $1,300 a
week before the benefits starts to get clawed back. But that could factor into how much work
they’re going to do and what their partner is going to do and try to balance that out together.
There’s other programs in other provinces, but just to be aware of the interaction.
The final point that I’d make about deciding who takes what leave is that it isn’t just about the
math. It is one of those times to consider your values and preferences that we started talking
about in the earlier episodes. You may opt to take, both take time together. There may be
different family, or cultural factors that come into the equation and that may add support, or it
may also add other pressures as well. The other thing I’d say is a professional, or a business
owner taking extended time away from your business, or your practice raises other practical
challenges as well. You want to be thinking about all these things in advance and discussing it
together to help not only plan the financial part, which is what we’re talking about here, but to
decide better how to deal with some of those non-financial aspects as well.
[1:12:36] BF: Yeah. Some of those interactions with other benefits that may be available is
definitely important. I really like that point about, should you even be taking a leave in your
specific situation as a professional, or a business owner? I’m not self-employed. I wouldn’t have
that opt-in decision to make, but if I were in that position, knowing what I’ve done for our past
kids, we’ve got four kids, not having any more. But I know what I did for each one. I think I took
two weeks off for one of them, and that was the most of any. For me, it probably would not have
made sense to opt into EI. I never took officially time off work with reduced pay or anything like
that.
[1:13:11] MS: I think one of the things that physicians face, too, is we could potentially wor
even a couple of shifts, or a couple of days here and there to keep our skills and also make
enough money doing that, that it starts to overpower the EI benefits anyways. Like I say, really
depends on your situation.
[1:13:27] BF: The main point that we’re making though is if it would be plausible and sensible
for someone to take leaves, the financial aspect can actually look pretty good, which is not what
people generally believe. The additive benefit of maternity-plus parental leaves may be one
factor to consider at the time of having children. Another issue beyond kids, hopefully, further in
the distant future is that having paid in the EI could help other caregiver benefits are needed
down the road, like for caring for an aging parent. This brings up another factor for business
owners. If you’re not incorporated, you have to pay into EI for the rest of your career, assuming
that you keep earning income.
If you are incorporated, as we’ve talked about in the last few episodes, including this one, you
have a choice about how to pay yourself, between salary and dividends. You’re required to
continue to pay into the EI program once you’ve benefited from it when you pay yourself salary.
But as we’ve been talking about, you don’t have to always pay yourself a salary. The other thing,
and this is your thinking, Mark, it’s really brilliant, honestly. We’ve talked about how when you’re
incorporated, you will likely start with a high salary. This is the dynamic salary concept. You’ll
start with a high salary early on. Then as the notional accounts start to get larger, you’ll start
shifting more toward a dividend income. The salary component of your total income will
decrease over time, eventually, potentially being even zero when it gets completely dominated
by emptying out the notional accounts. Now that’s interesting, because it interacts with what
we’re talking about with the EI premiums. Using dividends only for compensation totally
eliminates your EI premium.
[1:14:55] MS: This is a big deal, because you’re taking, look, we assume is going to happen.
You pay into EI for the rest of your career. But when you actually put it together with a dynamic
compensation plan, like what we’ve been talking about, you could actually be only paying into
the EI premiums for a short period of time. As you move into dividends only, it may be much less
than that 39-year horizon that you’d used in the earlier modelling. What I did is I actually took
that and I bolted the EI benefits and premiums into my simulator to compare using our dynamic
salary compensation type strategy with, or without opting into EI, and then comparing how that
looked like after a 35-year time frame.
When you start to switch to that dividend-only strategy, it really impacts the results. Otherwise, I
kept the model parameters all the same as I did with the CPP modelling, but we really wanted to
see what’s the difference between opting in, or not opting into EI. Now, the basic message is
that an incorporated business owner who saves a lot in their corporation by making much more
than what they spend, they’re going to have an even larger benefit from opting into EI, because
they’re going to be using dividends for a larger proportion of their career, even if they use salary
early on. I’m just going to illustrate that with a couple of quick examples.
For example, there’s an Ontario corporation making $500,000 per year, pre-owner salary
income, and then they’re going to fund $150,000 a year of consumption. The owner’s salary
would shrink below the maximum EI and shareable earnings level of $63,000 and start to switch
over to the dividend-only strategy but about 15 years. That’s much, much shorter of a window of
contributions, but you still get the same benefit. In the model, a corporate active income was
reduced to zero for the duration of the leave, so you weren’t making active income for however
long the leave was, and I did test different lengths of leave. For example, if they contributed for
one year and then took a 52-week leave, there would be that $34,760 benefit. Basically,
$35,000, and there’d be no active business income in that year, because they took a full 52
weeks. That leaves you with a funding shortfall. That funding shortfall would be made up by
using dividends from the retained earnings from the corporations from previous years.
Now in the model that I used, since I was assuming we just opened a business, contributed for
one year. We didn’t have any retained earnings beyond that. If you did exceed what you had
retained, you’d have to use a line of credit with 5% interest to bridge that gap. In that worst-case
scenario, it did mean taking a $25,000 loan in the opt-out strategy temporarily to fund that gap,
which you would then pay back as soon as possible, which actually was less than a year in the
model. I did it just to be thorough, but I don’t think it really actually impacts the findings at all.
In the EI opt-in strategy, the bridge gap was done with more taxable income, so you pay out,
you get your benefit, you pay out some dividends or whatever on top of that, like you would
normally, depending on the leave. The final difference is large enough that those little nuances
probably don’t matter. The end of the 35-year simulated period, the net EI premiums were paid
as $12,500 over about 15 years. After that, it was dividends only. The EI benefit was $35,000 in
year two. Now that seems like a $20,000 difference when you just look at face value. However,
as we talked about for when you get the benefit also matters.
The difference of that early benefit resulted in $44,000 more after-tax assets compared to opting
out of EI when you looked at year 35. The reason why that is is that extra money that was
retained and invested in the corporation early on, because you use an external benefit, that
extra amount of money early on compounds over decades. Accounting for that massive return
from an early opportunity cost foregoing the EI benefit. If you were trying to look at different
durations, it actually ends up being that a six-month EI-funded leave was the breakeven point in
that model. You didn’t need to take a full 50 weeks of parental leave. Six months was enough to
break even, because of the not only getting the same benefit for less premium, but getting it
early, so the savings could then compound over time.
Now, as Ben described earlier, it makes sense when you consider how big of a difference
compounding makes. Paying into EI for 14 years, and then taking a leave, instead of taking the
leave up front reduced the advantage, so much that the opt-in advantage actually disappeared.
In fact, a full 52-week leave after 14 years of contributions would actually have been slightly
worse off than having not opted in earlier. Then opting at the same time, but taking the leave
upfront. Taking a leave late really made it less appealing, because of that compounding.
[1:19:47] BF: Crazy stuff, man. Because you take the whole idea of dynamic salary, which is
something that we’ve been working on collectively for about a few years just in terms of thinking
about how that all works. Then you start going downstream. What other decisions does that
affect? This is such a great example, where EI, you could make the argument that it makes
sense if you’re going to pay yourself a salary forever as a self-employed person if you’re going
to use the benefits, but the example you just walked through when you take the full picture and
account including dynamic salary makes a ton more sense financially to take EI. If you’re going
to use even a little bit of leave, it really changes financial planning when you start thinking about
– we’ve talked about this in past episodes. When you think about the full big picture of life cycle
financial planning, it really changes your perspective on stuff.
[1:20:29] MS: Oh, yeah. It shows just how a small difference at the beginning makes a huge
difference later on.
[1:20:34] BF: Yeah. I think EI has practical implications for families and financial planning, at
least to the extent that you can actually plan for when kids come into the picture, which can
sometimes be easier said than done. You could choose to not opt into EI and then at least a
year before you start trying, or start moving in that direction, you could opt-in. If things go well,
you’ll likely come out ahead if you used the benefits. If not and you don’t have kids and you don’t
claim, then you can just opt out, because no claims are made in that case. Again, I think this
highlights discussing in advance what you plan for parental leaves and by which partner in the
relationship could really inform the financial planning around EI opt-in.
This also highlights one of the things we’ve mentioned many times, communicating stuff like this
to your financial planner, if you’re working with one, or to your accountant if you’re working with
one, life plans like that can really inform optimal financial planning strategies.
[1:21:23] MS: Oh, yeah. Totally. The other thing I should mention is that I did try this at different
amounts of income and consumption. I know there’s going to be people saying, yeah, who
makes $500,000 a year and who spends a $150,000 a year? Most people are challenged on
both ends of that equation. I did actually run the numbers as well with a corporation that had
$300,000 of income and $125,000 of spending. I didn’t make it tighter than that, because then
as I had mentioned earlier, if you start getting really tight, then it doesn’t make sense to be
incorporated anyway. But that was about as much as I could push that envelope, it’s leaving
about $50,000 a year in the corporation if you’re using your other accounts.
I wanted to be somewhat realistic. I also used BC this time, too, just to be different. That’s an
important difference, because as we talked about before, there’s this tax integration anomaly in
Ontario and New Brunswick that could make a dividend-only strategy a little bit better at times, if
it doesn’t get closed or changed. Anyways, with that BC scenario, with more moderate income
and spending, there was still about a $30,000 advantage to opting in. If you took a 52-week
rental leave, a year after starting contributions into it.
At that lower income level, there were also less retained earnings in the corporations. The side
effect of that is the corporation uses salary for much, much longer, because they don’t start
getting to trouble trying to empty out their notional accounts due to requiring enough dividends.
In that situation, the corporation would use a salary for the whole 35 years, because they
haven’t built a large corporation requiring a lot of dividends to fund their spending on top of their
salary.
Still, though, that amounted to $29,000 paid in, and $35,000 paid out, which you may sound,
okay, that’s really close, but it’s the upfront payout that makes the big difference, because you
paid that $29,000 in over 35 years, but you got a $35,000 payout in year two, and the
opportunity cost of having had to use your corporation instead for that means that it’s much
better. Now, due to the premiums being closer, the breakeven point isn’t six months, or 26-week
breakeven, like it was with the higher income, but it’s still a 40-week breakeven. You’d have to
take 40 weeks or more of parental leave at that more moderate level to break even, rather than
if you’d opted out. It still works.
[1:23:43] BF: All right. That’s it for EI. I think we can move on to our post-op debrief. In this
episode, we covered CPP and EI, which are the two payroll deductions that may come with
paying a salary. CPP will, EI may. CPP is required. EI is initially an opt-in but becomes
mandatory once you’ve used any of the benefits. We showed that CPP is not a bad deal for
business owners, relative to employees, and that it comes with a unique set of benefits.
[1:24:11] MS: Yeah. The CPP benefit offers protection against three big risks that individuals
struggle to deal with in retirement. The inflation risk, sequence of returns risk and longevity risk.
This makes it a value a part of an overall accumulation strategy and a retirement strategy. At the
very least, it means that it’s not something that should people go out of their way to try to avoid.
[1:24:32] BF: That’s a big ticket. You can disagree on whatever bits and pieces. But overall, it’s
not a tax, I guess. That’s a big takeaway.
[1:24:39] MS: And even if it was, it’s not worth avoiding it.
[1:24:41] BF: With interaction with the tax-deferred account creation. Yeah, that’s a great point.
I related to that. Avoiding CPP by paying dividends is more costly than I think many business
owners realize, for a few reasons. CPP contributions resulting credits and deductions, which
reduce its overall upfront cost. Tax integration favours salary slightly over dividends, which
means that there is an additional integration cost borne by anyone paying dividends to avoid
CPP contributions. And Mark just mentioned, paying salary creates RRSP/IPP room, which is
advantageous in its own right.
[1:25:15] MS: Moving on to EI, EI is not mandatory for business owners. It’s an opt-in. But if you
opt in and use any of the benefits, you’re also required to contribute moving forward. If you have
paid into EI for 12 months prior to using the benefits and met all those other criteria, it can be
useful to you. Still, it’s common advice to avoid EI if you’re self-employed, but our modelling
suggests that this blanket advice may not always make sense.
[1:25:39] BF: Opting in EI and then taking a leave after 12 months can be beneficial by allowing
dollars to stay invested in the corporation. That comes with the cost of ongoing EI premiums
after the initial leave, but the alternative is a large opportunity cost on the corporate dollars used
to fund that leave.
[1:25:54] MS: Yeah. Even if you get fewer overall dollars from EI than what you paid in, the
timing of the large initial benefit and smaller ongoing benefits makes EI potentially attractive for
anyone who’s realistically going to take a significant leave from work. The other important thing
we found in modelling this is related to what we talked about in the last episode on dynamic
salary.
[1:26:15] BF: This is such a cool point. In many cases, optimal spending plans are going to
start with salary and then increasingly consistent dividends as notional accounts in the
corporation get larger over time, the perspective of EI, this means that the required lifetime
premiums will decrease over time as compensation shifts toward dividends. So cool.
[1:26:31] MS: Yeah, very cool. Pulling all together.
[1:26:34] BF: Yeah. I love it. I love it. It’s a very cool systems optimization problem. Okay, so
that’s it for our episode on CPP and EI. We do want to say at the end of this episode that we
probably won’t be back with an episode next week, at the time that this episode comes out,
because I think we mentioned this last episode, too, we created ourselves a lot of runway to do
prep for these episodes after our initial chunk of recordings, we realized that runway is not
sufficient to continue doing the quality of work that we want to do. These last three episodes
were intensive. A lot of thinking and work and time went into them.
[1:27:09] MS: Oh, yeah. When you get into these complicated topics and you realize a lot of
stuff hasn’t really been looked at, then we start looking at it, which consumes a lot of our time
and effort to really try to model it out well, because you have to build the models, run them
through, interpret it, run it by other people to see, make sure it makes sense.
[1:27:25] BF: That’s a big piece. We’ve been very deliberate about it, because we’re doing the
stuff that we’re not reading out of a textbook, there’s a lot of stuff here that’s legitimately new
planning, so we’ve been pretty deliberate about running it by other people with expertise to
make sure that the stuff we’re saying is accurate and makes sense. Anyway, all that to say, that
we have some big episodes coming up. Big in terms of the size of the topic and the depth that
we plan on covering them in. But for that reason, we won’t be back next week. We don’t have a
deadline for when we’re going to get the next episode out. We’ll get to it as quickly as we can,
but just a heads up that you shouldn’t expect an episode next week.
[1:28:01] MS: I would also say, it’s fair to say that these long episodes are super-duper long,
packed full of information. If you’re feeling itchy about it, you can always go back and look at
some of them again and look at moneyscope.ca, where we have the transcripts. They’re all
indexed by topic, so you can try to digest it in some different ways. We know this whole series
we’re doing is going to be something that people have to listen to and come back to repeatedly,
so this might be an opportunity to revisit and start digesting some of that material. There’s a lot
there.
[1:28:29] BF: Yup, definitely. We’ll be back whenever we’re back soon, but not determined yet.
[1:28:35] MS: We’ll keep plugging away at it. We’re having fun.
[1:28:37] BF: We sure are. All right, thanks for listening.
