In this episode of The Money Scope Podcast, Benjamin Felix and Dr. Mark Soth (The Loonie Doctor) take a deep dive into the complex world of pensions for incorporated professionals. They unpack the pros and cons of the various pension structures available in Canada—from RRSPs and IPPs to MEPPs—and explain how these compare in terms of tax treatment, investment flexibility, creditor protection, and long-term retirement security. Through their discussion, Ben and Mark illuminate how pensions really work for business owners who are both employer and employee, why “pension envy” can cloud rational decisions, and how evidence and math—not marketing—should guide your retirement planning. They also explore the behavioral and psychological side of pensions: why risk pooling matters, how defined benefit plans manage longevity and sequence risk, and when the added complexity of an IPP or MEPP might actually be worth it. This is one of the most comprehensive overviews of pensions you’ll hear—combining research, real-world application, and practical insight for anyone trying to optimize their corporate retirement strategy.
[Benjamin Felix] (0:02 – 1:20)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. Welcome to episode 18 of the Money Scope Podcast, shining a light deep inside personal finance for Canadian professionals.
We are hosted by me, Benjamin Felix, portfolio manager and chief investment officer at PWL Capital and Dr. Mark Soth, aka The Loonie Doctor. Before we jump into the content, we do want to acknowledge that it has been a long time since our last episode. We appreciate you sticking with us and tuning into this episode.
A lot has happened since the last time we recorded. Last time we did an episode was on the capital gains inclusion rate changes. Those changes never happened in the end and it doesn’t look like they will anytime soon.
That’s interesting that we spent a ton of time making that content and worrying about that and ended up not materializing. I think there’s probably some interesting lessons in there about tax planning anyway. Things can change.
I’ve also had and at least for now, defeated testicular cancer, which was a big thing. PWL Capital, the firm that I work for, has been acquired by an American firm called OneDigital. It’s been a busy chunk of time since the last time we recorded, but we’re super pumped to be back and we think we have some good informational content to share with you.
[Dr. Mark Soth] (1:20 – 1:49)Great to be back. In this episode, we’re going to hit up a topic that I know many people have been asking about. We’re going to take a critical look at different pension options that Canadian business owners have.
Previously in episode 14, we looked at the Canada pension plan from the perspective of a self-employed business owner. That’s a mandatory pension plan that we participate in with a salary. Even though we pay both the employer and the employer contributions directly, it still works out to be a good deal.
[Benjamin Felix] (1:50 – 2:16)CPP is a defined benefit pension plan that’s indexed to inflation. Incorporated business owners must contribute when they pay themselves salary. In addition to CPP, using salary has other benefits like favorable tax integration that we’ve talked about in past episodes and creating RRSP room.
CPP is a beneficial side effect of using the optimal compensation strategy that we unpacked in episode 13. It’s not going to be enough to fund someone’s retirement and that was not its intention when it was created.
[Dr. Mark Soth] (2:16 – 2:47)The retirement income system in Canada is underpinned by three pillars. There’s public pensions like CPP, there’s employer-sponsored pensions, and personal savings. So, in this episode, we’ll focus in on employer-sponsored pensions from the perspective of self-employed business owner.
There will still be some applicable information for employees about how pensions work, but also a detailed look at how it works for business owners where you are actually both the employer and the employee at the same time.
[Benjamin Felix] (2:47 – 3:19)We use the RRSP as a baseline just in the way that we explain everything because all Canadians can access that and I think people are generally pretty familiar with it. However, we will shine the money scope into the recesses of other options available to incorporated professionals like individual pension plans and multi-employer pension plans. You may not recognize those terms right now.
Don’t worry, you will by the end of the episode. There are also a number of branded versions of those options that you may recognize. You’ll understand more about those and what’s happening under the surface when you hear those acronyms by the end of the episode.
[Dr. Mark Soth] (3:19 – 6:23)That is key because we hear pensions and when you hear that word, it sounds great. Our knee-jerk response to that when someone pitches a pension to us is, “hell yeah, I want that.” Because we as business owners are most familiar with and often jealous of pensions that we see others have funded at least partially by their employer.
Now, in this case, since we are fully funding the pension ourselves directly, we really must know the tax and legal benefits of the structures. There’s trade-offs with all of them and the right answer for your situation will depend on how those trade-offs fit together with your situation and a big component of personal preferences. There’s a subjective component to this.
Before we dive into it, we do have some credit to give for reviewers that helped us with this. Before we get into the main content, we want to give credit to people who were gracious enough to offer their expertise in reviewing this episode. This is another complex topic and while we put lots of our effort into writing the episode, we wanted input from experts to make the content as accurate as possible and we got incredible feedback ranging from fun details and nuanced corrections and then some bigger things as well.
So, as always, any errors are our own but in no particular order, we’d like to thank Jason Watt. Jason is a coach consultant to the financial services industry with years of experience teaching topics like this one to financial planners and aspired financial planners. Spencer McKay is a senior consultant at West Coast Actuaries Incorporated.
They’re an independent actuarial consulting firm and they provide consulting on retirement plans for employees, IPPs for business owners, senior executives and actuarial evidence and expert reports required by legal professionals. Also, Melissa Morrison, senior financial planning associate at PWL Capital. Melissa had recently worked through client cases on RCAs which you’re going to find out more about today what that means and had some good practical insights into that.
And of course, Braden Warwick as well who is a financial planning product architect at PWL Capital and Braden, as some of you are probably aware, has done deep research and modeling of pensions for connected business owners. I’m just going to give a quick overview of the landscape and then we’re going to get into some more of the details. So, when we say pension, what we’re referring to are registered pension plans or RPPs and that means they’re registered with Canada Revenue Agency and sometimes also by a provincial or a federal pension regulator.
And RPP is defined in section 248.1 of the Income Tax Act. RPPs are distinct from RRSPs, though we do have many similarities and we’ll dig into that later. First, we do want to familiarize you with some of the main types of pensions and then go into more detail in the sections following that.
So, pensions are set up by a plan sponsor, which is an employer or group of employers setting a pension for its employees.
[Benjamin Felix] (6:24 – 8:53)And you’ll hear those words again as we go through and it’ll become more clear hopefully what they mean, how they relate to pensions and then the different roles that people and institutions play. The regulation of private pension plans in Canada is done by the federal and provincial governments. For pension plans linked to most types of employment, the relevant provincial government is responsible for establishing the rules and for its supervision.
Certain areas of employment like work in connection with navigation and shipping, banking, inter-provincial transportation and communications fall under federal jurisdiction. There are two overarching types of registered pension plans that we’re going to go into a lot more detail later, but just to warm you up now, we wanted to define them. They’re defined contribution plans.
That’s where the plan sponsor contributions and employee contributions, if any, they’re not required, are defined. The contributions are defined and the pension benefit is based on what has been accumulated in the account. The employee in that case takes all the risk of the investments in the plan performing poorly.
If you end up buying investments that don’t do well in your defined contribution plan, you could have a very small pension benefit in the future or a very small investment remaining at your retirement. Now the employee is typically able to choose what the plan invests in from within a limited set of choices determined by the plan sponsor and the financial institution providing DC plan. You’d be able to look at, well, I want to buy this fund, I want to buy that fund.
You may be able to access some advice through the plan sponsor. The big thing with defined contribution plans, as the name suggests, is that the contribution is defined, the benefit is undefined. Now the other one, which is in many ways sort of the opposite, is defined benefit plans.
In that case, the plan provides members with a defined pension benefit when they retire. These are the classic golden handcuff pensions that are much less common today from employers, like the federal government is one of the big examples that still has a defined benefit pension plan for most employees. The defined benefit usually depends on factors like years of membership in the plan and the member’s salary while they were working.
The pension benefit is a liability of the plan sponsor in this case though. The employer, the plan sponsor, they’re taking on all of the risk. If the investments do poorly, the employee is still entitled to their defined benefit from their pension plan.
Now incorporated individuals, self-employed people, can set up a defined benefit pension plan called an IPP, although it behaves a little bit differently from the group plans that I was just referring to. We’re going to go into a lot of detail on IPPs later.
[Dr. Mark Soth] (8:54 – 10:20)Those pension plans may be sponsored by a single employer or the other main legislated type of plan is a multi-employer pension plan or MEPP. An MEPP can be set up as a defined contribution or defined benefit plan. That’s a separate characteristic.
MEPPs are usually for employees in industries where the employees move around among different employers or are employed by more than one employer. An MEP is defined as a pension plan in which two or more employers participate. Obviously, the contributions are determined according to an agreement between the employers or a collective agreement, statute, or regulation.
We’ll talk more about that with some of the MEPPs available to corporate medical professionals. Two of the most relevant RPP options, so the pension options in general for self-employed and corporate rated business owners, is that there’s two big groups available to them. There’s an IPP, individual pension plan, and the MEPP, which is the multi-employer pension plan.
An incorporated business owner can set up an IPP on their own. There’s two big MEPPs, Medicus and Hoop, that physicians are able to join. There also are other MEPPs as well that any incorporated business owner can buy into if they’re interested in that type of strategy.
[Benjamin Felix] (10:20 – 12:26)It’s worth mentioning here that while these are all legislated registered plan types that we were just talking about, there are several brand-named pension plans that make claims about their superiority. A branded pension plan might offer things like specific investments, like they’ll say, will give you access to institutional grade investments or investments that you can’t access as an individual, or the ability to switch between types of plans, like switch between DC defined contribution and defined benefit. The point we want to make here is that under the hood, all of these plans, all of these products that get offered and pitched to people are ultimately one of the types of legislative plans.
These things exist in the legislation. You can call it whatever you want. You can put whatever you want inside of it, but ultimately it boils down to the legislative plan types that we just mentioned.
We will go through each of these in more detail and how they apply to self-employed incorporated business owners and when they do and do not make sense. Before we go further on this, one of the issues that we want to pick apart right away is the notion that self-employed people get a bad deal on pensions. I think that notion causes a lot of pension envy and it can cloud logical decision-making about whether pensions make sense for the self-employed.
Registered pension plans are at the most fundamental level, specific types of retirement plans that follow the applicable rules and regulations. When an employer contributes to a registered pension plan as part of someone’s compensation package, the contributions are simply part of their overall compensation. When an employer considers how much they can pay an employee, they include the costs of their training, salary and benefits, including pension costs in the calculation.
If they pay more in one area, like if they offer a pension, it will subtract or at least it shouldn’t very subtract from another. If you get a pension, you might get a lower salary as one example. While it’s unlikely to be a perfect dollar for dollar trade-off between the pension contributions and the salary in the example that I just gave, there’s got to be a relationship there on some level.
We’ve already discussed that in the context of publicly mandated pensions, like when we did our episode on CPP, but we’re repeating it here because I think it’s an important part of understanding how pensions work and whether they actually make sense for self-employed people.
[Dr. Mark Soth] (12:27 – 13:45)There is that empirical data from countries around the world that on social security contributions that form part of the company’s payroll. When that happens, for example, like with CPP, employees bear about two-thirds to 90% of that cost. It’s not dollar for dollar as a reduction, but there is definitely a relationship there.
It’s imperfect, but pretty strong. In the employer-sponsored pension context, there also can be some advantages to paying part of the cost of a pension. Even though it’s not dollar for dollar, the employer gets some benefit for paying that extra cost.
For example, it may help with recruitment and retention of employees, which ultimately saves them on other costs because they don’t have to have turnover and training. That’s why it’s sometimes called the pull the handcuffs for employees because it really locks them into that employer. In the private sector, the free market helps to influence employee wages and benefits.
If the compensation package is poor, they won’t have employees and they can’t run the business. On the other side, if the package is too rich, then they may struggle to run the business profitably. Ultimately, that does trickle down to adversely impact the employee’s job stability.
There are checks and balances in private sector to keep pensions as part of the compensation package.
[Benjamin Felix] (13:46 – 14:54)In the situation of a self-employed incorporated business owner, the relationship between pension contributions and personal compensation is obviously much more direct since the business owner pays the employee and the employer cost of the pension directly. A dollar paid into the pension plan is a dollar not retained in the company or paid out to the owner directly. Also, employee retention isn’t a factor if you are the business owner and the key employee at the same time as is the case with many self-employed people.
Fortunately, it is possible to make clean comparisons between various pension options and select what makes sense for you logically based on the quantifiable elements like costs, taxes, and fees. You also have to consider some harder to quantify aspects like whether you want to bear all of the risk individually like you do with an RRSP or an individual pension plan, an IPP versus potentially paying more to share risk with others like with a multi-employer pension plan, the MEPPs that we talked about with a defined benefit plan. Also, your preference for how much control you want versus how much you want to outsource is also going to factor in.
We’ll discuss how these different options work and how that impacts different considerations in making the right decision for you as an individual.
[Dr. Mark Soth] (14:55 – 17:53)If you have a discussion about pensions, we also have to mention RRSPs. RRSPs and RPPs have similarities and differences. So, understanding both is important because the decision to set up or join an RPP, a pension, is traded off against the alternative of simply using an RRSP.
So we described RRSPs in detail in episode 8, but there are a few important points to reiterate for today’s episode. To make the comparison as clear as possible, we will highlight separately the main similarities and differences between pensions and RRSPs. We’ll just start off with some of the similarities.
Primary Purpose One similarity is the primary purpose. Both RPPs and RRSPs are both designed to be part of that third pillar of the Canadian retirement system. They supplement retirement income sources like old age security and the Canada Pension Plan.
Tax Treatment They also have similar tax treatment. This is probably the most important similarity between the two. Contributions to pension or an RRSP are both made with pre-tax dollars.
Now it’s through slightly different mechanisms, but in both cases there is 100% personal income tax deferral on earned income that goes into the plan. With an RRSP that’s due to the personal income tax deduction. For a pension, it’s deducted straight from the business income, but either way it’s pre-tax dollars.
Contribution Limits And that’s important because using corporate dollars is often touted as one of the benefits of using a pension product, but functionally both a pension and an RRSP are pre-tax investments, so that doesn’t really matter so much. In both account types, the investments also grow on a tax deferred basis inside the account, and then tax is paid as regular income when it comes out for you to spend personally on the other side. Now one of the important similarities differences is also contribution limits.
Registered pension plans and RRSP both have contribution limits, and in certain cases the amount contributed to a pension can actually be higher than what it is for an RRSP. But it’s important that neither offers an infinite tax shelter, you just can’t put as much as you want into either plan and tax defer it. But there are cases like with a defined benefit pension plan, the actuarial assumptions that determine the contribution limits typically result in a higher annual contribution limit than an RRSP, somewhere around after the age of 40.
Talk more about that later. When it’s defined contribution plan, the limit is the money purchase limit for a pension, which is the same as the RRSP limit, but it’s one year ahead. For example, the new maximum RRSP room for 2025 is $32,490, which was the money purchase limit in 2024 for pension plans.
Legislation [Benjamin Felix] (17:54 – 20:53)Now I’m going to go through the main differences between RRSPs and pensions or RPPs. Both of them are governed by the Income Tax Act, that’s a similarity, but they’re governed through different sections. Some RPPs are also subject to additional provincial or federal regulations.
Creditor Protection They’re both legislated, but different sections of the Income Tax Act and RPPs pensions tend to have a little bit more regulatory oversight. Creditor protection is another important difference, both defined benefit and defined contribution pensions and registered pension plans more generally, they have creditor protection beyond what is available with an RRSP. They’re typically protected from creditors both in bankruptcy and outside of bankruptcy.
RRSP accounts have been protected in bankruptcy since changes to the Bankruptcy and Insolvency Act in 2008, specifically under section 67.1b3. Outside of bankruptcy, it’s more complicated and depends on the province and what is held inside of the account. Insurance contracts, for example, like segregated funds with a name to beneficiary are often protected. In general, RPPs have overall better creditor protection than RRSPs, which is something worth considering if creditor protection is important to you.
If an RPP, if a pension becomes exempt from its Provincial Pension Benefits Act, PBA, which is something that can increase flexibility and reduce red tape, there are some benefits to doing that, but it can also reduce creditor protection. It is worth noting that creditor protection does not offer any protection from the division of assets in a marital breakdown. Liquidity is another important difference.
Liquidity In general, assets in a pension, in an RPP, are less liquid than assets in an RRSP. RRSP assets can be withdrawn at any time, although it’s not advisable to do so, but they can be withdrawn at any time. There are no explicit penalties for doing that, but the withdrawals are fully taxable and the room is gone forever once the withdrawal has been made, which is why you probably wouldn’t want to do it unless you absolutely had to.
The RRSP also has two ways to access the funds in the account without making a taxable withdrawal. That’s the home buyer’s plan for purchasing a home and the lifelong learning plan for pursuing education. In both cases, the funds do need to be repaid over time to avoid being taxed as income, but it’s still, there are useful ways to get money out of an RRSP, temporarily anyway.
RPPs do not have those options. In retirement, there are similarly no limits on how much can be withdrawn from an RRSP in a given year. There are other constraints like pushing your tax rate up really high, but there’s no technical limit.
There are minimum starting in the year that you turn 72 when you convert to a RRIF, an RRIF, but there are no maximums. With an RPP, if you’re receiving a defined benefit pension, you’re not able to increase or decrease the amount that you receive. If you leave the RPP at retirement, the funds will go into some combination of a locked in account, which when converted to a LIF will have an annual minimum like a RRIF, but also an annual maximum withdrawal.
If you close down the pension, some of it may also go into a taxable account, which has no restrictions, but it’s taxed in the year that it’s distributed.
[Dr. Mark Soth] (20:54 – 22:56)I think one of the general themes when you’re comparing pensions and RRSPs is that pensions tend to have a little bit less flexibility in many ways than RRSPs. When they become RRIFs later on, they have more flexibility than what happens with a pension. Another thing that’s important to understand is that using a pension and or an RRSP, they actually can have interactions with each other.
For example, if you contribute to a pension, that decreases the amount of RRSP contribution room that you have in the following year. And that’s done doing something called the pension adjustment, which reduces the following year’s RRSP contribution limit. But the basic idea is that you cannot shelter money in both a pension and an RRSP additively.
They interact using one, so it cracks from the other. Now, that delay in a year is important. For a defined contribution pension and an RRSP, it’s also important that the annual contribution limit is the same and does not change with your age.
Whereas for a defined benefit pension plan, because it’s not just done off a strict number, it’s done off of a number that’s calculated using actuarial calculations based on how much is needed to provide that defined benefit. That contribution amount can vary with your age, it could vary by the performance of the investments held by the pension, because it has to have enough there to fund that benefit. And again, as a general rule, after the age of 40, defined benefit contribution amount increases to exceed the RRSP contribution now.
So this is why in general, it’s sensible to consider whether you’re going to use an IPP after the age of 40, but not really so much before then. Another important nuance that’s there is that if someone is fully maxing out the allowable contributions to their pension, they still have another $600 of new RRSP room each year due to the way that pension adjustment is calculated. So there is the potential to tax to first, lend me more when you use both a pension and an RRSP because it doesn’t take up all of the RRSP room.
[Benjamin Felix] (22:57 – 25:19)We mentioned briefly earlier, defined contribution versus defined benefit pensions. Let’s dig a little bit deeper into that, which is, as we mentioned, probably the most important defining feature of pension options when you’re looking at them. Defined contribution versus defined benefits.
So we’re also going to go over some of the basic pension terminology that we glossed over earlier in this section, lots of acronyms involved here. We’ve already mentioned the division between RRSPs, registered retirement savings plans and RPPs, registered pension plans. Registered pension plans can be broken into smaller subgroups and that’s what we’re going to talk about now.
That’s the defined contribution versus defined benefit. A defined benefit pension has a prescribed payout during retirement. So the participant and employer sponsor are going to contribute enough to target supporting that defined level of payout.
The plan sponsor is going to invest the pension contributions, but if there is a shortfall, the employer, the plan sponsor has to make that up. It’s their liability, their responsibility. This shifts all of the investment risk onto the plan sponsor or the employer.
In many cases, the plan sponsor will be the employer. If investment returns do not meet the obligations, then the plan sponsor is on the hook. That’s why it’s now increasingly hard to find these types of pensions outside of the public sector, because they are very risky for employers.
If you’re running a company, having a big pension liability to your employees is not great. For self-employed people, it’s a little bit different because they’re obviously both the employee and the employer. They’re both the plan sponsor and the plan member.
Now this has a couple of implications. The pension is less risky for the employer because the employee is not going to make legal claim on their pension benefit to themselves. It’s also less protected for the same reason, for the employee.
For IPPs, individual pension plans, many provinces allow exemptions from the Provincial Pension Benefits Act. Under the Federal Act, there are no requirements to make up funding shortfalls of the plan. If you’re running an IPP and you’re in a province that allows exemption from the Provincial Act, you can simply choose not to top the plan up in the event of a funding shortfall.
Again, that’s reducing the risk for the employer, but it also means that you as the employee aren’t getting that ironclad pension that you’d get from an employer like the federal government. That shortfall would be determined by an actuarial valuation. Just to be clear, this also means that the defined benefit is not as guaranteed as what you would get from a large employer.
[Dr. Mark Soth] (25:20 – 26:43)That is intentional. The intent behind that is to allow small business owners with an IPP some flexibility. You wouldn’t want to have a small business owner stared off for using IPP because they’re worried that they might have to contribute to a slowdown of their business and then put themselves in a bad position.
So that’s why that exemption is there. Over to defined contribution pensions. These are also very similar to RRSPs.
As we mentioned, you make a defined contribution, the performance of the investments that you choose will dictate the amount of money that you ultimately have in the future. And again, you, the employee, bear all the risk of that. The largest potential benefit of a DC pension is if your employer provides matching funding to your contributions that are only available if you participate in the plan.
So, that basically tops up your investment return right off the bat because the company’s giving you money to save for your retirement. The second possible benefit is that the company managing the pension plan for your employer has better investment options than you can access on your own. Now, of course, that’ll always be stated to be the case and that may have been a more salient consideration in the past, but nowadays with low-cost ETF investing, that’s really flipped the script on that aspect.
I think people have access to excellent, low-cost, highly effective investments on their own.
[Benjamin Felix] (26:44 – 26:49)I would say that a bigger differentiator now for pension plans is if they do offer low-cost index funds.
[Dr. Mark Soth] (26:49 – 26:50)No, that’s true.
[Benjamin Felix] (26:50 – 26:54)It’s relatively rare, but – And that’s important. It is important.
[Dr. Mark Soth] (26:54 – 27:08)You get that menu of things. Be careful because it may just get pre-selected for you based on some questionnaire or something, but you might want to actually look at the list of options that are there and try to pick ones that you think make sense from an evidence-based investing type of approach.
[Benjamin Felix] (27:09 – 29:05)Totally. That’s something that PWL does for clients. If they’re part of a group retirement plan or a pension plan that they choose the investment options for, we’ll review them.
It is pretty rare to be able to find, here are the great low-cost index funds that you should be using. It’s a tricky space in that regard. One other important consideration with defined contribution employer plans is their behavioral effects.
This is maybe less relevant to self employed people, but if somebody has a business that has employees, maybe it is relevant. I just wanted to mention it anyway. When contributing to a pension plan is what happens by default for employees instead of a decision that you have to make, it seems to help people save more.
There’s a famous 2001 study, The Power of Suggestion Inertia in 401k Participation and Savings Behavior, a highly cited paper. It found that moving from an opt-in model where the employee chooses to participate in the pension plan to an opt-out model where the employees automatically enrolled but can choose to opt out in a pension plan significantly increases participation. If you start with an employer who automatically enrolled you in their defined contribution pension plan when you start working there and you can choose to opt out if you want to, but by default you’re in, you’re much more likely to contribute than if you have to manage it yourself or if you have to make RRSP contributions.
At least that’s what the evidence says. Now for a self-employed person, like I mentioned, it’s not probably super relevant, but it’s relevant if you have employees potentially and you want to take care of them. If there’s no employer contribution and you’re able to implement a lower cost and more robust investment strategy using an RRSP, the RRSP may be more attractive than a defined contribution plan.
If your employer says, there’s no match, but hey, you can use this DC plan and here are the options and they’re all high fee actively managed funds, when you could just invest in index funds in your RRSP, the RRSP I think looks pretty attractive. Also keeping in mind that the RRSP has more flexibility during withdrawals in retirement and assets for an RRSP may be locked in in retirement, resulting in maximum annual withdrawal, as we mentioned earlier.
[Dr. Mark Soth] (29:06 – 31:34)That leaves nicely actually about what happens to these accounts in retirement. An RRSP must convert to a registered retirement income fund or an RRIF. That happens in the year that you turn 71 and minimum payments must start coming out of it the following year.
However, you could choose to do that sooner and access the pension tax credit. As an RRIF, you must withdraw a minimum amount each year and there is no maximum. So, if you do want to convert to an RRIF early, but keep the minimum withdrawals as low as possible, you could actually convert part of your RRSP into an RRIF and keep part of the savings as an RRSP until later on.
That pension tax credit sometimes attracts people to do that. If you leave a pension plan for both, whether it’s a DC pension or a DB pension, a large portion, if not all of the funds will be deposited into a lock-in retirement account, which is a LIRA, which is typically locked in until the age of 50 or 55. The minimum life income fund, which is the next step, LIF, the age at which that has to happen varies by province.
In some cases, an additional amount is fully taxable in the year that it is also received as part of that. That happens if you decide to commute a pension. So you leave the pension, you commute the value, and if the value of it is large, some of it may be continued to be tax shelter, but some of it may be fully taxable income in the year that you do that.
We’ll come back to commuting pensions later on. Some provinces allow the unlocking of a LIRA into an RRSP or an RRIF in certain cases. So when you do have that LIRA, you can potentially switch to have more control and flexibility with it.
Converting to an RRSP or an RRIF gives you more flexibility in the drawdown stage. If it stays as a LIRA, then it must be converted to a life income fund to make any withdrawals from it, and it must be converted in the year that you turn 71, just like it would be with an RRIF. A LIF, what makes it a bit different is that it has both a minimum and a maximum annual withdrawal amount.
That’s in contrast to only having a minimum withdrawal amount with a RRIF. So a RRIF, which is the successor of an RRSP does have more flexibility.
[Benjamin Felix] (31:34 – 33:17)Comes back to that flexibility aspect of the RRSP versus pension point. Okay, we’re going to move on to group pension plans. Now that’s other than defined contribution versus defined benefit.
The main other dichotomy for pensions is whether it is a group pension, where you’re pooled with a bunch of other people in the pension plan or an individual pension plan, where you’re the only member. Now we will come back to individual pension plans or IPPs in quite a bit of detail, excruciating detail, I would say. We go pretty deep with the money scope there.
But we do want to focus on group pension plans to start. The main difference is that with an individual pension plan, you are the employer, you’re the plan sponsor and the employee plan member. With a group pension, you are one member in a larger group of plan members.
A group pension can have benefits, particularly for defined benefit pensions, because risk is shared across all of the members in the group. The plan sponsor has a legal obligation to provide the promised benefits to the group. In a group pension, whether it’s defined benefit or defined contribution, investments and administration are pooled and overseen by a board of trustees.
As we mentioned earlier, a group pension can be for one large employer, like a big company or the federal government being the classic example, or for multiple smaller employers that are part of a group. Those multi-employer pension plans or MEPPs are what are sometimes promoted toward incorporated professionals. For example, there’s Medicus from MD Financial and Scotiabank and Hoop.
They’ve also just recently announced an option for incorporated Ontario physicians to buy into their pension structure. There are also other MEPPs that are available to members of some unions.
[Dr. Mark Soth] (33:18 – 35:49)One of the potential advantages of a group pension plan could be access to lower cost or otherwise unique investments due to the scale. They lump a bunch of people’s money together. A pension has a larger amount of money to invest.
This seems like a good pitch and this is obviously one of the things that is pitched by people promoting those group pension plans, but I would say it’s not obvious that there’s a real benefit there. If your baseline is investing in high-fee retail mutual funds with management expense ratios in the one and a half to two and a half percent per year range, yeah, then it’s definitely possible that a well-run pension plan may have lower costs than that. The problem is that most pension plans actually do take an active management approach and use alternative investments, which usually come with significant costs associated with it.
For example, I have seen a defined contribution multi-employer pension plan. It’s not one of the ones we mentioned, but it’s transparent about their fees and those fees come in at around 1.25% per year. That is less than actively managed mutual funds, so it probably is better than that, but it’s also much higher than you’d have with index-based funds or ETFs.
Having looked at this in detail, it can be tough to find a pension’s cost. Just for a quick example, I recently took a look at Hoop and Hoop describes their investment management costs as 0.39% for 2023, which that sounds great. That’s fantastic, really.
However, when you dig into their detailed annual report, that excludes fees paid to external managers. They’re obviously managing investments too, so we add that in, the investment cost is more like 0.64% per year. Still not terrible, but higher than what you see at face value.
And of course, because this has this pension structure that has to be managed, there’s administrative costs on top of that. And we add all that together, the total cost for you investing in that pension and getting your money out of it was 0.75% per year. That’s lower than some of the higher fee options that are out there, but you also have lower fee options as well.
Now, Medicus, which is the other big MEPP, I couldn’t find any public data on that, but I would suspect that it’s comparable to what the other pensions are. Now, it is much better than a high fee fund or advisor model, but still definitely higher than what you pay using, say, an asset allocation ETF or other low fee ETFs invested in RRSP.
[Benjamin Felix] (35:50 – 35:51) Hoops, not even that bad.
[Dr. Mark Soth] (35:51 – 35:53) No, it’s pretty good actually for pensions.
[Benjamin Felix] (35:54 – 36:07) It’s one of the better ones. Canada Pension Plan, which is the largest one, is actually quite a bit more costly to run, which is not great. CPP is a great program, but not a fan of the relatively high fee investment management approach that they’ve taken.
[Dr. Mark Soth] (36:07 – 36:13) They made a change a while back to do that on purpose, which has ballooned their costs.
[Benjamin Felix] (36:13 – 36:14) 2006.
[Dr. Mark Soth] (36:15 – 36:17) Without evidence of improving their ROCA.
[Benjamin Felix] (36:18 – 39:47) Without broader evidence, which is what I’m going to talk about in a moment here, but also without them anecdotally producing a benefit over the last 20 or so years, which is also something that I’m going to comment on. The pitch with these investment approaches, of course, active management and alternative asset classes like private equity, is that they’re going to add more value than cost. You should invest in these things because they’re going to make you better off.
When we look at the research, there’s a 2018 paper from Hook and Yook. They described the grand experiment taken on by American state and municipal pension funds who were allocating more aggressively to alternative asset classes and active management starting in 2008. The authors compare aggregate public pension fund returns and volatilities with a series of benchmarks and replicating indexes.
They ultimately conclude that states and municipalities obtained neither lower risk nor higher returns with the higher level of active management and diversification implied by alternative assets. The grand experiment in that case seems to have been a bit of a failure, which is interesting because it follows the same path as Canada pension plan. A paper by NS, a 2020 paper, finds that public pension funds and educational endowments, despite their large allocations to active management and alternatives, underperform simple low-cost passive portfolios, largely due to fees.
They find that public pension funds in the sample underperform a passive investment by one percentage point per year, while endowments trail by 1.6 percentage points per year. The author, NS, advocates increased adoption of low-cost passive management by institutions. 2021 paper by Hammond examines 58 years of university endowments performance, finding that the average endowment significantly underperforms its annual required return, its long-term return objective, and a simple 60-40 index fund benchmark.
The author of that paper, Hammond, concludes that the average endowment in the sample would have been better served by simply indexing to a passive 60-40, 60% stock, 40% bond benchmark. Another 2022 paper from NS, who I mentioned a moment ago, finds that a sample of 24 US state pension funds underperform a passive investment by 1.4 percentage points per year for the decade ending June 2020, mostly due to fees. Pretty similar story all the way through.
There’s another 2024 essay by Aubrey and Yin. They examine the performance of state and local pension plans in the public plans database in the US. In that case, they find that they have underperformed a simple portfolio of index funds for the full period, the year 2000 to 2023.
Pension funds did outperform briefly from 2000 to 2007, but they’ve trailed an index portfolio since then and over the full sample in that analysis. It’s worth saying that this isn’t a slight against private equity managers. There is evidence that they are skilled, and I’m sure any alternative asset class, those portfolios will be run by skilled managers.
The problem is that most of that skill tends to get eaten up by fees, which is really the concept of there being an efficient market for manager skill. If you look at the pre-fee returns of any of these investments, they do tend to look really good, which is great for the managers because it lets them charge higher fees, but then net of fees, the investors in the products don’t actually get much of a benefit. It’s possible that larger pensions could attract better managers, maybe.
The market for managers is very efficient. The best managers get more to manage, and then because of that, they have a harder time generating alpha as they scale up. It’s tough out there to say, hey, look how great our pension is.
We’re investing in this stuff. I don’t think that’s a great pitch.
[Dr. Mark Soth] (39:47 – 42:23) It is tough out there. I mean, there’s many large pensions and endowments investing in private equity now, so a lot of dollars competing for a relatively small market for private investments and for the top managers in that space, so it’s very, very competitive. Like with other investments, past performance in private equity does not predict future performance.
Usually, a successful private equity manager has had some home runs early on, and that’s why they survived as a manager, and so there’s going to be the survivorship bias influencing that. Due to the way that private equity performance is typically presented using internal rates of returns or IRRs, those early returns can make their long-term performance look great forever, so they hit an early home run. It doesn’t matter almost what happens after that, which is when you’re entering into the equation.
It’s always going to look like a fantastic number whether you experienced that or not. Anyone who invests after that doesn’t get the benefit of those early home runs. One of the difficult things that also comes up with pension boards is that they’re using active management for any asset classes, choosing managers, and once an active manager is chosen, then they face the challenge of having to evaluate their performance, firing underperforming managers, and then looking to rehire new ones, and in reality, these hiring and firing decisions have somewhere between no effect before costs and a detrimental effect, and there’s a couple of papers which we’ll link to in the show notes that show that.
Another purported advantage of a large group pension is the ability to have an extremely long investment horizon, so it isn’t just one lifetime they’re investing. It’s multiple rolling lifetimes, so they could invest in investments that are going to have super long-term return time frames, so it makes investments in longer-term assets like infrastructure more reasonable, and as the risk is spread across this many cohorts of investors. So there might be some logic there behind it, but personally, I’m not sure that I would be looking to invest in something that may or may not make my returns until the latter part of a 100-year time window of multiple lifetimes.
Really, a lot can happen over a long period of time. Infrastructure that was important to us even 50 years ago is probably not the same importance to us now. Just look at telephones, for example, like landmines.
That seemed like a great long-term infrastructure investment at the time, I’m sure. It would be extremely hard to measure those returns over that time frame and compare performance. I don’t really buy into that argument either.
[Benjamin Felix] (42:24 – 44:50) It makes for a great story, but it’s not super obvious that there’s actually anything interesting there for investors. One of my favorite examples, I mentioned it earlier, is CPP Investments. That’s the investment manager for Canada Pension Plan, which is one of the largest pension plans in the world.
CPP Investments manages, as of their most recent annual report for 2025, more than $700 billion for Canadians, which is just an incredible amount of money. CPP Investments does invest heavily in illiquid assets and they use quite a bit of active management. Like you mentioned earlier, Mark, they did used to use index funds up until 2006, where they made this very deliberate decision to adopt an active management strategy.
Since then, they’ve increasingly allocated to illiquid assets and just other alternative asset classes. They’ve made it kind of confusing. In the 2025 annual report, they’ve introduced a benchmark portfolio, which is different from the reference portfolio.
The reference portfolio is 85% stocks, 15% bonds. The benchmark portfolio is index benchmarks for the actual asset classes that they invest in. This is a whole other thing.
Like the fact they switched that, I don’t think it’s very good. I’m going to make a video about that. But the reason I had to mention that is that they’ve trailed the reference portfolio blended with, for 2025 fiscal year, the benchmark portfolio.
It’s two different benchmarks, I guess, over the full period. But from 2006 to fiscal year 2025, they’ve underperformed that blended benchmark by 0.2% annualized. Canadians, we collectively are paying billions of dollars every year for the fees and costs of this active management strategy, which is underperforming.
Anyway, just an interesting example. Access to those asset classes, even if you’re one of the largest and most well-respected pension managers in the world, which CBP Investments is, getting access to those asset classes is not necessarily a good thing. In those examples, it’s actually been a bad thing, at least over those time periods.
I don’t think that should be a reason to join a pension plan. I have seen one of the plans that we have mentioned, I won’t name it, but in their website literature, they say access to investments not typically available to individual investors as one of the reasons to join that plan. My main point here is that, specifically, access to investments should not be a reason that you get compelled to join one of these plans.
It actually may be a reason to avoid them in some cases. You’ve really got to look past that and think about what the other attributes are that may be useful to you.
[Dr. Mark Soth] (44:50 – 45:44) There are other attributes that would be potentially attractive to some people. It’s easy to lambaste DB pensions for underperforming a passive benchmark, but it’s also not a completely fair argument. To find benefit pension plans, they have fixed legally binding liabilities, and they’re required to make their future pension payments.
As individual investors, whether it’s an RRSP or be an IPP, our approach, we attempt to make it take as much compensated risk as we can handle to maximize our potential return. We do that while balancing with enough stable assets that we can stick to that plan over time. If things don’t work out as we hoped, we spend less.
To measure how successful we’re investing, we usually look at something like some annual return rate or some other benchmark that goes with that, or importantly, how much can we actually spend in retirement? Those are the outcomes we’d be looking at.
[Benjamin Felix] (45:45 – 48:45) It’s an important topic. It’s really the difference between asset only performance evaluation, how did this asset I invested in perform relative to some alternative versus liability relative performance evaluation. A pension could perform poorly relative to an index fund, but really well relative to its liabilities, which is what really matters.
Just using the CPP example, in their annual report, they don’t mention that at all. They’re not managing to a liability driven framework. They don’t get a pass, they don’t think.
Hoop does talk about specifically their liability matching portfolio and their long-term growth portfolio. I don’t remember the specific language, but they differentiate between those two approaches within their plan, so they can get a pass if they did underperform. Now, a defined benefit of pensions, they don’t have the option to spend less.
Because they have these required pension liabilities, they have to fund. That’s great for pensioners, as we’ve talked about, because the pensioner knows exactly what they’re going to get, as long as the pension plan stays solvent. They know exactly what they’re going to get from their pension, but it means that portfolio management for a pension is different from portfolio management for individuals.
The pension funds will often take a liability matching approach, like I mentioned, Hoop does that with some of their assets. Instead of measuring a risk as something like standard deviation or downside volatility, which is what individual investors come and look at, they’re going to measure risk relative to their liabilities. The present value of a pension liability changes with things like interest rates and inflation expectations, mortality expectations, and a pensioner wants assets that respond in similar ways.
That’s a concept of immunizing their liabilities. Now, while they’re relatively inflexible, some pensions can deal with potential shortfalls by pulling levers with the benefits or the contributions. If a pension is doing really well financially, they may add cost of living adjustments to the pension payments.
If it’s doing less well, there could be reductions to benefits, for example. On the other end, contribution rates could also be increased. There are regulations for how pension plans can do that.
No pension manager really wants to do that, going to your plan members and saying, we’re boosting contributions or we’re decreasing benefits. That’s pretty unpleasant for plan members. To prevent getting into that situation, pension managers will often attempt to match their investments to their liabilities.
They’ll attempt to immunize their pension liabilities through asset allocation. That could be like a big component of fixed income that matures around the same time when the money is needed, just as one example. Although bonds can be a bit more of a challenge for pensions with real liabilities.
CPP, for example, is very explicitly indexed to inflation, so buying nominal bonds would not be super useful for them to hedge their real liabilities. The main point here is that risk management for defined benefit pension plans is more about matching liabilities and investments than it is about balancing investment returns and volatility, just to the point you made earlier, Mark. It’s easy to make funded pension plans, like you guys underperformed an index fund benchmark, but to be fair to them, it is a lot more nuanced than that.
Sequence Risk Pooling [Dr. Mark Soth] (48:46 – 51:04) One of the things with a defined benefit pension plan, especially if you’re pooled with a bunch of other people, is that it helps you with some of this risk sharing that you mentioned. One of the problems that volatility could cause for us as individual investors is sequence risk, or alternatively having to have spending variability depending on how markets are doing. Markets don’t just move up in a steady fixed amount each year, they go up and down in the short term.
And if you happen to have an unlucky large percentage drawdown when your portfolio is at its pre-retirement peak, and you need to take that money out to live on, then you face a problem. If you can’t make adjustments to your spending, you have to take that money out and you could take a big hit that you may not be able to recover from. Spending a lot in a down year means less money that’s invested to ride markets back up when they do recover.
That may not be a big deal in late retirement because there’s not much of your portfolio left and it doesn’t have to cover as long of a liability anymore, but a big bite out of a portfolio in early retirement could decrease the odds of it being able to fund your full retirement at your desired spending rate. And this is one of the ways to deal with that. One of the ways to deal with that is also if you could reduce your spending, but that’s not always possible or desirable.
But the sequence of return risk may be better named sequence of withdrawal risk because it’s really those withdrawals that you’re making that affect the portfolio’s long term survivability. It’s about making those withdrawals when returns are bad. I recently did a common sense invested video on this then, which was really great.
Either way, it’d be multiple rolling lifetimes of members in a DB pension plan helps each individual member with the sequence risk. So instead of having to adjust your spending or taking that risk of running out of money, you have this defined benefit that’s for your lifetime and you have this group of members that are constantly contributing and retiring over a wide range of years. So that sequence risk isn’t one sequence of returns.
It’s a whole bunch of them spread out amongst the group. So one group may be retired, but another is still active and contributing to the plan and that mitigates the effects of these bad mark conditions on the plan as a whole.
[Benjamin Felix] (51:04 – 52:26) Just to relate that to something that we’ll talk about later of pooling mortalities is to think about this sequence risk thing. It’s like pooling of time horizons. Instead of your one individual time horizon that you have to worry about as an individual investor, an ongoing group defined benefit pension plan is diversified across the time horizons of many plan members.
So that risk sharing is a distinct benefit of a group DB pension plan. For an individual planning for retirement, it’s a way to get this fixed income stream that’s not going to be affected by market volatility because to your point, Mark, dealing with sequence of returns risk by changing withdrawals is great in theory and it does help like if you model it out, but it’s not always easy to do practically. Telling someone to cut their expenses by 30% when they’re retired is not always great.
One important question is whether the pension is indexed to inflation. A non-indexed pension can still suffer from sequence risk if you live through a period of extremely high inflation. I just mentioned how stable pension benefits are great if you’re the pensioner.
If your pension is not indexed to inflation, inflation is high, that’s like a different form of sequence risk. You can keep getting the same nominal amount from your pension benefit, but if stuff is getting more expensive, then that can really hurt your purchasing power. Now on the other hand, an index pension benefit would adjust its payments based on something like the consumer price index, which is what CPP uses.
[Dr. Mark Soth] (52:27 – 53:47) For individuals managing this risk, you may have to make adjustments to your lifestyle essentially. When markets are doing well, you can spend normally and when they’re not doing as well, you may spend a bit less in particular or if there’s a big inflationary period, your buying power may decrease. People do tend to do that naturally to some degree, but it could take effort.
The other issue I would make is the psychological issue for people. We know that we have this vulnerable period from a sequence of return risk period around the time that we’re retiring. It’s also a big psychological adjustment for people to move from having an income to being dependent upon their portfolio.
They may be more sensitive to these things psychologically than they would be otherwise. There are other approaches. If you don’t want any variability in your spending and you don’t have a pension, but you otherwise want to keep your aggressively invested portfolio, another approach might be to do something like a GIC ladder to fund several years spend date.
For example, take five GICs with one maturing each year that would each cover a year of your essential spending requirements. You can make flexibility in some things, but there are some things you’re not going to want to be flexible on and you want to cover that. You’d have one of those mature each year that could help bridge you through that period of highest risk in the early retirement period.
It also provides you some of that psychological buffer to help you get through that.
[Benjamin Felix] (53:48 – 55:32) That has been studied academically, the idea of having this cash buffer. It’s psychologically pleasing for sure and we see this with clients too, but it’s not optimal in a model. Which doesn’t mean it’s not optimal for an actual human who has psychological concerns, but when you model it out, the lower expected returns of having a cash buffer tends to more than offset the ability to avoid drawing down the portfolio and down markets.
In the long run, riskier investments should return more and that higher growth rate also decreases the chances of running out of money. You still need to be able to weather the ups and downs psychologically, which is easier said than done and does lead real people even if it’s suboptimal to hold cash. There was a recent paper by Scott Sederberg who’s been on the Roush Reminder podcast a few times and his co-authors that looked at asset allocation in retirement using returns based on long-term data from markets all around the world.
They use this thing called a bootstrap simulation. You can listen to Scott’s episodes on the Rational Reminder if you want to hear the details about that. Basically, you have this huge data set and run a whole bunch of potential scenarios.
They do find in one of their specifications, an optimal allocation with 27% in treasury bills at retirement, reducing to 0% over roughly the first five years of the retirement period. That is interesting. The advantage of that allocation, so you’re all equity up until retirement, then 27% in bills, decreasing to zero over the first five years roughly.
The advantage of that allocation relative to staying 100% in stocks was minor in the numbers, but I can imagine that the psychological benefits would be significant. Holding something safe like treasuries or bonds over the very long term may be risky due to inflation risk, but over a short period, at least in that paper, it shows that it could be useful.
[Dr. Mark Soth] (55:33 – 57:56) Pulling sequence risk looks really good if you happen to be living through a period of low returns, but it also means that a period of high returns will not result in anywhere near the same benefits if you’re investing on your own and you stay aggressive. Some pensions might be more liberal with cost of living adjustments with performance is good, and this is something to bear in mind as well. Even though they don’t have the fluctuates up and down directly with the market, like we’d see with an individual, the decisions that they make as a pension board, a cost of living adjustments and increasing benefits can be impacted by what the markets are doing.
It won’t come close to the benefits of owning the assets directly if you have a big period where the markets are doing great. There’s a cost to that. The other big risk that group defined benefit pension plans mitigate is longevity risk.
Mortality Risk Pooling So that’s the risk of living for a long time, and that may seem like a weird thing to call a risk, and since living a long time and a healthy life is something that most people want, but the reality is that if you live longer than planned, it could put a strain on your finances. Group defined benefit pensions and annuities solve for this by pooling mortalities together. So in simple terms, people who die earlier than expected contribute to funding the benefits of people who live longer than expected, and this becomes an important consideration deciding whether to use an RRSP or an IPP versus a group pension plan like an MEPP.
With a DB group pension plan, when the beneficiaries die, there may be some death benefit or survivor benefit, but typically, you’re going to be taking a loss overall, and that loss is going to help fund the surviving people in the pool. If you have a larger portfolio, then you could reasonably outspend or outlive. Then not only are sequence and mortality risks of less concern, but you’re also more likely to have excess funds when you die, and if there are excess funds in an RRSP when you die, they form part of your estate unless you’ve been able to give it directly to a designated beneficiary.
If there’s excess funds in an IPP, they stay within the IPP to be dispersed to beneficiaries, but with a group pension plan, you’re sharing risks with the group, which can end up being a benefit or a cost depending on when you die relative to what the group is doing.
[Benjamin Felix] (57:57 – 58:40) I think a clean way to sum all that up, we talked about sequence of returns risk, we talked about mortality or longevity risk. One useful perspective to wrap that up is that in the group defined benefit pension schemes, you’re going to get exposure to different risks that you can’t access alone. You’re able to hedge risks in a way that you can’t do very easily as an individual, and instead, you’re taking different risks like in the example you just gave, Mark, if you die early, well, that was a risk.
If you live for a long time, then that risk pays off. Then likewise, for sequence risk, if you get a bad sequence, well, you’ll be very happy that you’re in a pension plan. If you get a good sequence, you might have done better individually, but you’re getting this protection from risks that are really hard to protect from as an individual.
[Dr. Mark Soth] (58:41 – 59:59) That’s one of the things. If you’re considering the multi-employer pension plan flavor of group pensions, how much you pay for the benefit and mitigating those risks is important because what value does that have for you? That has to be compared against your baseline investing strategy, how much wiggle room for flexibility in spending or variable investment returns you have.
That could have factored or decided because whether that’s a risk for you or not helps influence whether it’s worth mitigating or not. Whether using an MEPP, IPP, RRSP, or some combination of your retirement plan might depend on those. The lure of an MEPP is stability and predictability.
That, to me, is the big lure. Best performance net of fees and a track record of how they handle different markets is important. It’s very pension-specific and a personal preference-based decision.
It’s not just about the numbers. I did write a couple of articles on the Bloody Doctor about that in the context of Medicus and Hoop where I look at some of the numbers and some of the track record of those pensions plans. Now, we’re going to focus in now on the IDPs in this episode, but I did want to mention that because I know it’s a common question amongst the doctor segment of our audience.
These pensions get to quite frequently.
[Benjamin Felix] (1:00:00 – 1:02:09) I think we will do a case episode to pair with this episode where we do dig more into those plans and talk about the work that you’ve done there, Mark. On drawdown, the pension benefits, if you have a defined benefit pension, there’s obviously going to be less flexibility with the benefit if you remain in the pension plan. The benefit is defined.
That’s the whole point. However, there can be adjustments made for inflation, bridging with CPP and OAS, or if the beneficiary dies and the pension has a survivor benefit, those types of details are going to be up to the discretion of the pension administrators and they may or likely will come at a cost if they’re selected as part of the pension benefit. If you have a survivor benefit versus not, your base pension benefit would be lower to accommodate that.
There can also be maximums to the annual benefits. With a registered pension for income earned after 1992, there is a benefit maximum for defined benefit plans. It is 2% of earned income per year of service indexed to inflation and prorated for partial years.
There’s also a maximum that is set each year. That limit comes out alongside the RRSP and RPP contribution maximums from CRA each year. For example, the DB max, the defined benefit maximum for 2025 is $3,757.
If I earned more than $187,834 this year, it would still only add $3,757 per year indexed to inflation for the ultimate pension benefit in the future. For an employee earning above that amount, a retirement compensation agreement or an RCA could be used to provide a higher level of retirement income. Now, that’s an entirely different structure that we will come back to in some detail later.
The DB maximum is designed to provide an actuarial equivalent for the DB plan to the RRSP or defined contribution plan. For example, if somebody earning $200,000 maxes out an RRSP from age 25 to 65 and somebody earning $200,000 maxes out a DB plan from age 25 to 65, both should retire based on the actuarial assumptions with similar pools to fund their retirement. Now, the RRSP contributor is going to have a smooth line and the DB contributor will have an upward sloping line.
[Dr. Mark Soth] (1:02:10 – 1:05:40)Let’s dig into the individual pension plans or IPPs. There’s two types of IPPs. There’s a designated individual pension plan, which is most commonly used by self-employed individuals or small business owners.
As a defined benefit pension where either of the following is true, either has fewer than four members throughout the year or 50% or more of the total pension credits in a given year are allocated to specified individuals. A specified individual is someone who’s either connected to the employer such as owning 10% or more of the corporation or being a related person or someone whose annual remuneration exceeds two and a half times the year’s maximum pensional earnings. Designated IPPs are subject to stricter funding restrictions than non-designated IPPs.
That’s in order to limit excessive tax deferred savings for owner managers and high income individuals. So if you’re in control of things, they don’t want you to have an excessive benefit. Technically, you could have either a defined contribution or a defined benefit IPP.
However, the main benefit of using an IPP as an incorporated business owner is as a defined benefit pension. Otherwise, you could likely simply use an RRSP with more flexibility and less costs associated with it. Now we will come back to the idea of a defined contribution IPP later on.
There are a number of features of defined benefit pensions that allow a corporation owner to shift more money from the tax exposed corporation into the fully tax deferred compared to using an RRSP. And that’s really the big benefit of using these pensions is trying to take tax exposed money from the corporation, shifting it to tax deferred growth within a pension plan. Now there’s several mechanisms to do that.
So we’ll tackle them one at a time. We’ve already mentioned this a couple of times, but one of the most obvious ones is the contribution room of a defined benefit pension versus an RRSP. And if you have a defined benefit IPP, instead of having just an annual amount that set each year, like 18% of earned income up to a maximum like it is with an RRSP or a DC pension, it’s actually determined by an actuarial calculation.
The actuarial calculation looks at how much is in the pension, how much is needed to meet the defined benefit obligation that will be impacted by things such as your age. So how close you are retirement, your life expectancy, expected market returns, contributions that you’ve made. And none of those things are static.
It is required at least every three years to reset things and reevaluate things. Now we’re not going to go into the details of those calculations. You really require an actuary to do them and they’re complicated.
But the important point is that the numbers generally work out such that the annual contribution limit for an IPP becomes larger than an RRSP contribution limit somewhere around the age of 38. Now IPP pension structures do come with added costs. There’s the costs of running the pension, there’s the actuarial costs.
And when you account for those costs, an IDP becomes potentially beneficial in terms of the added contribution room somewhere after the age of 40. And that’s assuming actuarial costs of $2,000 per year on average. Now those costs are also deductible against corporate income, so it’s all pre-tax money.
[Benjamin Felix] (1:05:40 – 1:07:30) As you get older, the contributions required for a defined benefit pension do increase. So the difference between an IPP and an RRSP widens over time, which increases the defined benefit IPP room advantage over the RRSP. So for example, in the model used for our IPP optimal compensation white paper, an IPP owner would be able to contribute about $38,000 per year by age 50 versus $32,000 per year for an RRSP.
And by age 60, it’s $46,000 per year while the max RRSP room would stay the same. It doesn’t generally make sense to have a defined benefit IPP before age 40. The benefit of increased contribution room does grow fast after that though.
Before age 40, you would use the room generated from T4 income to contribute to an RRSP. And that gets you the deduction and the tax deferred investments growing. If you start an IPP later, you can transfer from the RRSP into the IPP through a past service pension buyback.
Past Service Buy-Back It is worth noting that for someone currently under the age of 40 that intends on starting an IPP in the future, they may consider taking enough T4 salary income to maximize the creation of RRSP contribution room, which then maximizes the past service buyback available to them in the future. If you open up an IPP with no history of salary, then there’s no buyback, which can be one of the initial benefits of setting it up. When you set up an IPP, you do get that opportunity to buyback the previous service of the employee owner.
You have to have been collecting salary from the corporation for that to work though, as I just mentioned. For each year of previous service, you look at the salary earned and project that forward to age 65, assuming a 5.5% per year salary increase. You also determine the maximum defined benefit that salary would pay for, which is 2% of projected salary at age 65 using that 5.5% per year raise. This is quite generous.
[Dr. Mark Soth] (1:07:31 – 1:09:16) I don’t think most of us get 5.5% per year raises. That benefit calculation is still up to a maximum though. As mentioned earlier, CRA sets a maximum benefit per year of service.
For example, 37.57 for 2025 that you mentioned earlier. That maximum also increases at that 5.5% per year projected rate into the future for purposes of the calculation. With those generous calculations, it is pretty common that a large amount of dollars can be used for previous service buyback.
That comes from two sources. You transfer money from an existing RRSP into the IPP to buyback some of that service. The difference between that and the buyback amount is topped up using corporate dollars.
That corporate top-up expense is a deduction against corporate income. So that is functionally a shift of corporate pre-tax dollars into the IPP. So it’s definitely a good bet.
To figure out how much of the buyback comes from RRSP transfer is another calculation. Basically, it is the larger amount of two calculation options. One option is how much you would have been able to contribute to a DC pension.
That’s that 18% of T4 income up to the current year’s maximum. The other option takes how many years you’ve been employed by your corporation divided by your number of working age years, which is your age minus 18. It’s entering the workforce in 18.
How many years have you been working? That proportion of your working life is then spent. The corporation is multiplied against your RRSP’s current value plus any unused contribution.
So there’s a couple of factors that come into play there. How does that complex general play out?
[Benjamin Felix] (1:09:16 – 1:09:38) To generalize, if you had barely taken any salary from the corporation, then the amount of past service buyback decreases. It’s a function of both the salary amount and the number of years of salary paid. The ratio of the buyback in terms of RRSP to corporate dollars is going to be dependent on the value of the RRSP.
So, the lower the RRSP value, the lower the qualifying transfer and the higher the corporate contribution.
[Dr. Mark Soth] (1:09:39 – 1:11:27) One of the interesting nuances that I came across when considering an IPP for our situation is with spouses. Your spouse, as long as they are an employee of the corporation and get paid a salary for that work, can also be a member of your IPP. And the other competing interest is spousal RRSP.
So, a spousal RRSP, if you’d use that, will be included in your spouse’s RRSP balance for determining the spouse’s RRSP qualifying transfer amount. If you’re using a spousal RRSP and not including them in the corporate ITP, then there could be impacts. This could be good or bad, depending on how much the owner-operator has in their personal RRSP.
They’ll have less in their personal RRSP than they could have had because they’ve put some of that money into a spousal RRSP instead. However, if the contributions plus growth are not enough to meet the 18% of each year’s income threshold, then it limits the buyback amount that’s possible. That’s undesirable.
However, if it is enough, but less than what you have otherwise have had, you’ve gotten over that 18% year contribution threshold, but it’s not as much as you would have had because you invest some of that money in a spousal RRSP, then that means more of the buyback will come from corporate money functionally shifting more of that tax-exposed corporate money into the tax shelter, which again is desirable. So it could go either way.
If including a spouse employee in the IPP, it probably doesn’t matter all that much more of their RRSP total is used and less of yours. It’s shifting from one to the other. If not, and using a spousal RRSP and making sure that your personal RRSP has enough growth in it to make up for the redirection of money to that spousal RRSP could be important if you’re ultimately planning on using an IPP.
[Benjamin Felix] (1:11:27 – 1:12:57) It is worth mentioning that the past service buyback is optional and you can choose how many years to purchase, especially in cases where the RRSP value is high and therefore the qualifying transfer is high and the corporate contribution is low. It may actually not be worthwhile to buy back past service and effectively transfer money from the more flexible RRSP tax shelter to the less flexible IPP tax shelter. We mentioned earlier that an actuarial calculation needs to be redone at least every three years because of the different moving parts that determine how well a defined benefit plan can meet its obligations.
One of the major unpredictable variables is how well investments are performing relative to expectations. The expected benchmark performance is the realized wage inflation plus 2%. The Income Tax Act uses 5.5% per year wage inflation for service buyback, so it’s a common misconception that the benchmark is 7.5% per year. If wage inflation is lower than 5.5% per year, as it has been over the past decade, then the benchmark is actually lower than 7.5% per year. That may change with recent wage gains in the post-COVID period. When the actual value is compared against what it should be based on the benchmark return, there are three possible outcomes.
If the actual value of the pension is within 100% to 125% of the predicted value, contributions continue as normal based on things like age. If it is higher than a contribution holiday is required and if the pension value is lower than predicted by that model, then an optional top-up is allowed.
[Dr. Mark Soth] (1:12:57 – 1:14:38) So, if the IPP’s value is more than 25% higher than predicted, then it’s required to take a contribution holiday. No further contributions can be made until its value drops to that range. For example, if the benchmark calculation predicts an IPP of $100,000 and its actual value is $135,000, that actually doesn’t mean that no contribution to be made.
It means that the contribution for that year must be reduced by $10,000 to bring it back to that $125,000 boundary. So if you were allowed a $40,000 contribution based on your age, that would mean a $30,000 contribution instead. Now that is less than the RRSP and it blunts the IPP contribution advantage for that year, but it’s not an all-or-nothing event.
If the IPP outperformance is large though, it could mean no contribution at all for that year, or even for a few years. This is why it’s termed a contribution holiday. Since you are trying to shift money from your corporation into the IPP tax shelter, it’s an undesirable holiday.
On the other end of the spectrum, if the pension value is below the benchmark due to poor returns, then the corporation can contribute extra to top it up. That helps to shift even more of that corporate money into the pension. Holidays from excess returns are forced, but top-ups are not forced, but top-ups are desirable.
You don’t need to worry about crippling your operational company trying to top up an IPP in a bad year, but if you have the opportunity to do that, it’d be a good thing.
Strategic Actuarial Evaluation [Benjamin Felix] (1:14:38 – 1:16:13) That brings up a couple of important issues when considering whether to use an IPP and if using one, how to manage it. Markets, as we all know, do not move up smoothly. They’re volatile with large fluctuations, both up and down from year to year, even from month to month, as we’ve seen in 2025.
While an actuarial calculation is required at least every three years, if there’s a major market downturn, you could strategically do one early. That would allow for a top-up to the IPP. When the markets recover, that is going to be growth within a tax shelter rather than the more tax exposed corporation.
Asset Allocation If you were to look at IPPs using a stable return each year, they would be less attractive for someone using a high equity allocation because that would be expected to outpace the benchmark return for those calculations. Because there’s a 25% overfunded allowance and top-up allowed in a three-year period of underperformance, it’s not totally symmetrical with the fluctuating markets we would see in reality. In the modeling used by the optimal compensation IPP white paper, we did using Monte Carlo simulations from random returns and PWLs expected return assumptions.
Someone with a 70% to 100% equity allocation may not have additional IPP contributions on average. If they had a 50-50 stock bond allocation in the IPP, then they would on average have more top-ups. Not having extra top-ups doesn’t nullify the IPP strategy.
Even with an all equity portfolio, there are still opportunities for service buyback, higher regular contributions and terminal funding payments to shelter more money. It does impact the magnitude of the advantage.
Asset Location [Dr. Mark Soth] (1:16:13 – 1:16:42) The other issue that comes up and I know you’re not a fan of asset location, which is trying to match investments differently to different accounts to optimize the taxes across that. With the added boost of an IPP and the ability to top-up more to an IPP perhaps be something that makes it worthwhile to target more bonds to an IPP and equity elsewhere to try to have those lower returns in your IPP and allowing you to do more of those top-ups.
[Benjamin Felix] (1:16:42 – 1:18:36) I wouldn’t say I’m not a fan of asset allocation. It’s just that it’s been hard to find really airtight use cases for it. To your point though, this could be one of them.
Asset location is really hard to model. It’s even harder when you account for the fact that uncertainty of future returns can blow up what would have otherwise been an optimal asset location strategy. We can only build an optimal asset location strategy based on assumptions about what future returns will be.
If future returns are different from that, it could end up being worse than if we had just kept the same asset mix across all accounts. Now in the case of IPPs, the fact that lower realized returns, which we expect to get from assets like bonds, does mean more opportunities for tax efficient transfers from the corporation to the IPP. I think it does make asset location extra interesting in this case.
Now to your point, one of the challenges with asset location is that when you don’t have the same asset mix in all of your account types, you do need to be aware of your after tax asset allocation, which is what economically actually matters to you. The embedded tax liability in an IPP or in a corporation should be netted out of the asset value to determine what your after tax allocation is. Now if that’s not done, your exposure to the underlying assets may be much lower than your account values actually suggest, leading to a potentially off target asset allocations.
If you put all your fixed income in the IPP and don’t account for the embedded tax liability, you could end up with a much riskier asset allocation than it appears to be when you just look at your account values, which interestingly could actually be a good thing because increasing your expected returns may not be so bad, but it’s just important to be aware of that implication. We did find in our IPP paper that IPP strategies were most advantageous for people with low risk tolerances or relatively conservative asset allocations because the lower expected returns of those portfolios were more likely to trail that prescribed growth rate, allowing for those tax beneficial top up contributions.
[Dr. Mark Soth] (1:18:36 – 1:20:05) Pre-tax versus post-tax asset location, whether it’s an advantage or a disadvantage depends on If you automatically convert taxes from all your accounts in your brain every time you look at it, that’s different than if you just get scared by surface numbers, it may not be the same impact on what you’re trying to achieve. There’s often another episode. So back to the IPPs, the other way that we can get money in there is with terminal funding.
And this is the third way that you can shift extra from your corporation into the IPP, and that’s terminal funding at retirement. This is optional, but the corporation can make a lump sum contribution to the IPP. Without terminal funding, a defined benefit pension plan for someone retiring at the age of 65 would be indexed to inflation as measured by CPI minus 1%.
So, it doesn’t quite match inflation. As a default, there’d be a gradual erosion of buying power. What terminal funding does is it juices up the IPP so that the benefit could be fully indexed to inflation for those retiring earlier than 65.
The terminal funding allows for no reduction of benefits and merged benefits as well. So this could be a way of putting more money in there into that IPP. The amount of terminal funding allowed is calculated again using a formula that uses the amount of the benefit based on the contributions each year.
So, a larger benefit for more contributions will allow for a larger terminal funding lump payment on top of that.
[Benjamin Felix] (1:20:05 – 1:22:38) There is an enhanced annuity factor for the enhanced benefits and a regular annuity factor. The difference between those is multiplied by the benefit. The amount of terminal funding, it can be very large.
For example, when a 65-year-old retires, the difference between the enhanced and regular benefit factors is about 10.7. So for an IPP benefit of $100,000, much lower than the maximum, the IPP could have a little over a million dollars paid as a lump sum by the corporation into the IPP as a terminal funding top up. A practical consideration here is that to maximize the corporate tax deduction, there needs to actually be active business income in the corporation to deduct against. Passive income is a bit of a gray area in terms of tax deductibility here.
So it might make sense to consider starting the IPP benefit a year or two prior to retirement if terminal funding is going to be purchased. That deduction can be spread out over a few years. The annuity factor differential does change over time, but a terminal funding is somewhat neutral between the ages of 50 to 71.
It does grow with age, but generally not by an amount that would materially change most retirement plans. Terminal funding is typically done as soon as the extra corporate deductions are desired. Someone under age 65 benefits from the higher annuity factor differential, but it’s going to be applied to a lower pension.
They have lower total assets by foregoing the regular funding that would have occurred up to age 71, but they’ll also be drawing down the assets more slowly due to the lower pension amount. Someone very young, for example, under age 55 would often see the smallest terminal funding amount, but their pension would likely be a very small drawdown on the assets each year. The smaller terminal funding amount would therefore recoup the value based on the long-term growth during their extended retirement.
Terminal funding does typically grow with age. Someone over 65 benefits from a higher pension amount, but the annuity factor differential diminishes with age. They have maximized the registered assets by continuing to accrue and fund benefits into their late 60s.
They’ll also be drawing down the assets at a higher rate due to the larger accrued pension at the later ages. The higher terminal funding amount for a later age may be partially or entirely offset by the delay in funding it and the higher pension drawdown. Terminal funding also depends on bond rates.
During periods of low bond rates, terminal funding room can increase pretty substantially. Terminal funding can be really valuable. It can be a big number that you get to add to the IPP, but as with all of the IPP components, it’s a fairly complex calculation and it would be an actuary telling you what the terminal funding amount is.
[Dr. Mark Soth] (1:22:39 – 1:22:57) From a planning standpoint, if I were to put that together, I think, okay, well, I want to wait as long as I can for the terminal funding to make it as big a number as possible, but do it early enough that I can take the deduction and apply it against my active business income and fully use that deduction before I actually retire.
[Benjamin Felix] (1:22:58 – 1:24:02) Yeah, that’s exactly right. As we talked about in some past episodes, I don’t remember which one specifically, but the idea of being very aware of what your financial plan is, so that you can action things like that appropriately is really important. It’s not the kind of thing that you can be like, “okay, well, I’m going to retire now.”
Let’s make this happen. If you knew that you’re going to retire, you probably would have planned differently for the reason that you just said. We’ve covered how an IPP can allow an incorporated business owner to shift more money from the corporation into a pension tax shelter relative to something like an RRSP.
The next question though, is what to do with the IPP in retirement. The three main options are to continue with the IPP. That particularly makes sense if you’re semi-retired or if the business is a going concern with family members, for example.
Use it to buy an annuity or commute the IPP, which means take the commuted value or the dollar value of the pension out instead of receiving the defined benefit. Closing down the pension basically and moving the value to a combination of registered accounts and potentially a taxable account depending on the size of the IPP.
[Dr. Mark Soth] (1:24:03 – 1:25:39) Let’s start first with the option of keeping an IPP in retirement. One of the advantages of an IPP besides being able to shift tax exposed investment income in a corporation to the tax deferred investment in a pension is getting regular pension benefits. Some people struggle to sell assets and pay it out from their accounts to spend.
Psychologically, it’s often tough to switch from the accumulation to the decumulation phase. People also bulk at paying tax on their tax deferred investments, so they can struggle with that. A DB or defined benefit IPP forces the issue by requiring regular benefit payments.
So, if you struggle with getting yourself money to spend and you’ve got more than enough, this could be a way of helping force you to take money out and spend it more smoothly over your retirement. And if you have way more than enough for your retirement, this could be something that’s helpful, forcing you to smooth out that consumption. Spend more, give more while you’re alive.
If you retire early and draw from an IPP, the income could be eligible for the pension splitting with a spouse as early as age 50. So, that’s much earlier than age 65 with an RRIF. Although you could plan using a spousal RRSP as an alternative, but if you haven’t, then an IPP is a way to do that.
Another advantage of an IPP in retirement is if there’s ongoing active income, for example, you’re partially retired. In that case, the corporation could continue to make contributions to the IPP, increasing the chance that it will last for the full retirement and getting those deductions at the same time. That also alludes to one of the potential disadvantages of an IPP.
[Benjamin Felix] (1:25:40 – 1:29:55) In a group pension plan, there are participants contributing while others withdraw and the sequence of returns risk is dispersed among the group as we talked about in some detail earlier. With an IPP, the beneficiary bears the risk of an unlucky sequence of returns and running down the IPP faster than anticipated. One way to shift that risk would be to use the IPP to buy an annuity.
That is another possibility with IPP assets in retirement is purchasing an annuity from an insurance company. This makes the assets pension-like, but a lot of people struggle with annuities. This is known as the annuity puzzle.
Annuities are theoretically optimal in financial plans, but not used nearly as much as theory would predict. An annuity does solve sequence of returns risk protection, sort of, to an extent, and does offer mortality pooling. If you live for a very long time, annuities will tend to look really good, but there are not inflation-indexed annuities for sale in Canada, which is why I said they sort of solve the sequence of returns risk problem.
They solve it in nominal terms, but not in real terms, and that can actually make an annuity benefit fairly risky at very long horizons, depending on the inflation outcome that we happen to get. The next option that we mentioned is commuting the IPP. The downside of maintaining an IPP during retirement is that the corporation has to continue to pay for the management costs of the structure.
Actuarial calculations at least every three years is a big one. Also, if you would normally DIY invest your RRSP using ETFs and are using a financial advisor for the IPP, which is typically a requirement, that would be another ongoing cost, paying that advisor fee for that account. If you’re no longer using the IPP to shift assets out of the corporation, which is its main benefit, it can make sense to close down the IPP and save on maintenance costs.
Now, that involves commuting the value. When you’re commuting an IPP, a defined benefit IPP, some of it can be transferred directly to an RRSP on a tax-deferred basis. You’d then have the usual control and low cost that an RRSP offers.
The maximum amount of an IPP that can be transferred this way is the value of the defined benefit multiplied by the RRSP max transfer factor, which is age-dependent. It’s 12.4 at age 65 and age 64, but lower at younger and older ages. For example, a 65-year-old with $100,000 defined benefit and no enhancements, the amount that could be transferred to the RRSP would be 1.24 million. That is 100,000 times the 12.4 max transfer factor. If the IPP is fully funded for that benefit, it may have $1.45 million in it. That means the difference of about $210,000 would come out as taxable income in that example.
That highlights the importance of planning your compensation from your corporation in conjunction with commuting an IPP. If you draw no other corporate income that calendar year, it would be less tax than if you were paying yourself normally and then piled that taxable portion of commuting the IPP on top of that. There still would be an initial tax hit even if you plan for it.
The subsequent savings from not having to maintain the IPP may potentially make up for that in the long run. That again ties back to the importance of linking all of this stuff up with a broader financial plan. After we recorded this episode, Mark and I both attended a session with an actuary on the topic of IPPs.
We talked about RCAs as well. We ended up picking up some further context that we wanted to add to this episode, because it could change the way people think about IPPs in certain cases. We had said during our initial recording that IPP assets are commuted to an RSP.
That is true for the type of business owner IPPs that we’re discussing in this episode in Ontario specifically. It’s a little bit more complicated when we look across other provinces. We just wanted to add that context to this episode for completeness.
CRA prescribes the maximum amount of defined benefit pension assets that can be transferred to an RRSP. CRA broadly defines it as an RRSP, but the provinces and federal regulator enforce various locking in restrictions on pension funds. That means that in some cases, it’s necessary to have the money go into a lira or a locked in RRSP.
Jurisdiction has different rules for the locking and unlocking of pension funds.
[Dr. Mark Soth] (1:29:56 – 1:31:50) The main implication of that would be that sometimes if it’s in a lira, you’d have to wait a bit longer to access it. When you do access it, there is that upper limit on how much you can take in a year. For someone who’s retiring and accessing it at a regular timeframe and trying to smoothly draw it down over their lifetime, it probably wouldn’t have that much of an impact.
But the best way to illustrate this is with a few examples. Looking at Ontario, business owner IPPs that are exempted from the registration. Those would be new plans set up after 2020 or existing plans prior to 2021 that elected to become exempted.
They’re not subject to any lock-in rules. That would probably be a lot of small business owners because it gives you that flexibility about contributing versus not. The prescribed portion of the commutative value can be transferred to a regular RRSP or be paid in cash depending on the calculations.
Non-exempt pensions would require transfer to the lira. But there is also 50% unlocking available on conversion from the lira to a life income fund. That’s when you switch over to start drawing the money out.
In other words, half of the lira balance can be transferred to a regular RRIF and then half to the LIF. Now in BC, all plans are subject to locking in. So this is different.
The prescribed portion of the commutative value would be transferred to a lira and be remained locked in and then convert to a life income fund when you get a bit older. Alberta, again, all plans are subject to locking in and the prescribed portion of the commutative value be transferred to a lira. In this case, 50% of the unlocking is available to life income fund and you can put half of it into an RRIF when you make that conversion later on.
[Benjamin Felix] (1:31:51 – 1:32:52) Lots of complexity. In Quebec, IPPs for connected persons are exempt from locking in. The prescribed portion of the cash value in that case goes into an RRSP, very similar to Ontario in that case.
The other thing to note though is that provinces have other exceptions for the locking in rules for pension assets. For example, in cases of non-residency, shortened life expectancy, financial hardship or small benefit amounts. For example, in Ontario, if you have a very small lira, you can typically unlock it under those small benefit provisions.
To wrap up on this little addendum that we wanted to add in here, CRA always considers the pension asset to go into an RRSP account, but it’s the province that defines whether the asset goes into a lira or locked in RRSP or RRSP and the associated restrictions that would come with that. This makes it really important and this is why we wanted to add this piece in here. It makes it really important as is often true in financial planning to understand how an IPP fits into your specific situation.
[Dr. Mark Soth] (1:32:52 – 1:34:41) The best option of what to do with an IPP upon retirement depends on the situation and preferences. A business that continues earning active income either through semi-retirement or a family business that is continuing on after one of the retirees will likely maintain the IPP to continue to benefit from shifting money into it from the corporation. It also depends on how well-funded the IPP is.
Someone with an underfunded IPP may want to commute it to an RRSP. Someone with a well-funded IPP but looking to transfer some risks and get a predictable retirement income stream may want to use it to buy an annuity. That of course needs to be considered in the context of their other sources of retirement income, all their different investment accounts and their personal preferences.
Timing may also be important. If you plan to commute an IPP, its value will decrease as you draw upon it in retirement, decreasing the tax liability of commuting it. A market drawdown could also do that and that could be an opportunity to keep the pension.
Proper planning and adaptation is important. Now the other thing to talk about is what happens with IPPs on death. One of the interesting aspects of pension plan assets that’s distinct from RRSP assets is that upon the death of the second spouse, any remaining assets can be attributed to beneficiaries rather than the deceased person’s estate.
In some cases, this can have meaningful estate planning benefits. In cases where there is a multi-generational employment situation in the business, multiple family members could join the IPP, allowing the plan to persist even on the death of some of the plan members. In that case, the family is able to benefit from something like mortality pooling while also deferring the tax liability as a whole family unit, so even for a longer period of time.
[Benjamin Felix] (1:34:42 – 1:35:40) Definitely some interesting estate planning components of the IPP. The big question for listeners is whether an IPP is worth it versus just using an RRSP. Fundamentally, that is the trade-off you’re making.
If you’re deciding, hey, I think I might set up an IPP using an RRSP would be the alternative. How do you figure out whether it’s worth it? That was one of the core, if not the core question from the PWL white paper that Braden Warwick and I wrote a couple of years ago.
It seems like a simple question. We’ve covered a lot of the potential advantages of an IPP, but it’s actually really complex to answer. Using an IPP requires taking salary.
How much salary usage for an incorporated business owner is optimal depends on their income, spending, which province the corporation resides in, and its passive investment income. This is all stuff we’ve talked about in our optimal compensation episode. You have to ask that IPP question while also using an optimal compensation algorithm.
Those two things end up working together to determine what is actually optimal for that situation.
[Dr. Mark Soth] (1:35:41 – 1:36:14) Yeah. It’s kind of like when we do a medical trial, the baseline has to be what the best standard care procedure is. We went through that optimal compensation algorithm in episode 13, which would be kind of like your baseline optimal situation.
Some of the nuances that we unearthed there have since been added to your updated algorithm since the one used in the white paper as well. We did that episode after the white paper. The other point that the white paper is that it was done in Ontario, which has this wrinkle, which may favor some dividend usage when the corporation has a lot of passive income over that passive income threshold.
[Benjamin Felix] (1:36:15 – 1:39:00) We model this for clients. I’ve talked to actuaries about this too, who also have interesting perspectives and they tend to agree with what I’m about to say. When we model it out, setting up an IPP is not always the sensible choice.
It’s really important because, in many cases, when someone’s presented with an IPP as an option, it’ll be compared to the RRSP alternative based on the amount of additional contribution you get with the IPP. You could have this much money in an IPP by age 65 or age 60 versus what you would alternatively have in an RRSP. That doesn’t actually tell you how much better off you are overall because money is still invested in the corporation and tax efficiency of withdrawals from different types of income sources are also going to affect what’s actually optimal.
For the IPP to make sense, there needs to be the right combination of factors. I’m going to generalize a little bit here. If a corp has large notional account balances that need to be drawn down, IPPs probably won’t look great.
If the business owner has really high spending and the corporation has low notional account balances or low investment assets to start with, IPPs start to look really good because the business owner is taking a high salary anyway, back to that optimal compensation tie-in, which is a prerequisite for IPP room to fund their expenses. The issue of consumption in corporate notional accounts can carry on into retirement, too. An IPP requires a larger benefit payout than the RRIF minimum.
Sometimes, it may make sense to commute the IPP, even though that is a taxable event, to give more opportunity to use dividends for clearing notional accounts. Other times, it may make sense to keep the IPP in place. I think that in the right cases, the benefits of the IPP can be material and we’ve shown that in our modeling, but it doesn’t always make sense and it’s definitely not a decision to take lightly or be made without the proper analysis.
I do want to mention a product that’s often pitched to incorporated business owners, which is the PPP or the Personal Pension Plan. There are other similar plans like the FPP, the Family Pension Plan and the CPPP, the Canadian Physician’s Pension Plan. It’s important to understand that under the hood, these are all fundamentally IPPs.
IPPs exist in legislation. All of these other terms, the PPP and the CPPP are marketing terms for different ways to use the IPP structure. I just think it’s important for consumers to understand that any IPP can be structured the same way as those branded products if you wanted them to be.
Those are examples where they’ll differ on how it’s implemented or what type of investments are offered inside of it, but fundamentally, they’re still IPPs. There are two phases where marketers of these products claim that they’re advantageous, the pre-age 40 phase and the post-age 40 phase. Both cases involve switching between the defined benefit and defined contribution components of an IPP to claim an advantage.
[Dr. Mark Soth] (1:39:01 – 1:40:11) Before the age of 40, one of the benefits of a PPP or an RRSP would be that you get to double up contributions in that first year. That’s gains due to the way that room is calculated. You can make an RRSP contribution based on last year’s room and a pension contribution based on this year’s MP limit because it’s always staggered by one year.
You can also contribute at the money purchase limit each year instead of the RRSP dollar limit, which is a year ahead. That allows you to put a little bit more in faster. The problem with this idea is that any of the benefits of doing that are probably eaten up by the higher cost of setting up and maintaining an IPP relative to simply using an RRSP.
These offset any early investing benefit, most likely using the DC option before the age of 40. That might offer roughly an additional $200 to $1,600 a year in annual deductible contribution relative to the RRSP, depending on how much the limits are rising each year. But if you’re paying an extra $1,500 or so in fees to access that benefit, that may be more than the benefit of putting a bit of extra money into the tax shelter.
[Benjamin Felix] (1:40:11 – 1:43:46) After age 40, the other time period where a benefit is claimed of these different branded strategies is supposed to be the ability to make contributions by switching to the defined benefit contribution plan if the IPP is in a surplus position that would otherwise preclude further contributions. That’s the contribution holiday that we talked about earlier. The problem is that in this case, the DC plan would be 1% employer and 17% employee contributions, but the 1% employer contribution isn’t allowed due to the overfunding.
You can only contribute 17% of your income. In this case, it would be better to not have the DC component, stop the IPP and switch to an RRSP to contribute 18% of your income. Another component of this is the idea of a family IPP.
A family IPP involves having multiple family members join the pension plan. This can have significant tax and estate planning benefits. It’s a complex undertaking.
It has to be the right fit for the business. The children should be legitimate employees of the sponsoring company. The family should all unanimously agree to a pooled retirement pension plan and all of the trade-offs that we’ve talked about throughout this episode.
It becomes pretty complex to disentangle if there is a breakdown of the generational relationship or if there’s a divorce of one of the family members, which could expose the assets of the entire structure to the division of marital assets for that separation. The longevity of the parents could exhaust the pension assets if the company experiences financial hardship and can’t fund the plan. It’s an idea that can make sense, the family IPP.
I do think it’s something that has to be approached with caution. It’s not something that we see much of at PWL. Last thing I want to talk about is the contribution versus benefit timing for IPPs, MEPPs.
MEPPs typically have a flat funding rate like an RRSP. That’s usually around 18%, which means a 62-year-old and a 45-year-old with the same earnings fund the same amount into the MEPP to receive the same pension. However, the pension is payable 17 years later for the 45-year-old than it is for the 62-year-old, which is partially offset if the pension is indexed each year up to retirement, usually by wage inflation.
In general, the earlier commencement of payment of the pension makes the MEPP more valuable for the 62-year-old than for the 45-year-old. MEPPs with a fixed contribution rate rely on younger participants to subsidize older participants. IPPs in contrast, that are funded appropriately based on age and the IPP member owns all of the assets.
There’s no clear gain or loss based solely on the age of the contributing member. A 45-year-old makes a smaller IPP contribution than a 62-year-old but has a longer horizon for tax deferred growth on their deposit. The other impact of age on both the IPP and EPP is when the value of the pension becomes more valuable than an RRSP.
For IPPs, this is typically sometime between age 40 and 50. You can see it in the amount of IPP contribution room. For an MEPP, it’s less clear when that happens since the participant is exchanging their money for guaranteed pension income at retirement.
The point where the MEPP benefit becomes more valuable than an RRSP will only be clear in hindsight based on what the participant receives out of the MEPP during retirement up to their death. Assuming average life expectancy, the MEPP probably becomes more valuable than an RRSP sometime between age 40 and 50. The MEPP pension will generally be smaller than an IPP pension but it’s also funded at a lower rate during the prime ages between 50 and 70.
[Dr. Mark Soth] (1:43:46 – 1:46:46) One of the challenges that you have when you’re trying to compare things like an MEPP to an RRSP is that you also have to remember, you’re comparing it to how you would otherwise be invested personally too. If you invest and earn a high rate of return in your RRSP, then an MEPP is going to have a harder time competing with that. If you’re a conservative investor or you have a high fee structure that you’re investing in so your returns are going to be lower when you’re doing it on your own, then your lower returns would make an MEPP look very attractive sooner.
I think it’s partly the pension itself but also what would you otherwise be doing and how would that be performing. That brings us to one of the final things to talk about which is this retirement compensation arrangement or an RCA. We mentioned this a couple times throughout the episode but another potential vehicle for business owners is a retirement compensation arrangement or an RCA.
The one limitation of a pension is that the maximum amount of retirement income they can pay per year of previous services capped by legislation. That thereby limits the amount of employment earnings that can then generate a pension benefit. Most recently this earnings maximum is around $188,000 a year based on a 2% per year benefit.
Now for employees that are earning more T4 income than that, the RCA is an option to have more retirement income paid out each year above that amount. Now the amount that can be paid out has to be considered reasonable but there’s not a legislated limit like there is with a pension. This may be beneficial for a high-income employee and a large business to have a larger retirement compensation package.
Whether it’s helpful to an incorporated owner of a small business or they actually control being paid using dividends from the corporation during retirement I think is much more debatable. The way that an RCA works is that it’s a trust. Contributions are made from the employer and or the employee and the trust acts as a custodian for those funds and they would be distributed later on to the beneficiary, the employee during retirement or when they are no longer employed.
Now the details of that would be set out in a formal trust agreement. Now it’s not a pension so contributions do not impact the RRSP or the IPP contribution. This is something that could be on top of it.
However, if there is a contribution to an IPP, the incremental amount that you can contribute above that to an RCA would have to be considered reasonable relative to their employees’ total salary. So, just to quote from a CRA roundtable discussion in 1998, “a normal level of benefits would be the same benefit amount provided under a registered pension plan without regard to the CRA maximum.” This would be 2% times years of service times five final year average earning or about 70% of pre-retirement income for an employee but 35 years of service.
[Benjamin Felix] (1:46:47 – 1:48:38) In contrast to an RRSP or a pension, an RCA has a mechanism to ensure that there isn’t a significant tax deferral benefit. Tax deferral in a pension, RRSP or even in a corporation leaves more upfront capital to invest and grow which is one of the benefits of those account types. The contributions to an RCA are deductible to the corporation, so the operating company has no corporate tax.
However, when you contribute to an RCA or realize a capital gain within it or receive investment income within it, a 50% tax is applied to all investment returns including capital gains with no preferential tax treatment. That 50% tax is credited to a refundable tax account. Like other notional accounts we’ve talked about, it is in nominal dollars and it does not pay interest.
The buying power of that refundable tax account is going to shrink over time in real terms. You will get it refunded as you pay money out of the RCA to the beneficiary. If retirement is a long way off, that impact could be pretty significant.
That RTA, the refundable tax account is refunded to the trust at a rate of $1 for every $2 paid out on a one-year trailing basis or when the RTA is terminated. Capital losses can be used to offset not just capital gains but also other types of income in the trust. In years where losses exceed other types of income, an application can be made to recover more refundable tax.
Also on termination of the plan, all refundable tax will be refunded to the RCA. The 50% after tax portion of RCA contributions and investment income is invested within the trust. The custodians control those investments and there would be ongoing costs of management fees and investment product fees in that case.
There are also administrative costs of maintaining the trust and filing a T3 RCA with the government each year to maintain it.
[Dr. Mark Soth] (1:48:38 – 1:49:19) Payments from an RCA, they’re taxed as other income at the regular marginal tax rate of the recipient. Taxes are withheld at source and if the RCA funds are used by an annuity and the beneficiary is also over the age of 65, then some pension splitting with a spouse may be possible. Upon death, the RCA can potentially roll over to a surviving spouse.
Death in the subsequent beneficiary or estate planning can have all sorts of nuances with this because of that structure. So it’s definitely an area to consult a tax specialist about as the trust agreement is crafted because it’s not specifically prescribed by legislation. How you set this up could have impacts down the road.
[Benjamin Felix] (1:49:20 – 1:50:40) RCA is a bit of a funny one, but putting it all together, there are some possible use cases that I can see for an incorporated business owner. They’re going to be a little bit niche though. If regular income is preferred and the business owner wants to have the asset managed at arm’s length, could make sense there.
It may have some credit protection, so if that’s important, it could be relevant there. Contributing money to an RCA could be a way to reduce the value of a corporation prior to selling it, which could matter for tax planning reasons. Another interesting one is for an offshore retirement.
If the beneficiary of the RCA is planning to retire abroad, there can be additional tax benefits. Unlike the 30% withholding on withdrawals from our RRSPs, withholding can be as low as 0% or as high as 25% for non-residents withdrawing from an RCA, depending on the tax treaty between Canada and the country that they’re in. Taxes paid to their resident country could be very low, again, depending on the country.
It could be an interesting use case there for somebody that wants to retire abroad, potentially. If the business is not really saleable, as is often the case with physicians, then it may make much more sense to just keep the money in a holding company that succeeds the professional corporation. They’d have the tax deferral of the corporation and more control over distributions as dividends.
Over the age of 65, income splitting via dividends from the corporation is also possible.
[Dr. Mark Soth] (1:50:41 – 1:52:07) The last thing that we wanted you to note before we wrap this up is that we didn’t mention whole life insurance. Whole life insurance is often pitched to fund retirement. There’s different means to use it, like insured retirement and stuff like that.
However, to do that, you have to borrow against the insurance policy. That comes with the risks of borrowing. Participating in a whole life insurance policy may be pitched as a tax-free way to grow investments.
In contrast to pensions and RRSPs, which have tax-sheltered and tax-deferred growth, it’s actually much more complex than that. The relative growth of the investments, netted the fees and taxes that can be hidden within the insurance policy, is really, really vital to make a fair comparison. It’s a completely different feast.
We’ll be doing a separate episode on insurance products as investment vehicles. We’re going to also include in that an analysis of easy-to-fund retirement spending relative to some of the other options. Great.
That brings us to our post-op debrief. In this episode, we covered pensions for Canadian business professionals and business owners. We explained the similarities and differences between registered pension plans, or RPPs, and RRSPs.
We also delineated the main ways to classify pension plans, including whether they’re defined benefit or defined contribution, and whether they’re group plans or individual plans.
[Benjamin Felix] (1:52:08 – 1:52:28) We also reminded listeners that having an employer pay for a pension plan is not really an advantage or disadvantage for self-employed people, because an employer’s contributions will come out of the worker’s pay. Instead, it’s important to focus on the specific tax, legal, and estate planning implications of using registered pension plans, which can, in some cases, be advantageous for self-employed people.
[Dr. Mark Soth] (1:52:29 – 1:52:56) The main similarities between a registered pension plan and an RRSP are their purpose, retirement, their tax treatment, tax-deferred contributions, and taxed health or shelter growth, and their contribution limits, which are overall similar, though we explored how defined benefit pension plans can have higher contribution limits after approximately the age of 40. The main differences come down to legislation, creditor protection, and liquidity.
[Benjamin Felix] (1:52:56 – 1:53:27) We were careful to caution listeners about the allure of pension style or institutional investing, which is often used as a selling point for some group pensions, but it does not hold up very well to evidence. We did go into detail on the distinct advantages of a group defined benefit pension plan, which can include sequence of returns risk and mortality risk pooling. These advantages can be a double-edged sword, however, as while they offer protection in periods of poor returns or an unexpectedly long life, they can be punitive through periods of high returns or an unexpectedly short life.
[Dr. Mark Soth] (1:53:28 – 1:53:59) We went into significant detail on the individual pension plan or IPP, as this is likely one of the most practically useful tools for corporate professionals and business owners. We detailed their contribution room advantage over RRSPs in certain cases, the ability to buy back past service in a lump sum, setting up an IPP, contribution holidays, and top-ups, which allow for flexible cashflow planning and potentially more advantageous IPP room. We covered what to do with IPP assets through retirement.
[Benjamin Felix] (1:54:00 – 1:55:01) An important point we spent a brief time on is that the IPP exists in legislation, while many branded pension plans targeting incorporated business owners and professionals, and in some cases, physicians specifically do not exist in legislation. They’re all ultimately IPPs. We also discussed the Retirement Compensation Arrangements, or RCAs, an additional planning tool for high-income professionals.
We did not talk about permanent life insurance as a pension plan because it is not a pension plan, though it is often sold as a retirement vehicle. We will, as you said, Mark, revisit that idea in a future episode. All right, that’s it.
We will do a case episode for this topic, as I think I mentioned earlier, where we’ll cover some examples, looking at the cases of Medicus and Hoop. Then we will also look at some IPP cases, highlighting one case where it would make sense and one case where it would not make sense for the individual. All right, thanks for tuning in.
We’ll be back with our next full episode after the case conference on life insurance for incorporated business owners.
