In this episode of Money Scope, Benjamin Felix and Dr. Mark Soth take a deep look into pension options for Canadian incorporated professionals. Building on their previous pension episode, they analyze whether Individual Pension Plans (IPPs) or Multi-Employer Pension Plans (MEPPs) like HOOP make sense through real-world case studies. Financial planner Aravind Sithamparapillai joins to break down detailed modeling of HOOP and how it compares to RRSPs, IPPs, and RCAs. The conversation tackles tax implications, income planning, and behavioral factors that affect pension decisions—equipping listeners with a clearer framework to assess their own options.
Ben Felix: This is 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.
Dr. Mark Soth: This episode accompanies the recent episode that we did on pensions for Canadian business owners that covered pensions in general, but also individual pension plans for IPPs, multi-employer pension plans, MEPPs that incorporated business owners can use.
Ben Felix: The idea of a pension is inherently attractive to many people. As a business owner though, you choose whether to opt in. You pay all the costs directly and you can choose what type of pension plan you want to participate in.
The question becomes how the various pension options compare to your other options, like using an RRSP and or retaining earnings inside of your corporation to invest.
Dr. Mark Soth: That’s actually not a straightforward comparison. Pensions or options themselves are complicated and the comparison across options is also affected by the rest of your financial plan. For example, how much you want to spend retirement, how well you prepare for longevity risk, which is the risk of living a long time, how you pay yourself now while you’re working through your corporation, whether you want to prioritize your spending during life or your eventual legacy at debt, how do you invest along the way also impacts the decision.
Ben Felix: I can tell you at PWL, and we’re considering an IPP as an option, for example, we have to model that out in the context of the rest of the person’s financial plan. I think this comes up when we talk about HOOP with Aravind later as well. We’ll use a couple of cases today that illustrate when an IPP does make sense and when it doesn’t.
These are hypothetical cases with inspiration from real scenarios we’ve encountered, but they illustrate some of the considerations and the general thought process.
Dr. Mark Soth: Yeah, we’ve also seen a couple of MEPPs come to market that have been marketed towards physicians specifically recently. There’s the Medicus plan that’s available in a bunch of provinces. There’s also HOOP near the healthcare of Ontario pension plan, which is specific to Ontario, but they’ve now opened that up to physicians, incorporated physicians.
There’s also other MEPPs that are available to any incorporated business owner. Out of all those, I would say though, the HOOP is the most established and complicated of those passions. So, we’re going to focus some time on some cases using HOOP today.
However, I would say, even though we’re talking about HOOP, which is a pretty narrow field of people, many of the general considerations would translate to other MEP plans as well.
Ben Felix: Yeah. Digging into HOOP was a major undertaking, like properly digging into it, which I don’t think many people have done, but it did require building a model from scratch that accounts for some important nuances that are hard to capture otherwise. So, we actually enlisted the help of one of our friends, Aravind Sithamparapillai.
I don’t think I pronounced that correctly. Aravind does explain to me how to pronounce it when he’s on later. So, you’ll hear it then.
I’m sorry, Aravind. I did my best. Aravind is at Ironwood Wealth Management Group.
So, he helped us with his analysis. We’ve worked together on a few complex modeling projects. He did a lot of legwork to clarify aspects of HOOP mechanics and he built it into an Excel model so that we could compare it with an RSP, with an IPP, with an RCA for people with very high salaries and with investing in the corporation.
So, Aravind is going to join us for the second half of today’s episode to discuss his work on HOOP and his findings. Before we get into the meat of the episode, before we start talking about IPPs and then get to our part with Aravind, I do want to mention that as with many of our topics, there is a ton of complexity here. I mean, we could have probably said this about past episodes too, but this is a really complicated topic.
Dr. Mark Soth: This is hard.
Ben Felix: It’s got to be out there with the top of the complexity pyramid for the topics that we’ve covered. And that’s not just in, that’s both in how pensions work, like the actual mechanics and pension benefit calculations and all that kind of stuff, but also in how they should be optimally applied to a given financial plan, to a given situation. So, we did spend a lot of time making the information in this episode as accurate as possible, including drawing on Aravind’s expertise.
We also had Braden Warwick, who’s reviewed past episodes, review the notes for this one. But as always, you should obtain independent advice specific to your situation before acting on the information in this episode.
Dr. Mark Soth: With that, let’s dive into some IPP cases. So, we’re going to start off with IEP case number one, choosing not to use an IPP. So in our first case, we have an incorporated professional Ontario. They earn a million dollars in gross revenue per year through their corporation.
And they have a source who’s also earning $145,000 per year from an external source who can receive a small amount of income from the corporation as well. So, stay right up for this is obviously an extremely high household income. Don’t worry, we will have a case later with a more moderate income to discuss as well.
But this case was based on a real case and it illustrates some important aspects of the decision making process. So, this professional had been taking a salary from the corporation for many years. So, there is a large past service funding opportunity available at the IPP when it’s set up.
They have been diligently contributing to their RRSPs and TFSAs annually along the way up to this point. And they’ve also managed to save significant retained earnings within the corporation and invested that in addition to their personal registered funds. So they have lots of investments from different accounts.
They also do not have any debt. Both spouses in this case are in their mid 40s, which is around the time where we’d consider IPP and they have no kids. Their main financial planning objective is approving their long term spending outcome and leaving a financial legacy is not important to them.
Ben Felix: So, the first step with an IPP is getting an IPP quote run from an actuary. And when we did that, we found unsurprisingly based on their age, as you just mentioned Mark, that they could contribute several thousand dollars more per year to the IPP relative to using an RRSP. So, this gets dollars out of the corporation and into a tax sheltered account into an IPP, more dollars than you would get into an RSP.
Plus they could shift further money from the corporation into the IPP immediately for past service funding. And then there’s also the potential for terminal funding at the time of retirement. So, these are all different mechanisms to get money out of the corporation where it’s taxed, which is particularly problematic if there’s corporate bloat going on and into a tax sheltered environment.
Now that is, as we discussed in the last episode on pensions, one of the main benefits of IPPs for people over the age of 40, you get more room relative to an RRSP and you may also get the past service funding, which just helps that further. So we did some initial modeling in our financial planning software and we found that the IPP could potentially improve this client’s spending outcomes relative to the RRSP only approach, which again, that was their main objective. However, good planning is not always that simple.
You have to consider what would happen if the client’s situation changes. The IPP requires making these consistent contributions over time for it to make sense.
Dr. Mark Soth: This was someone who is grossing a million dollars per year. And an obvious question that came up to you as soon as I saw this case was whether they can sustain that type of workload. And I’m not sure what their profession was, but that would be an extremely high revenue for a physician, even if they worked many, many hours in a well-paid special.
Ben Felix: We discussed how people feel about their current situation and probe about possible changes throughout these planning discussions. It was actually uncovered to your suspicions, Mark, that this professional had considered scaling back their workload. So based on that, we started considering planning strategies to reduce their workload without reducing their standard of living.
And when the overall situation was analyzed in that context, the numbers started to change pretty materially. With reduced workload came minimal retained earnings in the corporation each year, once the RRSPs and TFSAs were maxed out. And that made the additional IPP room over the RRSP a lot less valuable.
That would have been the main benefit and that benefit kind of went away. So ultimately in this case, it was actually decided that the mental overhead and the financial costs and complexity involved with the IPP did not make for a good trade-off in the context of this case’s updated goals once they started thinking through what this was going to look like in the long run.
Dr. Mark Soth: This case is a great example of how planning is used to support our goals, which are driven by our values. That’s why we started The Money Scope with four episodes on those topics. Taking the time to know your values and goals is vital.
And I think it’s great that the advisory team actually explored that and used it because it actually changed the strategy in this case. When you are in a position to consider whether you want to save even more for the future, and you’re considering even more complex strategies to do so, like an IPP for that, I mean, it’s important to remember that this is actually a decision opportunity for you to consider whether you want to spend more of that money now instead. And, you know, the incentive shouldn’t always be, let’s just try to build the biggest pot of money forever and ever.
It’s like, how are you going to use that? So in this case, they used it to buy more time now rather than keep working to as much to spend it later, maybe. All right, so case number two.
This is a case where someone does choose to use VAC&B. So in our second case, we have two corporate professionals, both earning more than $500,000 gross in their corporations per year. They’re in Ontario.
And again, this is a very high income couple, and they each have their own corporation separately. So some double doctor couples will share a corporation to keep complexity and costs down. And particularly if they combined incomes are more moderate, but this is a case where they have very high incomes in combined.
Ben Felix: Yeah, and in this case, they’re at least 15 years away from retirement. They do have children. They’re over the age of 40, meaning that the IPP is creating more tax sheltered room than an RRSP would just based on their ages.
Now, unlike the last case, leaving a legacy for the children is important to this household. So in addition to improving their long-term spending outcomes, we actually do care about the legacy, about the amount of assets after tax that we expect to have left over in their estate at the time of their deaths. Both spouses in this case have been drawing salaries from their corporations for a couple of decades.
Now that’s important because it creates the past service funding opportunity with an IPP. If you don’t have that historical salary with your corporation, you won’t have that past service funding. And the other interesting thing here is that due to some recent investment portfolio changes, one of the corporations had a significant CDA and NRDTOH balance.
And that corporation with those balances also has lower active business income. So that meant that there was an opportunity to move some money out tax-free using a capital dividend. And it also meant that applying the dynamic compensation approach that we discussed in episode 13, they would want to use non-eligible dividends for a portion of their income to start recovering some of that NRDTOH that they have in the corporation from realizing the capital gain.
So, that could mean and likely would mean reducing some salary over time, which would obviously impact RRSP or IPP room generation.
Dr. Mark Soth: This case is a good illustration of how corporate investment income can impact the strategy when you account for using that optimal compensation. That’s also a relatively common dilemma because the age at which you’d be considering an IPP, whether that could make sense is usually in the latter half of somebody’s career. And at that point, there could be significant and rapidly growing amounts of corporate investment income.
So that means that there could be this trade-off and this tension that starts to exist between using salary to try to get IPP room versus using dividends to get those NRDTOH refunds.
Ben Felix: Tension is the right way to describe that. That’s exactly what it is. As always, to start off with an IPP, we had an IPP quote run by an actuary.
And we found that the higher earning spouse in this case could contribute several thousand more per year to the IPP relative to the RRSP. And there was also a decently sized past service funding amount from a corporation when it was initially set up. So we modeled the scenario in our financial planning software and we did observe a modest increase in sustainable spending.
We also ran this by the client’s tax accountant who appreciated the idea of tax diversification, which is a concept that we’ve talked about through Money Scope. Just having different buckets with different tax treatment to draw income from just in case legislation changes, affecting one of the buckets. In this case, having one spouse using the IPP and the other dealing with their notional accounts using dividends is kind of where we landed.
That’s what resulted in the tax diversification.
Dr. Mark Soth: One couple with two corporations and two different approaches. One focusing on salary, IPP, and the other one using dividends to try and clear out all of their NRDTOH and their capital dividends. It’s actually a great case to contrast those two different situations.
Now, both these cases that we’ve done so far were extremely high incomes. They would be able to axe out their TFSA, use an IPP, still invest in a corporation beyond that. Plus the second case, the situation was going to continue long enough to fully take advantage of the IPP.
It wasn’t like they were just going to start cutting back as soon as opening up this IPP. I think the other wrinkle worth highlighting in the second case is the notional account issue. If you have a corporation with a high passive income, it will require substantial dividends to keep the RDTOH refunds flowing.
And that may mean a shrunken salary and less of an advantage for the IPP. We talked about that in episode 13. So for the spouse with a pile of CD and RD TOH to realize capital gains, the IPP was less attractive in that case because they needed to use dividends to get that money out of the set.
The other thing I did say is that the case was in Ontario. In Ontario, there’s also this passive income tax limit that has some tax integration anomalies there, which are actually beneficial. New Brunswick has the same thing, which is even more potent.
So using less salary would allow for more active corporate income to take advantage of that anomaly that’s there and pay out eligible dividends. So it’s another incentive in this case that would actually point us away from using an IPP. We talked about that in episode 10.
With that lower salary, the IPP becomes less attractive.
Ben Felix: It’s interesting. We’ve got one case where the professional ultimately decides against using an IPP due to a minimal financial benefit and added complexity at a time when they were scaling back work. Then we have one case where there’s two incorporated professionals who are spouses and they come to different conclusions about using an IPP due to differences in their notional account balances, a desire for tax diversification, a bit of a difference in incomes as well.
You mentioned it, Mark. Interesting to see how two corporations from two spouses who are in overall similar situations, one ends up with an IPP making sense and one ends up we’re focusing on bleeding out those RD2H accounts make sense.
Dr. Mark Soth: Yeah. I think another point to consider is your baseline investment and advisor costs. So, if you’re a DIY investor and you have very low costs doing that using an RRSP, the IPP would require additional help due to its complexity and those costs will be in addition to the usual investment fees.
Now, on the other hand, if you’re already using a full service advisory firm, that advice and tax execution should be included in the fees that you already pay, except for the additional actuary fees. So the bar would be much lower to jump over if you’re already using a financial applies.
Ben Felix: Yeah. I think that’s a really important point to bring up. The incremental value of an IPP is generally small and that does come up in the cases we’re talking about here.
Even when it does make sense, it makes a bit of sense, but it’s never like you’re getting millions of extra dollars from using the IPP as opposed to not. There are definitely quantifiable planning benefits in some cases, but in isolation, those benefits would likely not be enough to offset the cost of switching from being a DIY investor to using an advisor. So like you said, Mark, if you already have an advisor or if there are other reasons that you’re considering hiring an advisor, the IPP can be a useful tool.
I would be hard pressed to say that hiring an advisor for the sole purpose of getting an IPP would make sense.
Dr. Mark Soth: So case number three, this is an IPP with a more moderate corporate income. So this probably a more common scenario. Someone who has a active business income and they actually decide that IPP does make sense in their case.
So this is a case of a couple in their late fifties. One of the spouses is an employee of the corporation and is also eligible for the IPP. So not both spouses in the couple.
The corporation has around $250,000 a year in steady corporate income and up to another $250,000 per year in less certain additional corporate income. That’s much more variable. Now they have been taking a constant salary that’s closer to what they can count on each year.
They’re taking a salary around $220,000 a year and they’ll continue to do that until their retirement. There is currently $2.5 million in the corporation invested in an indexed portfolio. So they do have to consider paying dividends and through a salary.
So that those funds on that $3.5 million in their corporate portfolio are going to pay out dividends and they’re going to have to pay out some dividends from their corporation to keep that RDTOH flowing back to the corporation, which would mean reducing some salary.
Ben Felix: That’s right. So again, in this case, step one, actuarial quote for the IPP, see what the numbers look like. We use that information to model the case in financial planning software to see how much value the IPP would add over the counterfactual of just continuing to invest in the corporation using the RRSP.
There was a decent amount of past service contribution room available because they have been taking that consistent salary historically. So again, that’s going to get dollars out of the corporation into the tax sheltered IPP, which is going to help to reduce things like corporate bloat. So that did play into the decision here.
Now in this case, we found a benefit of around $400,000 adjusted for inflation in additional net worth at death in the financial plan. That was a real number, an inflation adjusted number. So it’s not nothing.
I mean, there’s something there. In this case to get there, the compensation plan did include decreasing the salary incrementally over time to try and strike that balance between generating IPP room and recovering RDTOH. So that’s another case where not a crazy, crazy high income, but there was something there for the IPP and that ends up being based on the way they’re taking compensation, their age and the overall financial plan.
I think these cases show that IPPs can definitely make sense in some cases, but not in all cases. Even when they do make sense, the value added tends to be incremental rather than transformational. It’s not going to take your financial plan from not working to working.
There might be an identifiable quantifiable benefit to setting one up in certain cases. One issue that I’ve always had with IPP marketing and one of the reasons that we have done so much modeling around this is that IPP marketing often highlights the additional tax sheltered room afforded by an IPP. It’ll show like, here’s how much you could have in your RRSP and here’s how much you could fit into an IPP.
That’s not an untrue benefit, like that is a real effect, but it doesn’t tell the whole story. You have to consider all of the other moving parts and the counterfactual of investing in the corporation and paying dividends to release RDTOH. When you do that, the comparison, the benefit tends to become a lot smaller.
The alternatives tend to be a lot closer.
Dr. Mark Soth: I think the story changed when we started looking at optimal compensation. I mean, looking at optimal compensation changed just paying salary or dividend mix to not just, well, could we get an IPP or RRSP with it, but actually what’s the best mix for that? That’s something that doesn’t cost us anything to do with it.
Once you understand how it works, that’s actually not that much more complicated, whereas an IPP would be a whole other level of complication and an extra layer of expenses.
Ben Felix: All right. In a moment, Aravind’s going to appear on the screen and we’ll continue with the rest of the episode with him. Okay. Moving on now to discuss some multi-employer pension plans. As we mentioned earlier, we have a guest here today, which is our first Money Scope guest ever, which is kind of fun. Aravind Sithamparapillai.
Did I say that right?
Aravind Sithamparapillai: Well, you got the first name, Aravind Sithamparapillai.
Ben Felix: Ah! I messed it up on Rational Reminder. Tell me how to say it again.
Aravind Sithamparapillai: Sithamparapillai.
Ben Felix: Sithamparapillai. Aravind is a financial planner at Ironwood Wealth Management Group. His focus in his practice is on helping midwives and physicians.
He’s actually helped us as one of our expert reviewers in previous episodes of Money Scope.
Dr. Mark Soth: Yeah. I mean, we’re kind of kindred spirits in building highly detailed Excel models to see what’s really happening in specific situations. For example, Aravind helped us with our modeling of CPP for business owners.
There’s all sorts of tax credits and other factors that people usually miss, but he didn’t. I’d also point out that Aravind recently had the highest score in Canada on a CFP exam, which surprised exactly no one, I think. He was actually already digging into HOOP around the same time that I was started writing about it on The Lady Doctor.
So we were able to kind of talk about it back and forth that he went really deep into it, contacting them, getting a lot of details together. Took us a lot longer than we expected, right, this episode, because there are many nuances into how multi-employer pension plans work. And they also vary quite a bit too.
Medicus, for example, is pretty straightforward, but it’s relatively new. HOOP is massive. It’s been around a long time, but because of that, it also has a wide range of members, and there’s a whole web of rules that go with that.
Ben Felix: And Aravind nerded out on this stuff super hard. As you mentioned, Mark, this is not the first time that we have nerded out with Aravind, and he’s as nerdy as they come, which is great. So with that introduction, we welcome you, Aravind, to the MoneyScope podcast.
Dr. Mark Soth: Hopefully the prep didn’t keep you up all night. We’ll try to go lightly.
Aravind Sithamparapillai: Oh man, I’m excited to be here. It’s an honor to geek out with both of you, but if both of you know me and many people know me, I was definitely up all night making sure I was ready for this.
Ben Felix: You sure were.
Dr. Mark Soth: Yeah, I saw the, you know, 130 edits.
Ben Felix: I think it went a little later than that. At least the text did. I don’t know.
Aravind Sithamparapillai: So, I’m happy to be here. Looking forward to it. Mark, why don’t you kick it off?
Dr. Mark Soth: Sure. Yeah. I mean, there’s a lot of creative analysis that’s between a few cases that we’re going to go through, but I would say before we get too deep into the numbers, I do want to point out that it’s really not just about the numbers.
The overarching reason to use a group pension plan is that you want to have some regular income and retirement that is relatively stable and predictable. And that’s in contrast to your investment portfolio. With an investment portfolio, you have to see it fluctuate in value.
You have to actively draw money from it using some combination of dividends or interests and selling some investments to supplement those needed. So this is a different approach.
Ben Felix: Yeah. And the thing is, is a lot of people prefer having that automated income stream from a pension. Absolutely nobody that has a pension is mad that they have the pension when they’re drawing from it.
And it makes it easier for people to spend money too. That’s another interesting thing. People will spend their pension income, but it’s hard for people to draw from their portfolios.
At a firm like PWL, we do that. And at Ironwood too, presumably, we do that with clients’ portfolios by using dividends and capital gains from the portfolio. But we as the wealth management firm are generating a monthly payment from the portfolio and it just hits the client’s bank account like their paycheck would.
And so they don’t have to think about how much they’re spending. And then we add onto that or couple with that financial planning so that people can see that they’re going to be okay with their current level of spending. Now to find benefit pension does the same kind of thing without an advisor, without having to have a firm doing it for you.
And then another benefit of a group pension is it allows you to pool your sequence and longevity risks with other members of the group. So it mitigates some risk, which are types of risks that are really hard to hedge on your own. And they’re particularly attractive if you expect to live for a long time.
Aravind Sithamparapillai: That’s a great point about the preference. And that’s actually where I would start when considering whether you want to buy into an MEPP or multiple employer pension plan, like who, if it makes sense. You want to ask yourself, how much of your retirement income do you want to pensionize versus how much are you willing to actually accept the trade-off of risk and variability?
A pension is going to provide that predictability. But in contrast, investing outside of the pension, using an RSP, an IPP, maybe an RCA, it has more variable outcomes, but they could be flexible in ways that people don’t often consider like extra funds to leave for your estate, particularly if you die earlier than expected. And whether that’s likely or not depends on how you use the pension versus also how you might invest otherwise, the risk you’ll take, so on and so forth.
Dr. Mark Soth: Yeah. Someone with more than enough money and a solid financial plan that allows them to stand with confidence from their portfolio. They may prefer the flexibility of managing their own investments.
On the other hand, someone who has a hard time selling investments to spend money, they may prefer to pensionize more of their money. I would also say someone with a borderline portfolio for retirement due to size or conservative investing or high costs may do better by pulling their investments through an MEPP. They’ll also sleep better and have a more worry-free retirement.
And basically that’s what you’re paying for. You’re paying some money to do this, but you’re buying security exchange.
Aravind Sithamparapillai: Which leads us to another important question. Which MEPP is most likely to give you that security? Because there are a number out there, but that security, if that’s the goal, that’s what you’re paying for, then you want to know that this pension and your reliability on the pension, you want to know that that’s certain.
So that’s where the track record is going to come in. How long has the pension been around? How long have they been making those payments or sticking to those guarantees and your trust in the pension management?
You might be willing to pay a little bit more for an MEPP that you trust. And if you want contractually predictable income, you could also buy an annuity as an option. But that increased predictability, the contractual obligations that come along with it, like an annuity tend to be a lot more expensive than the contributions that would go into a pension.
So this is why we spent most of our time analyzing HOOP, because even though it applies only to physicians in Ontario, it is large. It services more than just the physicians and it has a very, very long track record. So building our model and our assumptions from there gives us a reliable foundation or a reliable base case to start with.
Medicus is another option for physicians in other provinces, but it has only been around for a few years at this point. There are other companies that sell MEPP memberships for non-physicians and any of the principles that we talk about today around using a pension, timelines, et cetera, can be extrapolated or adapted to try to fit other MEPP options.
Ben Felix: Which doesn’t necessarily mean they’ll be equivalent because HOOP, like you said, is pretty large and well-managed, but the principles I think are still, you can think similar. You built a model and nerded out, as we mentioned earlier, super, super hard. I mean, the amount of time that you spent on this, the amount of texts, emails we’ve exchanged on this is like mind-numbing.
You tested a bunch of different variables to see how they impact the outcome of using HOOP versus other options, like using the RSP, the IPP, the RCA, investing in the corporation. We’ll talk about some of these findings using cases, which is the purpose of the episode. But before we get into the cases, can you just tell us a little bit about how you thought through this and approach modeling it?
Aravind Sithamparapillai: I proactively apologize to everybody at PWL that I pestered over and over again with questions. I think I sent a bunch of emails to West Coast Actuaries to get some clarification. Mark, I know you and I talked about this from the physician standpoint, so I appreciate all of the feedback to get here.
But the core challenge that I was trying to solve, and it didn’t feel like there was an appropriate answer out there, was on a dollar-for-dollar basis, what every client, what every physician wants to know is for the dollars that I put into HOOP, if I kept those commensurate dollars and invested them, would I be better? And all of the research out there and all of the discussions, they don’t really focus on this dollar-for-dollar comparison. Instead, there is a lot more of the qualitative definition style approaches to what an IPP is versus what a true pension plan is, like predictability of income, funding models, top-up, et cetera.
So we know the answer is it depends, but the issue is there was no analysis to give us a directional framework to start to talk to clients about how to do this. So I had to create a model that would allow me to then take individual client cases and say, okay, can I compare on an equivalent basis? If you choose one versus the other, where we keep all the other variables the same, how is that going to work?
Now, this sounds easy on the surface, you just create a model, they have the pension estimates, et cetera. So in theory, this should be easy. But as I started to dig into this, what I realized was there’s so many moving parts to HOOP, and specifically for physicians, there’s actually some choice that has to be made.
So, to give everyone a quick overview of some of the variables, HOOP starts with two core calculations. There’s a contribution and a benefit related to the amount of income that’s earned below the YMPE or the year’s maximum pensionable earnings. And then there’s a contribution rate and a benefit for income earned above that.
The final benefit depends on your five consecutive years of best earnings. And it’s related also to what the YMPE is at the time you retire. It’s not a per year piece.
Dr. Mark Soth: Yeah, that YMPE, just for people to understand, that’s set by the government. That’s basically the year’s maximum pensionable earnings that people use when they’re paying into CPP, the Canada Pension Plan. So they use that same number that’s set by the government to make a split in how they allow people to build their pension.
There’s a different rate below that, and then there’s a different rate when you get above that to higher incomes.
Aravind Sithamparapillai: Just so everyone understands why they would do that, the point of these pensions was essentially to make sure that people would be fine with retirement. Since YMPE is tied to CPP, the assumption was you don’t need as much of an income replacement for income below the YMPE because you’re already going to have CPP as a partial coverage. So it’s kind of like making sure that people aren’t over-saving for retirement.
Well, then once you cross above that, it’s all on you, which is why the contributions are higher, but the benefit amount is higher. And then finally, the physicians actually have some choice because they can decide when they want to start contributing it to, and they can also decide within a very tight band, but they can still decide to increase or lower their salary over time. And then that might potentially change what the actual benefit amount and contributions are.
So to get this model right, we need to take all of those considerations into account. We have to figure out how to grow the YMPE independent of the other pieces. We have to figure out setting, choosing your own start date, the adjustable contribution rates, plus the commensurate benefit.
And then we have to be able to identify the five best consecutive years. And then we have to create a pension that we can also independently toggle with inflation because inflation is often provided to the pension benefit or the pensioners, but it’s not guaranteed. So to be able to create all sorts of variable cases around this, we needed to actually figure out a model that did all of that.
And then, because the whole point is dollar for dollar comparison, we have to be able to take all of those dollars that we’ve just done and figure out how to model putting them inside of an RSP or an RSP-IPP hybrid or an RCA, and then look at drawing it down and see where we end up. Where do you run out of money? Where are you better off?
That kind of thing. I then took those Excel outputs. And then I think you’ve talked about conquest or financial planning software in general on this podcast before.
For everyone who is wondering why we then take this and take those outputs and put them into software, it’s to be able to properly account for taxes, account for things like refundable dividends out of the corp, and also account for market volatility. And how much better off are you actually in a realistic approach to modeling retirement? So that is kind of the full story behind it.
I do also model RCAs. We don’t talk about it too much in the cases because in general, the RCAs are super tax inefficient. And so, I would say that for the most part, the way I look at it, there’s not a lot of use cases for the RCA for a physician as it relates to pensionizing income or drawing retirement income inside of Canada.
Ben Felix: There’s some interesting points on the RCA with respect to HOOP that we’ll come back to later in the discussion. Okay. So we’re going to dive into our first HOOP case here.
This is a case where HOOP does make sense. So we have an Ontario physician. They’re considering using HOOP.
They’re also from a long lived family, like family members who tend to live for a long time. They often die in their mid to late nineties within this lineage. So having seen that, they’re really worried about spending down their money.
They’re worried about living too long and spending too much of their nest egg or all of their nest egg. Having a regular income for life is also very attractive to this person. So a pension for those reasons may be attractive to them psychologically, and then also to mitigate longevity risk.
So let’s take a look at the numbers here to consider how to best approach this.
Aravind Sithamparapillai: To start with, they currently invest using a 60-40 stock bond portfolio through a fee-based advisor. So when we needed to model out fees, when we consider the AUM fee plus low cost fund execution, we’re looking at an average fee of about 1.5% per year. Now the expected return from that portfolio after fees would be 4.09%. So again, reminder, that’s after the 1.5% fee based on the assumptions that Conquest currently has built in. I will also highlight that when I did this in Excel, I used straight line assumptions using the PWL market cap weighted returns paper, which we’ll talk about briefly. Those weighted returns tend to be a little bit higher and the returns can change the outcome a little bit. Now the assumptions for the actual physician or the physician case, they’re earning 25K monthly through their corporation, through their fee-for-service billings, and that’s increasing at about 1.5%, somewhere in line with just below inflation based on the historical norm for doctors. So we’re looking at a total corporate income of about 300,000. They’re drawing a salary to match their lifestyle needs of $226,000, and we’re decreasing that at about 1% a year to account for what has been termed dynamic compensation.
Dr. Mark Soth: This case is someone starting pretty much right at the beginning of their career. So you put age 30 as the beginning meeting age to do this. And when you talk about dynamic compensation, what we’re talking about is that the corporation, as it gets more passive invested income, it has to pay out more dividends to get the refundable dividend taxes back to the corporation.
So we’ve talked about that in previous episodes, that as you get more passive income, you may use more dividends to keep the corporation efficient. And that may also mean shrinking your salary down over time to accommodate for that.
Aravind Sithamparapillai: When I started running these assumptions inside of Conquest, I remembered, Mark, what you and Ben had discussed in prior episodes, especially when you talked about capital gains and deferring or crystallizing capital gains. To start any type of different decision, you have to start with this ideal scenario, using all of the base tools that we already have at our disposal. So in this case, the corporate savings starts out at roughly $60,000 to $70,000 per year.
And because of that, we’re going to end up with that passive income accruing more rapidly in the corporation than I originally expected. So to create an ideal scenario where everything is optimized, we had to reduce that. Now, assuming standard TFSA and RRSP contributions from 2025 on, if we’re not using past room to try to keep everything relatively even from a dollar perspective, they’re going to be contributing 7,000 to their TFSA and then $32,490 to their RRSP in 2025.
And then going forward, they’ll be scaling those up with the increasing room that accrues as a result of the salary and TFSA. And then we have them retiring at age 60. The reason we use age 60 is that’s the age when you can take an unreduced HOOP pension.
So it made sense to at least test out a lot of our cases starting from that point. Additionally, based on their lifestyle needs, they’re going to be spending $9,000 a month, which is approximately what remains after the take home 226,000 salary, maxing out the registered accounts. There will be a little bit of residual from the tax refunds and things like that that will flow into the non-registered account.
And then we also index their spending to inflation to keep everything in current dollars. Last thing, on the backend, when they retire, we’ve already deferred CPP and old age security to age 70. And you’ll hear us talk about these numbers a lot.
We talk about retirement spending failure rates or retirement certainty rates. So what that means is when we run out a thousand different scenarios, looking at market ups and downs, how many times are there market downturns that caused the portfolio or the plan to not go according to plan? And so in this case, their spending failure rate is 29.3%. Or in other words, 70% of the time, they’re going to get to age 95 with the exact same sort of expenses increasing with inflation, everything like that to fund their lifestyle as it exists today.
Ben Felix: You mentioned deferring CPP and OAS. Doing that if you don’t need the income can help as a hedge against longevity risk, just like a pension, same kind of idea. When you defer, you get a higher benefit that just makes it a better longevity hedge and a better sequence of return risk hedge.
We talked about this quite a bit in episode 14, where we covered CPP and EI for incorporated business owners.
Aravind Sithamparapillai: And also 29% failure rate sounds scary, but remember, that’s with a really unlucky set of sequence of returns. That would be like a big market crash right before you head into your early retirement. When we look at the weighted average of all of the thousand scenarios where markets go according to normal expectations or they go above expectations, the weighted average of the estate at age 96 was $4.46 million after tax. So there’s a 29% chance of failure if things go and you don’t change anything at all. You don’t adjust your spending. But in general, the weighted average leads to a very significant excessive returns outcome.
So in general, it’s not bad for targeting an age 95, but we still have somebody who’s concerned about making sure that they don’t outlive their money. And that’s why we take a look at HOOP in this case. And so the HOOP assumptions, we’re going to try to pensionize their full $226,000 salary.
So whatever the contribution rates are to get to that equivalent amount, we’re still going to have that salary decrease at 1% per year, which you can do. You can reduce your pensionable earnings by 1%. And then we’ll still have them save to the TFSA and the residual amounts to the non-registered, but we’re going to stop saving to the RSP with the assumption that most of the RSP room is going to be gone with the pension adjustment eating up most of the room.
Ben Felix: Just real quick to make sure it’s clear for listeners. So we just talked through the case. We talked through their retirement success rate without HOOP.
And now we’re saying, okay, how does HOOP change this baseline scenario without HOOP?
Aravind Sithamparapillai: Yeah. And so we’re saying without HOOP, 60-40 fee-based advisor, 1.5%. All of those savings rates, roughly about 70% success that you don’t have to change anything. You’ll get that $9,000 with inflation spending of expenses in retirement.
Dr. Mark Soth: Yeah. And the most likely situation is that you actually end up with a big excess. So people are afraid of the failure part, but the reality is if less things go super terribly, they’re actually going to have access unless they adjust their spending upwards as they see how the future unfolds over time.
There was one other little tiny nuance, which is when you do contribute to a pension, you still probably have about $600 a year of RSP room that you can use on top of the pension, just because of the way the pension adjustment works where we just ignore that for this analysis and it doesn’t actually change the results.
Aravind Sithamparapillai: A couple of things for this base case that I want to include, given I talked about all these variables that need to be considered. So first we’re going to start our base case, assuming that there’s no indexation for the pension when they retire. This is potentially overly conservative, but because the pension amount that you get, the HOOP board has to make a decision to increase that pension once you retire with inflation, it is optional and it’s not guaranteed.
So we want to start with the base. What are our known guarantees? Wage indexation.
So this is going to apply to the YMPE portion is going up at 2.61%, which is the conquest default. This has been discussed, I believe on Money Scope and on Rational Reminder that labor wages tend to go up a little bit faster than regular inflation. Regular inflation we have set at 2.2%. And for anyone who’s wondering why I’m talking about inflation when I just said, hey, we’re not going to index the pension in our base case is because there are certain costs like the OHA costs that have to be factored in, and those likely will go up with inflation. And so a key reminder that I want to point out, we’re still taking out $226,000 of salary. And technically, because we’re not contributing to an RSP anymore, it’s a little bit more salary than one would need for perfecting the tax deferral inside of their corporation from a personal income standpoint. It’s a little tough, but we wanted to try to create this apples to apples scenario where it’s $226,000, $9,000 of expenses.
And this was the closest way to try to create the exact pensionable income. And the last piece is when we model this all out, and we model salary decreasing slowly over time, their base pension in retirement 30 years into the future is going to be $111,000 or $111,456 as their starting point in retirement. Since everyone’s wondering about the dollar for dollar piece, we also took a look at how many dollars are going into the RSP over that 30-year period versus how many dollars are going into HOOP as a total cost.
And what we see in the no pension scenario is by the time we get to age 60, we’ll have contributed $1,031,437 to the RSP. In the HOOP scenario, contributions to HOOP directly account for $1,057,552 plus about $50,000 in OHA fees over 30 years. So the total pension cost is just over 1.1 million or about $76,350 more than we would have contributed to the RSP during that time. And it’s close enough to be somewhat fair, I think, on an apples to apples basis. But I would also point out to everyone that this is where the difficulties of trying to get super precise become a problem when we talk about financial planning in the real world. I’ve talked a lot.
Ben, do you want to cover the PWL assumptions piece here? Because this is where things change a little bit when we look at what return assumptions we’re using.
Ben Felix: What do you want me to say with the assumptions?
Aravind Sithamparapillai: Well, I know the PWL assumptions are slightly higher. In general, do you want to quickly highlight thinking about assumptions and base rates and why that’s really important in the context of what we’re doing here?
Ben Felix: You show it in your analysis and in your notes that when you change the assumptions, you can get pretty different results. Small changes in expected return assumptions make big difference. I was thinking about this when you’re laying out the case too, about the fees.
If you’re a DIY investor and aren’t paying those advisor fees, or if your advisor fees are lower, or what else, or if you’re in a higher expected return portfolio, all of these little details can materially change what is optimal in that case. I think it is super specific. Making assumptions is hard.
I do it for PWL. We have a methodology that we do. I also sit on the Projection Assumption Guidelines Committee for FP Canada that creates the guidelines for Canadian financial planners to use.
Then Conquest has their own assumptions that they use from a different source. They’re all different. You can get different results from all of these, what I would say, three pretty credible sources.
Dr. Mark Soth: The assumptions are hard to make and put precise numbers on, but I think a couple of the general principles would still apply. The way a pension invests is likely to be a little bit more conservative. If I were an all equity investor, I’d probably be a lot more aggressive and I’d probably have a higher expected return.
A pension comparing that to a 60-40 portfolios would probably be pretty reasonable. If there’s higher returns in the portfolio, there’s probably higher returns in the pension than vice versa. I think it’s as close as I think we can come to being able to compare it.
We are going to compare later on to someone who’s an aggressive investor, who’s DIY has low fees, high expected returns over the long run, just to show that difference as well, which is actually quite interesting.
Ben Felix: There’s an interesting, I don’t know what I’d call it. I guess it’s a conflict here for people who do what we do, Ervin. Where if someone, one of our clients, if it makes sense for them to use HOOP, and we see this with other things too, like paying off your mortgage, anything that makes the assets leave an advisor.
We just did a Rational Reminder episode recently where we told a client, it wasn’t HOOP, but we told the clients to take their pension benefit as opposed to taking the commuted value. One of the things we talked about there was that that gave up a lot of revenue for PWL by telling the client not to invest with us. I think this conflict always exists.
I’m not worried about a firm like PWL being affected by this type of conflict when we’re giving advice, but when you look across the industry, like if you’re a physician listening to this podcast and you’re talking to your advisor and they’re saying, no, you should absolutely not use HOOP, I think you do have to be aware of that conflict of interest. Because even if it is the best thing for you, like if you’re paying high fees, you’re in a conservative portfolio and your advisor is saying, no, you shouldn’t use HOOP. Even if you’re paying high fees and you’re in a more aggressive portfolio, there’s a massive conflict there that I think the consumer, the potential pensioner needs to be aware of.
Again, I don’t want to paint our industry in a bad light, but that is a real conflict of interest. Whether we like it or not, I think that can affect the type of advice that a financial advisor would give.
Dr. Mark Soth: I see this in real life speaking with colleagues, which is why I brought up at the beginning that this isn’t just about the numbers. There is a bias that’s there that if you have a bunch of money invested, well, how can you use a bunch of more complex instruments to keep the tax deferral going as long as possible? Because the advisor will get paid a percentage of that tax deferred pot.
Whereas if you take that money out, pay some tax on it and then spend it, there’s less than that pot. You have to be aware as a consumer that you want to make sure that you’re spending your money appropriately and not just the answer to everything is, how can we defer taxes and build the pot even bigger without actually using it for anything?
Aravind Sithamparapillai: I want to call out a couple of things because I agree with Ben that there is this bias and it doesn’t just exist in the decision to spend versus save or pay off debt or HOOP. It comes down to assumptions. We just came through this ridiculous three-year performance for any portfolio.
I know this has been talked about, but everybody is biased by recent returns. So expectations start to drift up. People start to think, oh, this is normal in some sense.
So if an advisor models and they model using even a 1% higher expected rate of return, that’s going to have a dramatically different outcome on what the ending rate is, what the estate value is, retirement, certainty, things like that. I think part of this is there’s certain pieces around taxation and there’s also certain pieces around how you study the portfolio that comes to the numbers. But the conquest numbers have us missing retirement a much larger chunk of the time.
When I modeled those lower numbers in my Excel, even on a straight line, not accounting for market volatility, I don’t hit 95 with the RSP scenario. If I increase my rate of return assumption by only half a percent, and as Ben talked about, there’s so many different sources out there that it’s not unrealistic to increase your rate of return assumption for that 60-40 portfolio by half a percent. All of a sudden, it looks way better and it looks like you’re going to be fine without the pension.
So I think that’s really important to discuss. On the other side, I don’t think this is going to be just HOOP specifically. I don’t think it’s going to be just AUM conflict.
There’s a complexity piece here too. Regardless of who your advisor is, regardless of compensation, what I tell everyone is ask them for the work, ask them for the sources. Did they do the math?
Did they model this out? How did they think through it? Because this is a very complex decision and not one to be taken lightly.
I just wanted to call that out as well.
Dr. Mark Soth: People will figure that out after and listen to these couple of cases, I think.
Ben Felix: I want to just mention your rational reminder appearance too, Ervin, where we talked about due diligence on alternative investments. Because I think another place where this conflict appears or where this issue appears is that if an advisor is using some alternative asset class, say it’s private equity or private credit, and they’re saying you should expect 3% higher than public market returns. Well, all of a sudden, HOOP is not going to look so good because this private equity fund is expected to return whatever, 9% or 10% a year after inflation, which is, in my opinion, ridiculous.
If an advisor holds that belief and is using those assumptions, it can really sway decision making. I think that’s just another piece to be aware of. People should definitely check out your rational reminder episode where you talked about your due diligence process for alts and why they often aren’t quite what they seem.
Aravind Sithamparapillai: People are going to wonder what I do with none of my spare time. With that said, we’ve talked about due diligence. We’ve talked about the approach to remind everybody because the goals are two things.
The main variables, the main outcomes that the client is going to care about, so everybody listening to this, they want to know, okay, is the doctor better off? In the first case, with no HOOP, they have a retirement certainty of 70.7%. 707 times out of 1,000, you run your market scenarios and they hit their retirement. They can die at age 90 with a sizable amount of money.
In the HOOP scenario right now, where we start with 226, no inflation on the pension, that retirement certainty goes up to 74.6%. What happens is now, instead of 707 times out of 1,000, it’s 746 times out of 1,000. You know that you’re going to have money with a little bit higher certainty. However, the estate value goes down.
We’ve taken all this money out. We put it into HOOP and we lose out. The estate goes down, the net of tax estate at 95 by about $639,000.
Effectively, look at it as you’ve traded for a higher certainty in your retirement that you won’t run out of money and you’ve left $639,000 less to your heirs.
Dr. Mark Soth: This illustrates one of the reasons why someone may want to use a pension versus their RRSP. Their priority is certainty of spending while alive. That’s going to go up.
A trade-off there is that you may not have as large of an estate or you may not have things go well as much money. So an RRSP, you may come out ahead, likely, depending on the variables, but it’s also much less predictable that that happens depending on your return. In this case, he’s a 60-40 portfolio, which you’d think would be a reasonably stable return while offering some growth.
But even that mix had a hard time competing with the pension in terms of predictability and funding here. I thought that was pretty interesting.
Ben Felix: I would say one thing that if we could remodel this case, what would be interesting is to, for every dollar that goes into the pension, we increase the allocation to equity in the non-pension portfolio. That might make up some of that shortfall in the estate because the pension is much more like a fixed income asset than like an equity. I know in the literature on optimal pension allocations, that’s typically what is suggested is that you’re not just buying annuities with your equities, but you’re basically using annuities in place of fixed income, which implies in the remaining financial portfolio, increasing the weight in equities.
Anyway, my guess is that would probably keep the stability, the success rate the same, maybe even boost it a little bit and net estate value might also go up.
Aravind Sithamparapillai: I would guess so. I would just think the growth would obviously outweigh a little bit. Also, I think there would be slightly more tax efficiency because equities tend to be more tax efficient than fixed income.
Ben Felix: Another good point, yeah.
Aravind Sithamparapillai: Again, not necessarily for this, but you got me thinking because you’re going to be more tax efficient, less corporate bloat, less forced dividends, which also allows you to keep your salary up. There’s a lot of pieces.
Ben Felix: I’m laughing because this is like three more sleepless nights for you probably to figure this out.
Dr. Mark Soth: Yeah. I think just to put that in quick terms, if you’ve got a pension coming and you might be ever more aggressive with the rest of your portfolio, which makes actually the pension even more useful to you.
Ben Felix: Correct. We talked about that with when we did our episode on CPP and why it can be attractive even for business owners who are investing. If you have a large CPP pension, which is this inflation indexed annuity, which is kind of like HOOP, although as you mentioned, Aravin, that part’s not guaranteed, but if your pension asset is allowing you to take more risk with your portfolio, then the whole pie, the whole picture starts to look a lot more interesting.
Anyway, another discussion for another time and optimizing the overall financial situation with HOOP. It’s one point there. This comes up with permanent insurance too, actually, where permanent insurance, it doesn’t generally make sense, but it can look pretty interesting when you compare it to fixed income.
That again, implies that if you’re going to take some of your fixed income and use it to buy permanent insurance as an estate planning tool, you have to be taking more risk in your financial portfolio, in your investment portfolio. Otherwise, you’re probably actually going to look worse off. Just interesting stuff to think about.
Overall allocation of financial products, as opposed to just asset allocation. One big constraint though is behavioral, where if someone is comfortable in a 60-40 portfolio and we say, oh no, you have a pension now, you can be 80-20. Then they panic when the market drops.
Well, then the whole thing doesn’t work. Okay. You mentioned, Aravind, that this scenario that we just walked through was not adjusting for inflation.
Now HOOP does, we mentioned it’s not contractual, it’s not guaranteed, but it does have a good history of making cost of living adjustments over time. How would some inflation indexing to the pension benefit affect the outcome here?
Case 4B – Full Pension with 1% CPI. In other words we modeled the impact of the same pension increasing at 1% inflation (while regular inflation is increasing at 2.2% – the standard conquest assumption)
Aravind Sithamparapillai: In most of these cases, we look at 1% and then we look at 2% to try to give a little bit of a range to give people some idea of what could happen. When we take that full pension, what we just modeled in the original scenario, and we increase it by 1% inflation, adding even a partial cost of living, as I think most people would guess or assume, it continues to increase the success rate. Since this doctor is drawing from multiple plots, they’ve got their pension, their corporation.
Increasing the pension means that they need to take less out from the corporation. It essentially allows them to keep more money invested in compounding over the same time. What ends up happening is they’ll still have the same average retirement spending, but the estate net worth, it moves back in line with what happened before.
The average weighted estate value in the case of 1% inflation adjustments goes back to 4.41 million. It’s only about $46,000 less than the original RRSP scenario. We’re basically in line, but the doctor now hits their retirement goal 79% of the time compared to the original 70.7% in the RRSP scenario. That 1% inflation, and again, remember, we’re talking 60 to 95, so I think there’s this compound effect in play, but you dramatically increase your retirement success and you’re basically keeping your estate almost the same at this point.
Dr. Mark Soth: It’s the most costly adjustments that make a major difference later in the pension.
Case 4C: 2% Inflation increases to the pension.
Aravind Sithamparapillai: Exactly. Now if it’s 2%, so almost completely matching inflation, the estate value becomes even larger, 5.41 million, so a sizable increase from the 4.46, and the extra predictable retirement income stream helps them fully fund their retirement 83.1% of the time. This is a clearly improved outcome versus investing within the RRSP, but I do want to remind everybody that pension increases aren’t guaranteed, nor are stock returns.
In short, I think from a base case, the pension does seem to add a decent amount of certainty to a situation like this, and it should be considered.
Dr. Mark Soth: I think in this sort of base case scenario that we’ve got, even without a pension, you have a reasonably likely chance of being successful, but you know their preference was to fund their base lifestyle and mitigate long-duty risks, so they wanted a pension. Anyways, for those reasons, if they were willing to take some risks in hopes of gaining some extra spending or legacy, but they also wanted to have a base level of income, so a bit of both, they could have tried to opt to build a smaller pension, so it’s not an all or nothing decision. They could still opt to build a pension, but build a smaller one, either by paying less into the pension despite their salary, or starting to build the pension in the years leading up to retirement instead of starting at age 30, start maybe at age 50.
Is there a preference for that?
Ben Felix: It’s an interesting question. If you start paying into the pension early, it’s a super long-term commitment obviously, then on the other hand, if the contributions that you make to a pension like HOOP in the years leading up to receiving the benefit are going to have a higher internal rate of return. If you contribute when you’re 25 and don’t get the benefit until you’re 60, the IRR is going to be lower than if you contribute when you’re, I don’t know, 55 or 50 and then take the benefit when you’re 60.
You’re accruing the same benefit. The calculation, the formula is the same, but you’re going to wait fewer years to receive it, so it’s just going to look better. Waiting also gives you flexibility in time to see how your financial plan and your circumstances evolve earlier in your career.
It’s super common for people to make major life changes. We’ll often have cases, I’m sure you do too, Ervin, where you sit down with a client, you make a super detailed financial plan, here’s what we’re going to do, here’s how we’re going to accomplish it. Then five years later, they make a total life change or career shift or they stop working to stay home with kids or whatever.
There’s just so much uncertainty. You get a lot more optionality when you’re not starting to contribute early.
Aravind Sithamparapillai: This is why I also love financial planning software because at least you can set your base case. I just imagine having to take all this information and re-put it back in and then be like, oh my gosh, I got to do this from scratch again. It would be so painful in some sense.
This is why having these profiles in the planning software is so handy. I agree. Both are valid options.
They both come with different pros and cons. The other thing is, starting earlier with that smaller base salary, for our listeners, a reminder that your HOOP pensionable earnings base salary is different from the actual salary that you’re paying yourself. You can have a higher personal salary but then set a lower HOOP pensionable salary as an example.
The thing is, if you start earlier and set a base salary, you only can increase or decrease that salary by a maximum of 3% either way. An increase of up to 3% or you can decrease it every year by 3% and then still stay in line with the whole every year you’re accruing pensionable income. You’ve locked in a fixed path for your salary as it relates to pensionable earnings.
Now, if you wait till later and start contributing, since you haven’t locked in that defined salary, if you decide that you want more pensionable earnings or maybe a lot less, you have the ability to do that. The flip side being though that if you decide that you want a really, really large pensionable amount of earnings, you have to pay a larger salary for a tighter time period if you start later. That’s going to have a lot of negative tax consequences when we consider optimal corporate tax management.
Likely, if you’ve been saving money in the corp, you’re going to need to be paying out dividends to clear out the refundable taxes. With that said, if given a choice, I would still probably, for most people, err on taking salary later. This is due to the fact that since you have the same contribution calculation for each year of pensionable earnings with no consideration for how close to retirement you are, like Ben said, that internal rate of return is going to look really good when you’re closer to retirement.
Case 4D – What if they waited until Age 50 to contribute to the pension
I could benefit potentially from not contributing to HOOP early on and then taking those dollars and sticking them in my RSP or RSP IPP hybrid until say age 50. Then maybe if life changes or if I decide that I want some amount of pensionable earnings, I could turn around and start contributing to HOOP. That brings us to the next case, which was we took this same decision with the 1.5% fee, the 60-40 portfolio, and we said, okay, we know that they’re better off potentially with a pension, but what if we just waited?
What if we waited until they’re age 50 to contribute? We didn’t look at buybacks in general through the set of cases. To give everyone some context, buybacks are a different formula.
It’s not one that’s open and available and easy to replicate. It comes with a number of actuarial assumptions that we don’t have access to at this point in time. HOOP will provide you that.
Here’s your buyback number that you can use. In all of these cases, we’re just using, hey, we’re going to start at a certain age and we’re just going to turn on whatever salary and then determine our pensionable earnings from that point. If we map the same pension or sorry, the same salary, so we’re decreasing over time.
By the time they get to 50, they have a very small salary that they’re drawing from their corporation. That 10-year period is going to generate a defined benefit of only $29,076 in nominal terms at age 60. We did this to keep the variables aligned.
They get to age 51. They’re not at 226 in salary. They’re at 182,998, so almost 183,000.
That’s the base salary that we’re starting with, and then it’s going down over time. Now, a reminder for everyone, the first case, the base case, the RRSP only with no HOOP pension whatsoever had a 70.7% success rate and an average estate of 4.46 million. Using the pension, but waiting until age 50 provides a 72.7% success and a $4.72 million estate. A better outcome with no pension inflation increases. In this case, we’re only taking those last 10 years. We got to have our cake and eat it too.
We increased our retirement certainty and we increased our estate value by 266,000. From a behavior standpoint, we have a little bit of pension income as well. It’s not often that you get to have all the things work in your favor, so to speak.
No trade-off, if you will. Then really quickly, just to touch upon the inflation, if we factor in inflation as well, and again, just on that small piece of pension income, increasing by 1% boosts the estate value to 4.88 million. An extra 160,000 on top or from our base of RRSP only, an extra $426,000 of the estate value.
It modestly increases that success rate to 73.4%. Again, as everyone would assume, increases to both the retirement certainty and estate. Then a potential increase of 2% on CPI for the pension results in 5.08 million, which is $620,000 of extra estate value to our base case, and 74.4%. An increase of 3.7% on retirement certainty, which to me, that part was mind blowing to think that you really could have it all in a sense.
Dr. Mark Soth: To put that all together, in a case when somebody wants to reliably fund lifestyle as their main objective and their baseline portfolio is a 60-40 stock to bond portfolio with 1.5% per year assets that are managed and plus fund fee drag on top of that, in that kind of situation, the pension is very attractive for doing that. That is even more attractive if there’s a period of increased inflation that the pension is able to give cost of living adjustments for, that makes it even looking better. If I put this together, the starting point would be to look how much of your lifestyle do you want to pensionize, and then consider how long it would take you to build that.
If you wait until mid or later career, because you want a smaller pension and you’re good with that, you could do that later and get a better return on that. It’s possible compared to a 60-40 portfolio that funding that pension in your final working decade could give you both a higher success rate for not having a risk of running out of money, and it’s even a larger average estate value because those contributions leading up to retirement have such great returns, because you’re not waiting very long between giving the money and getting the benefit. Now, you could also do a pension buyback to build a larger return if you’re starting late, but it was pretty hard for that to be modeled.
Aravind Sithamparapillai: Yeah. I would also say in regards to that, it is still important to consider a buyback if a pension is for you, HOOP will provide those quotes. Again, if you’re using somebody like PWL or somebody like myself, who has some of the ability to take both the logic that we’ve just discussed here and plug the buyback plus all of these other factors into the software to do a more robust output, everyone listening to this has the ideas in their head of when and where a buyback might make sense, who they are as an investor, so on and so forth.
That’s not to say that we’re not considering buybacks, we just can’t model it, but if given the numbers, the right planner will be able to put those in. Additionally, one of the other benefits that we’ll talk about a little bit is when your income is rising or lowering over time. You can accrue pension credit for a full year of income, but if you’ve been decreasing your salary over time, as we’ve seen in these scenarios, you’re technically contributing less and less to the pension, because if your salary is lower, then your contribution rates are going to be lower.
This is a nuance that’s going to get really important as we talk a little bit. You have to remember that you are, if you follow those bands, you’re actually still getting pension credit against the calculation for the final best salary. This is a nuance that we’re going to talk about a lot more later on.
Ben Felix: One comment before we get to the next case is that a backdrop to this whole analysis that we have not mentioned is that there is theoretically a pretty significant optimal annuity allocation for most households. That’s true even when the annuity does not have potential for cost of living adjustments. We did episodes on Rational Reminder with Moshe Milevsky, who’s Canadian at UFT, Wade Pfau, who’s American, Alexandra McQueen, who’s Canadian, all of whom have done great research on and research communication on the importance of annuities and how they’re optimal.
It does come back to that idea of annuitizing and then increasing the risk in the rest of your portfolio, but there is a theoretically optimal solution where you should have this much annuitized. The results that you’re seeing that you found here, they make a ton of sense in that context. It’s just another piece of information that people should be considering when they think, should I annuitize?
Yes, there’s the preference. Does it feel good? Is it right?
Theoretically, to the extent that you care about that, there is an optimal annuity allocation that we can try and solve for.
Aravind Sithamparapillai: Ben, before we go on to the next case, can I add one thought just for people who are trying to get the math or the theory? The way I would describe it is everybody likes this idea of having this rock. Everyone likes the idea of maybe having short-term cash in case markets fall or an asset that you can pull from.
Really, if you think about this pension or the annuity and you can say, so in really, really good times, I can take some of my investment returns and supplement my pension. At really, really bad times when investments fall, because I’ve taken some of those investment returns and saved them or supplemented my pension, I can now draw mostly from my pension. Think of that pension or that annuity as this hedge that doesn’t fluctuate with markets.
When you think about it that way, you start to think, oh, okay, this makes a lot of sense in terms of how it cuts off all of those worst case scenarios where markets go down or that sequence of returns risk that we talked about.
Ben Felix: Those are risks that are, as we talked about in our CPP episode in Money Scope, those are risks that are just really hard for an individual to hedge on their own. Because you have sequence of return pooling, because you have all these different age cohorts of people in the pension plan and you have mortality pooling, pensions just do that better than people can, which is why they have this theoretical place in optimal portfolios or a reasonable at least. Okay.
Our last case, we have an aggressive DIY investor. Mark, you mentioned that we’re going to touch on this. They invest in an all equity ETF for 20 basis points a year, which Vanguard just cut their fees.
I think BMO’s was already lower. We’re already lower. TD’s are lower.
This is a very reasonable case, super low cost, all equity portfolio using an asset allocation ETF. It’s a very simple, easy to implement. They’re good to go and they’ve got high expected returns.
They’re not paying advisory costs because they’re using this DIY ETF portfolio. They’re paying occasional fee for service, financial planning costs. The way that we have modeled here is about $10,000 every five years, which is maybe on the high side.
However, for incorporated professionals, especially if it’s a couple, depending on who you talk to and which planner you’re working with, people are definitely charging that much and more. You can also find people charging less. There’s a whole question about the quality and the professional that you’re dealing with.
Anyway, the way that you have modeled here is $10,000 every five years. With that strategy, assuming they can stick to it with that investment portfolio, their expected return is 6.1% annually after a 20 basis point fee based on the conquest data, which is quite a bit lower than PWL’s assumptions for the same portfolio where we would have a 7% expected return. We will look at both scenarios and you’ll see how much that can matter.
They are going to save at the same rate as the position in scenario one, but they’re in this case, well acquainted with money scope. They listen to all the early episodes on portfolio management and discipline and all that kind of stuff. They feel like they can stay the course.
They can navigate the nuances of investing and optimal compensation pretty well with a bit of occasional professional input. They have had a plan to run projections. They’re comfortable.
They can spend and sell investments gradually to fund the expenses if needed. They’re also comfortable adjusting their spending in retirement if needed. That’s the variable spending concept, which can make retirement portfolios much more sustainable.
Their basic wants and needs relative to their portfolio are reasonable, but they will spend extra on wants if things are going well in the portfolio. They know they’re going to be fine for retirement. They do want to see if it’s worth contributing to HOOP at all or whether it makes sense for some of their income to be pensionized and if so, how much?
Very different from the first case.
Aravind Sithamparapillai: The assumptions in general, we’re trying to use mostly the same. We want to keep things from an apples to apples or from a physician looking at this as like a scientific experiment. We really want to limit the number of variables that play into this.
With that being said, if we’re trying to start with the base case also of like, have we managed this person or is this person managing properly? There are a couple of factors that lead to a more rapid buildup of notional accounts in their corporation that we have to address. The first is an all equity portfolio.
Even if the actual dividend yield or distribution yield on the portfolio is still fairly low, because equities are going to grow at a very, very rapid pace compared to a 60% stock, 40% bond portfolio, the dividends from that portfolio are going to grow very large, very quickly. The second is there’s no deductible fee. This both increases the return on the portfolio, but it also means that we can’t use that fee as a deduction against passive assets to keep that passive income and the passive income taxes down.
That also is going to directly impact the growth of these notional accounts. As a result of that, their notional accounts grow a lot faster and reducing a salary by just 1% isn’t sufficient from a optimal trade-off between salary and dividends for this physician. Some quick examples, when we start with just a, what is the base case of their retirement certainty?
Same expenses too. $9,000 of needed expenses increasing with inflation. If we reduce the salary at 1%, they have a success rate already of 83.3% and they have a final net estate of 24.2 million, which I think will sound large and crazy to a lot of people. Keep in mind that we’re talking about saving a bunch of money in an RSV and a bunch of money in the corp and TFSA, their needs don’t severely expand. Now we have from age 30 to age 95, the extra amount growing at this equity clip. Reducing at 1% is a success rate of 83.3% and an estate of 24.2 million. If we reduce the salary at 5%, it actually increases the success to 83.9% and the estate increases to 25.6 million because we’re keeping everything more efficient. We’re getting more of those refunds back into the corp to invest. If we reduce the salary by 15%, the success rate jumps again to 85% and the estate value jumps to 27.2 million. A reminder for everybody, I say decrease the salary, but we’re not just stopping with less salary. We’re replacing it with dividends and those dividends as we’re pushing it out are either tax free as a result of capital gains that have been realized in the CDA or eligible or non-eligible dividends where the corporation is now getting a refund back. That’s why this mix actually generates a lot higher estate value and a better retirement certainty because there’s just more money involved.
Dr. Mark Soth: So, when you have an all equity portfolio that’s growing really quickly, you have to decrease the corporate salary faster over time. We see that show up with an increased success rate and the estate value, but what’s underlying that is the corporation’s able to use dividends to keep that investment income tax efficient like we talked about in a previous episode.
Aravind Sithamparapillai: So, in this DIY scenario, again, starting with the base case, just to look at that 1% salary decrease in full pension to try to keep apples to apples the same. By stopping the RRSP and contributing to the pension, we end up with a net estate of 11.6 million only. So less than half the 24 million baseline using the RRSP scenario and fully investing.
This is likely due to a few factors. One, the compounding that’s lost in the RRSP versus being put into a pension over this full timeframe. So you don’t have that same long-term IRR.
And then as discussed above, these trap notional accounts work against us. When we have a salary decreasing at only 1%, the corporate investment tax dollars, they sit with the government longer. And as a result, they’re dragging down the potential estate value.
Interestingly though, and this is kind of surprising to me, we actually have a modestly higher retirement certainty. We hit age 95, completing our goals 88.5% of the time. So it’s worth understanding that to some degree, the pension actually did provide a slightly better hedge to making sure that we had full retirement certainty.
Ben Felix: That is interesting. I just want to comment quickly that it’s pretty neat to see. Mark, obviously you and I did a bunch of modeling on this when we did the episode on optimal compensation, but it is interesting to see in your modeling, Ervin, how optimal compensation comes up and how impactful it actually is.
It’s cool to see a different person use a different modeling approach to arrive at a very similar conclusion on the importance of optimal compensation.
Dr. Mark Soth: Yeah, it shows that it increases the success rate at a safe values. So things people actually can concurrently understand. Net estate takes a larger hit because paying salary to enable those contributions to the pension also needs fewer dividends.
And that results in a corporation having a big drag on growth due to there’s investment incomes taxed upfront in a corporation at a very high rate. And unless you get that refundable dividend tax refunded back to the corporation quickly, its value decreases over time. And that’s also money that could have been invested in growth.
The other thing is that additionally, the equity growth in the RRSP, because it’s a low cost, high return portfolio grows at a rapid clip and provides more than enough for retirement. There’s also some excess that’s there that can continue compounding on a tax deferred basis. So these smaller state to have 11.6 million using the pension versus $24 million using the RRSP, which is basically it’s more than double. Those are huge numbers. And I would think I did something wrong if I left an estate that large. I mean, if you’re not looking to leave that large of a state that excess, which you will see building over time, you don’t just have to leave it untouched, you can start to use that either spend or to give away while you’re alive and hopefully not have a $24 million estate.
But by having that flexibility, it gives you a lot more flexibility. In this case, using the RRSP in the corporation because you take out different amounts, different times, and you see that excess building you to use it. I mean, on the other hand, this pension does provide a steady income stream to more predictably fund their baseline retirement and does have a higher success rate of not running out of money, 88.5% versus 83.5%. So a 5% higher chance of not running out of money, which would look better if we just for cost living with the inflation that the higher what happens in this case if we make the inflation higher and most cost living adjustments.
Aravind Sithamparapillai: So if we use a 1% inflation increase on the pension, then the net estate value increases modestly to 11.4 million and increases retirement certainty to 90.1%. And an increase of 2% raises that estate value to just under 13 million and increases retirement certainty to 92.9%. I want to be frank here. And for everyone who maybe is listening to this, but they’re trying to wrap their head around, we keep talking about IRR and then we use the expected rate of return. So the way I look at the IRR is I actually modeled all of the dollars into the pension and then how much it paid out and then said, okay, what is the equivalent rate of return?
Just so everyone can understand the difference in how much 1% or 2% of a rate of return assumption can make. In most cases for the who pension, that return comes out to about 3% to 4% or in most cases like just under four, if you die at age 95. So when we look at that, we’re basically saying, hey, all of our contributions that we’re not putting in the RSP and then we have to do some extra contributions from the corporation for the employer side.
We’re basically choosing to put that money in and let it compound at four-ish percent. And then we just talked before that we have the ability to compound in an equity portfolio at six or 7%. So for everyone who’s wondering how this estate jumps so dramatically, it’s 2% over 30 plus years of contributions and 30 plus years of retirement.
I think it’s intellectually fascinating to see that there’s this incremental change in retirement certainty because we have all of these weird fringe cases where markets take just an absolute dive right before retirement. But I think if you ask most people, hey, is a five or 10% change in your retirement certainty worth giving up the potential of $10 million to your estate? I think most people are going to be hard-pressed to take that trade off.
Dr. Mark Soth: Yeah, definitely. I think pensions help people to spend comfortably, but having millions of dollars of excess money would make me pretty comfortable too, especially if I’d had that stress tested by a financial planner as well so that I can see that it’s almost impossible for me to run out of money. You’ve talked about that lowish return over time.
That does change though if you contribute later. So when you contribute later, that can have a higher impact because that internal rate of return in the few years leading up to taking the pension, it isn’t three or 4%, it’s actually much, much higher. What would happen if you tried to start contributing at age 50 and comparing that against an all equity portfolio because the pension looked pretty attractive in that situation?
Aravind Sithamparapillai: So starting at age 50, again, with a decrease of 1%, so we’re still being somewhat inefficient with the corporation. So I want to remind everybody, there’s a lot of nuance to your specific situation, but if we use that base case, we decrease that 1%, it’s going to result in a very, very tiny pension income of roughly $29,000. But interestingly, even with no indexation, that leaves the estate with 24.6 million and a retirement certainty of 85%. So this is in contrast to no pension, which with a minus 1% salary resulted in 83.3% and 24.2 million. So adding the pension indexation of 1%, because I’ll just wrap up all of the inflation pieces, it doesn’t really make a large impact, again, because we’re just increasing like such a small pension amount. The retirement certainty increases to 85.2% and an estate to 24.8 million. And then a pension indexation of 2% increases the estate to 25 million. So we’re talking about like $200,000 increments here and 85.7% retirement certainty. So like 0.2%, 0.3% increases. So in all cases, the changes are incremental. I would argue that we’ve kind of maybe for this physician who hypothetically is looking at a $20 million estate, most of the ability to fund their income, they’re very much at that diminished point of marginal utility. But directionally, this tells us something, which is that it’s still really interesting in those final five or final 10 years, that there is still a benefit to the pension, even against a no-advisor fee, all equity portfolio.
So in some sense, directionally, we know that this pension can allow you to have your cake and eat it too.
Dr. Mark Soth: This honestly blew my mind a little bit. That deferative return for those years leading up to taking the pension are just so large that even a low-cost, all equity portfolio struggles to compete against that, which is wild to me. And then you get the benefit of having some baseline floor in there, which is great for psychological reasons of spending and all those other reasons.
You can have your cake and eat it too. I thought that was neat. The issue that sometimes comes up with this, though, is like this intertwines with further reduction of that salary.
To keep in line, if you have a large portfolio, build up those years leading up to retirement, which is what’s likely to happen, you’re now faced with this decision, do I reduce my pay more salary than I otherwise would in order to get this pension? Or do I stay with more dividends to keep my corporation tax-efficient? Now, you tried to model that by decreasing the salary faster, which means going up on the dividends a bit faster.
What was the impact of that?
Aravind Sithamparapillai: So in this specific case, because just to remind everybody, HOOP gives you the ability to increase your salary by up to 3% every year or decrease your salary by 3%. So I just use the maximum that would keep me in line with the HOOP allowability and decreasing the salary by 3% truly gets to the point of like, if 1% decrease got us to the point of diminished marginal utility, we’re really scraping for the last parts of the bottom of the barrel here. But we enter age 50 with a pensionable salary of 122,000.
And remember for everybody in this case, because we started with this person who’s we talked about that YMPE and YMPE is going up over time. So almost all of that 122,000 is now in the future below the YMPE. So they’re only getting the 1.5% benefit attribution. And so in that case, the pension benefit at age 60 is about $17,000 in nominal terms. So keep in mind, we have to account for inflation. So it’s not very much in today’s dollars.
But with that said, the base pension with no CPP adjustments still provides retirement certainty of 84.9% and an estate of 25.9 million. So it’s still better than the age 50 with a 1% reduction in salary. So still very much a have your cake and eat it too scenario.
I will say this though, as I’m saying this out loud, what I realized is I don’t think, and I’d have to go back and look, I don’t think I’ve corrected for like with the retirement certainty. I’d have to go back and double check. So I’m just going to scroll up in my notes because I want to see what the retirement certainty for the original 3% reduction was just to make sure.
Reducing by three is 83.5 and a state of 25. So when I look at reducing by three, 84.9 and a 25.9 million. So yeah, the pension still modestly, modestly increases the retirement certainty and the estate value.
So again, still helps.
Dr. Mark Soth: Yeah. I think the bottom line is it’s actually the beneficial. Mediocrises might get excited to develop as you’re in there, but in practical terms, it’s not going to make a big difference.
Ben Felix: There’s something else that we talked about, Ervin. Most people think about increasing their pension as they work longer. Like the longer you work, the more years you contribute, the higher your salary is, the bigger your pension is going to be.
HOOP allows you to decrease your salary and contributions by up to 3% per year, as you mentioned earlier, if you want to. Now doing that, decreasing the salary would help with corporate bloat, the corporate bloat problem, but also reduce the pension. So when you think about those sort of two competing forces, how does that play out in terms of what’s optimal?
Aravind Sithamparapillai: I think this is the part that might surprise a lot of people. It doesn’t reduce the pension, the pension benefits, sorry. It doesn’t reduce the pension benefit as much as people might think, because everyone is thinking, oh, if I’m reducing all the time, then all of those years of reduced income mean my pension is going to be lower.
That’s not actually true, because the nuance that people look at is that with regards to HOOP and many other defined benefit pension plans, it’s not all the way through. It’s the five consecutive best years. Now people often think about the best years being at the tail end of their career, but if from managing our salary and our corporation compensation, we start with our best years at the beginning, then we’re essentially kind of locking in what our pension benefit is going to be upfront.
And then we’re just reducing the amount that we’re contributing to get that same pension benefit throughout. So when we decrease your salary by 3%, and then therefore we’re in some sense decreasing our contributions by a commensurate rate, it’s not quite 3% because of that interplay between YMP going up and all of that. Where it leads to more estate value, and it almost maintains the same pension income.
I looked at what happens if I just kept it flat. So if I started with that salary that we talked about, 226, and I didn’t decrease it by 3%, their benefit would have been 111,000. Decreasing it by 3% every year.
So remember those first five years are really what matters. It’s still almost the same. It’s $106,000.
So we’re not really losing a lot of the pension benefit if we’re thoughtfully decreasing our pension within those bands. So for everyone who’s trying to conceptualize this, because the numbers, the income, all of those pieces are really, really tough. What I did was I just looked at, hey, what are some of the total contribution dollars that go in?
So if they started at $226,000 at age 30, and they maintain the same salary, their final pension would be 114,000. So when I talked about 111 and 106, correction to those numbers, that’s a decrease of 1% versus a decrease of 3%. So decreasing at 1% gives you 111 as your final pension when you start at 226 at age 30.
Decreasing at 3% is 106. And if you kept it flat at 226, you would have had 114. So we’re talking about just a few thousand dollar differences in annual income.
If you kept it flat and you wanted that final pension of $114,000, you would have contributed 1.244 million. So $1,244,000 into the pension over 30 years. Decreasing the salary by 1% takes us down from 114 of pension income to 111 of pension income, a total decrease of only $2,685 altogether for pensionable income.
However, over those 30 years, the total contributions end up decreasing to $1,057,552. So you contribute $186,551 less to your HOOP pension, but you’re penalized by only a pensionable income of $2,685. If we decrease the salary by 3%, that’s what gets us down to 106,246.
So 5,200 less than our 1% decrease. And if we’re looking at that base, $7,895 less than the flatline option, no pun intended, Mark. But by decreasing it that 3%, we only end up contributing through the life of this contribution path, $786,763.
So a whopping 270,000 less than the 1%. And compared to the flatline option, $457,000 less. So think about it this way.
If I had that $457,000 over 30 years, I could be investing that money and I’m only being penalized by about $8,000 of annual pension income to do that. So this is where I said the model becomes really complicated because you have to consider this as part of the optimizing plan if you’re going to opt into HOOP. Because we’re talking about hundreds of thousands of dollars that you don’t necessarily need to pay in.
Dr. Mark Soth: From an actionable standpoint, you did a lot of work to arrive there, but the actionable part of that is actually great because it means those best five years could be early on. And then you get a very small decrease in pension for a very large decrease the amount of money you pay into it. And you’re going to want to be decreasing your salary overtime anyways, probably because your corporation’s compensation plan.
So the bottom line there is don’t just buy into it and leave it the same. Don’t mindlessly increase it because you think you’re going to get a bigger pension. You might want to be decreasing it because those best five years could be early on.
That actually can be a really good thing.
Aravind Sithamparapillai: I will highlight, like I suspect we’ll get a lot of questions about this. So I just want to point this out because on the HOOP website, they do a lot of the discussion and the marketing about like, hey, look, if you increase your salary overtime, look, you’re going to have more impensionable earnings at the end. And that is true because if you’re increasing, the final five will be at the end.
You have to look at all of the factories that we’re talking about.
Dr. Mark Soth:
Yeah. They’re saying build the biggest pension you can. Whereas we’re saying, how can you have the most money available to you that you can, even if that’s not at the pension?
Exactly. And if you look at the big picture overall, decreasing overtime is actually better than increasing. Even though you have a smaller pension, you have more money overall.
And it’s counterintuitive. So this is something that I know we spend a bit of time on PakiMap, but I know it’s counterintuitive and it’s against the marketing and the tendency that’s out there. Now, the one other thing I’d say that you touched with this a little bit earlier on, which was the retirement compensation agreements aspect of it beginning.
We didn’t use the RCAs in these cases per se. Can you explain a little bit why that is?
Aravind Sithamparapillai: Yeah. And to start, I will say that listening to the Money Scope, listening to Rational Reminder, RCAs weren’t on my radar at all. In most pensions, there’s a limit to the pensionable earnings that you can have.
This is the mandated amount of contributions that actually go into a proper pension plan that are tax deferred. They’re invested with that full tax deferral. And this where IPPs get their calculations from, is those pension act mandates.
Now, HOOP actually advertises to physicians, they’ve talked about it on other podcasts and stuff as well, that there’s a way around that limit. And there’s a way around the maximum pensionable earnings that the pension act has. You can have pensionable earnings in the hundreds of thousands of dollars.
So the 226K that we’ve been using as a salary, and if you wanted to go higher, those are actually allowable. When I read the details of HOOP, and when I read the plan text, what I realized is they do still technically follow the pension act. The contributions that go into what’s called the RPP, or the registered pension plan component, those are all tax deferred.
They follow the same tax rules. Any of the contributions that would exceed the pension act, they actually go into a separately held and separately managed RCA that’s also managed by HOOP. So when I saw that, I thought, okay, I need to try to model this to understand whether this is possible to replicate personally.
If an individual physician wanted to do the exact same thing, what happens if they were to put money into an RSP IPP hybrid, and then the extra into the RCA?
Ben Felix: This is a crazy thing to highlight for listeners. So HOOP will allow for doctors or other high income people who are able to be members of the plan to earn a benefit higher than what pension legislation would allow by using an RCA. Now, an RCA is not nearly as tax efficient.
It’s actually pretty tax inefficient, except for some very specific cases, and especially compared to an RPP. An RPP is a tax, it’s got special tax treatment, investments inside of it are not taxed, and RCA is not the same. So those legislative calculations are also what govern the IPP funding rules, like same, same exactly.
So if this is the case, HOOP allows for the legislative rules for their pension, sorry, follows the legislative rules for their pension, and then those contributions go into the tax sheltered regular pension, and then they use an RCA, which as I mentioned, is not as tax efficient for additional contributions above and beyond, for pension benefits above and beyond what the legislation would allow. So question for you, Aravind, is there a different pension benefit calculation for the contributions that are going into an RCA?
Aravind Sithamparapillai: No. So HOOP still guarantees the pensionable earnings that the doctor would set their base salary for. So even the earnings above the pension act, or the benefit that you’re accruing above what the maximum benefit that the pension legislation would say, when it goes into the RCA, it’s still guaranteed by HOOP.
So HOOP is saying, hey, all of your contributions above the YMPE are going to get the same contribution rate, and you’re still going to get the same benefit calculation on the back end, and we’re going to guarantee that. So that’s why I had to model it, because I was trying to figure out theoretically, we know how markets function, we understand all of those pieces, we understand taxation. I needed to know, is it possible to do this on your own?
Am I missing something? And the answer is no. Where RCAs are involved, for the purpose of our listeners, they tend not to be very helpful from a retirement standpoint.
Dr. Mark Soth: This is part of why I haven’t really taken a big look at the retirement compensation agreements either. And the main thing that I could see them be used for is if there’s a company, or in this case, a hospital that wants to offer a larger benefit patch to their very high income employees, this is a way for them to do it, even though it’s really actually a very costly and effective way of doing it, because of the way that it has a high tax rate up front. So it’s not something we would want to do as individual employers, it’s something that if they’re using it to attract their talent, that a big company might try to do that.
So with HOOP , and this is previously very few people, like senior executives that would have been using this RCA component of HOOP to get around having higher levels of pension income. You know, if a big pile of doctors decide to buy into the pension at higher income levels, like say three or $500,000 a year or something like that, that’s a lot of money now that’s going into this very inefficient structure within the HOOP plan as a whole. How’s HOOP going to manage that?
Aravind Sithamparapillai: To start with, everyone’s probably asking, okay Aravind if you can’t do this, or we can’t do this individually, what is happening inside of HOOP that they allow this? And so from reading the plain text, which is like the legal document, from what I understand, they’re able to do this via the surplus of the pension overall. So while the RCA might not grow the same way, we have the surplus in the RPP, and you can use those surpluses to essentially help supplement or fund the tax liabilities that keep the RCA from growing the same way.
So they’re relying essentially on the continued growth and the management of the tax deferred pension and the surpluses to cover off that liability. To be clear to all of our listeners, this opens up an uncertainty. I don’t know how to answer.
There’s not a clean cut answer for this because at the moment, like Mark, to your point, the RCA component of HOOP is very small in terms of pro rata share relative to the RPP or the true pension pool. So the liability is really small as well. Now, if that RCA component continues to grow, say as a result of all of our really smart listeners coming here, listening to this and now being like, oh, cool, we need to optimize for this.
I don’t know what the tipping point is from an actuarial assumption perspective where in the future they change things and a reminder that they can change the required contribution rate. It’s been very consistent, but if for some reason liabilities are growing, then they can require a different set of contribution rates from the employee and the employer. So in that context, are we locking in a base salary, a contractual obligation to try to earn this pension income without the ability to lower our income meaningfully if everything changes?
That’s a risk that the answer is yes, potentially, but we also don’t know. It might be no relative to the actuarial assumptions.
Dr. Mark Soth: So if they found that the RCA was becoming too big of a liability because it was becoming a larger part of the pension, they could say, okay, well, we want you to increase your employer and employee contributions to be able to make up for that liability, which kind of makes sense because then you’re matching the liability and making the people that are benefiting from it pay for it, which would be one thing for a hospital to do that.
But if we’ve locked in as an individual physician into that, and suddenly our contribution rates have to go up, that would change the math on this. Exactly.
Ben Felix: There’s also some interesting, I don’t even know what I’d call it, moral or philosophical questions to think about here. If we think about the spread of income between a nurse maybe and an incorporated specialist physician who’s now able to participate in HOOP, I don’t know what I’d call it, a tax arbitrage or pension. There’s some kind of arbitrage.
There’s something going on here where higher income individuals can benefit from the surpluses in the plan from the relatively lower income individuals because they’re getting the same pension benefit, but their portion of the contributions is going to this really tax inefficient structure.
Dr. Mark Soth: I think either we’d have to make that decision individually. I think taking our information and doing the best for our own situation standpoint, I guess the RCA part of it makes sense for us currently, although I think there’s the risk of what if that changes over time? I don’t think we know what the answer to that is.
Then there’s the philosophical question, do we feel getting a larger benefit and having that supplemented by the excess returns of the pension? I’m not sure.
Aravind Sithamparapillai: I would say to cap that to your tagline is what shining a light inside of the money issues. In some sense, the way I look at it is we’re all kind of believers that there’s smart people out there, markets work, efficient markets, et cetera. This is going to come to light in some way.
To me, this is like, okay, we found the information. The best thing we can do is at least address that it’s there, address the pros and cons, and also be very transparent to all of our listeners about what they’re signing up for, what the risks are. Then we do have to let them make their own informed decisions based on their personal preferences as well.
Dr. Mark Soth: Yes. Someone I would have thought of. We’re going to finish up with a few specific questions rather than cases.
I think we’ve wrapped up those cases, which I think highlighted a bunch of really important variables and things that we can control. What are the big variables within a physician’s control that need to be considered when assessing how HOOP compares to investing?
Aravind Sithamparapillai: I think there’s three main factors. They need to consider their desire for certainty, for income and retirement certainty versus potential upside and a state or legacy. They also need to know their savings rate and their risk, because that’s going to guide whether HOOP generally makes sense or not.
They also need to know a bit about taxation, or they have to have a planner who understands corporate taxation to guide them, because of this variability and decreasing your salary can have a major impact not only on what pension income, but also just in general, the estate planning components that we just spoke about.
Dr. Mark Soth: What are some of the variables that really are not in the physician’s control?
Aravind Sithamparapillai: Inflation is a major factor. This applies both to the pension and whether or not HOOP is going to increase the pension, but it also applies to market spending, et cetera. A reminder that from the pension standpoint, that’s not within control, nor is it within your control from how your investments keep up with regards to inflation.
Additionally, while contributions have historically remained stable, we have no guarantee that they will continue to remain stable in the future. You have to take that as one of those unknowns that you’re signing up for.
Ben Felix: Why do you think it’s hard to definitively say whether HOOP is going to provide a better outcome for a given person than investing?
Aravind Sithamparapillai: Well, one, the nature of the timing of markets. We saw how the retirement certainty changes and that’s because of all of those extreme tail risks as we talk, like if markets crash. Now, the other side of it is when you start contributing to HOOP, example, contributing later on closer to retirement also changes the impact.
That decision is going to depend based on the person’s risk, based on when they’re starting contributing into HOOP, so on and so forth. Additionally, the size of their income and the taxable nature of the different accounts that they might use also is going to play a role in this situation.
Ben Felix: You spent a lot of time looking at the details of HOOP, but also thinking about weird nuances as you love to do and fringe planning cases. Can you give us your top weird nerdy learnings from digging into HOOP?
Aravind Sithamparapillai: The first is we talked about the pension adjustment. This one might go unnoticed for a lot of people, but I think a lot of physicians is going to be really important. If you start early and your pension adjustment eats up most of your RRSP room, then you don’t have the ability to contribute to your RRSP, say for the purposes of a homebuyer’s plan.
Now, with the increased limits of the RRSP, 60,000, and again, we can also have a spousal RRSP. Even if you have a low-income spouse or a spouse that’s at home, potentially, you can get over time $120,000 out of your corporation effectively through the RRSP and through the homebuyer’s plan tax-free for a down payment on a house. If you prematurely start HOOP and blow up your RRSP room, you’re also potentially impairing some of your other goals that you might have like buying a house in the most tax-efficient manner possible.
I would say that, again, that has to be a major consideration. It also potentially is one of the factors that then helps push the decision to start contributing it to HOOP a little bit further down the line. I have another crazy one, but first, I’ll start with that because I think that one’s very broadly applicable.
Mark or Ben, anything you want to add or commentary around that? Nope. Makes good sense.
So, the other nuance that I think is really interesting and it’s a reason that many people don’t want to opt into HOOP and speaking with many other planners, this is often their first default as well to why HOOP seems like a bad idea. That’s the potential for dying early and losing all of the money that you’ve effectively contributed. So, for single physicians, so those that don’t have a spouse or a spousal beneficiary, there’s a 15-year guarantee.
So, within those 15 years, in most cases, again, as we talked about with when you time your contributions, etc, there is a positive payback. So, the 15-year guarantee can be given to a beneficiary. And I’ll talk about some interesting ideas around that.
But many doctors are married or in some type of common law or a couple relationship where they have a spousal beneficiary. If you have a spousal survivor, the guarantee drops to five years. So, if you and your spouse both prematurely pass away, HOOP is only guaranteeing five years.
So, that does make the planning really tough to consider. What’s really interesting though is you can actually have the spouse waive their right to the survivor benefit. And if they do, HOOP will give you the contractual 15-year survivor benefit obligation.
Now, it has to be done before retirement. You can’t make that choice partway through, but you can, with the use of a planner, decide that. Now, why is this really interesting?
First, for many physicians, the concern is managing the estate and giving up all of this money. So, mapping out a 15-year guarantee all of a sudden can become the default if that’s your concern. Like, hey, I’m pretty good with retirement, but I really don’t want to lose this money.
So, let me start by using the 15-year default to see if it makes sense. The second is that the beneficiary can receive that in the form of annuitized income. And that annuitized income is taxable in the hands of the beneficiary year over year over year.
So, all of a sudden, we have a way legally to get around TOSI at death, hypothetically, because if you have a premature death, you have this beneficiary, say your kids or somebody, who will receive some of this money from you, which you took out of your corporation, essentially, and out of your RRSP, and now you’re handing to them in a tax-deferred and structured tax-efficient manner. So, can we control our death? I don’t think anyone’s aiming to plan to give the money to their kids by dying early, but it hit me that if you are in a fringe case where you get diagnosed with a terminal illness, this all of a sudden opens up some nuances to think about the buyback a little bit differently or to think about opting into pensionable earnings for a few years if you have a shortened life expectancy, but you plan on working, whatever the case is. So, all of a sudden, there’s a really, really weird TOSI buyback tax arbitrage.
Again, I would not recommend this for everybody. You got to be working with a planner who’s going to be sharp and model these nuances and really communicate it, but it blew my mind when it hit me.
Dr. Mark Soth: Yeah, and I think that’s one of the things that there’s so many details. We’ve covered some of the big things to pick about when making a decision around this with the cases that we did, but there’s all sorts of nuances that can come into play. So, can you give us just a few key takeaways from the cases that we did?
Aravind Sithamparapillai: Yeah, for everyone whose head is spinning. So, first, it’s not a bad thing. I think many people were very quick to hand wave HOOP when it came out, at least based on initial conversations.
I want to say that the more I dig into it, the more I think that there’s value in almost every physician’s case to at least seriously look at and understand it. And if it’s timed properly, it can be very effective as a partial source of retirement income compared to your other investment streams. And as a diversification strategy, as we talked about, as Ben talked about from an optimal mix of income, it’s going to be very useful against a market fluctuating portfolio.
When we contrast to RSPs, and I would say also when we contrast to IPPs, because they share a lot of the same tax deferred mechanisms, what you need to keep in mind is that an aggressive portfolio, especially one that’s very low on the fee side, seems to typically beat out HOOP if you’re starting at an early age in terms of investing in compounding. For balanced portfolios, it’s a little bit less certain, and the timeframe is really important. Contributions later have an outsized benefit.
So, starting later into HOOP, if you have less retained earnings, or maybe you took time off, mat leave or parental leave or something like that, you should meaningfully look at HOOP. And then when contributing, remember, as we spoke about, that you don’t really want to keep your wages the same. Typically, I think the default should be to consider decreasing over time, but you also want to model increasing if that aligns with certain nuances to your situation.
And in general, if this all hurt your head, don’t rush into it, because as we discussed, later seems to be better in a lot of cases. So, pause, take your time, get the numbers, and think about it. Look at Stranger Things, man.
If you love it, you’ll watch an hour and a half TV show episode.
Dr. Mark Soth: Oh, yeah, totally. That’s true.
Ben Felix: We have just done that the last three nights in a row.
Dr. Mark Soth: I’m not allowed to after we took my daughter, but it’s all universally.
Ben Felix: Oh, yeah. It makes sense.
Dr. Mark Soth: She’s forbidden us from watching without her.
Aravind Sithamparapillai: Are you guys watching Stranger Things, too?
Ben Felix: We have been.
Dr. Mark Soth: We will. We’re waiting with the last season.
Ben Felix: It’s so good. People were complaining about it not being that good, but it’s great.
Dr. Mark Soth: I loved it. I’m not as good.
Aravind Sithamparapillai: Oh, it’s amazing.
So good. Micaela’s not it. She’s not into scary stuff, and has the violence and everything kind of progress.
My kids are still too young. I think my oldest, we’re about to introduce him to it, so I might vicariously live from season one all the way through with him.
Ben Felix: Nice, nice.
Dr. Mark Soth: Part of it for me is it’s cool. Part of it is just that I get to see, remind myself of the life in the 80s.
Ben Felix: All right, should we wrap this thing up? Well, Aravind’s part, then Mark, we have a bit more to hear.
Dr. Mark Soth: Yeah, we’ll keep going, yeah.
Ben Felix: All right, so let’s wrap this up. In this case conference episode, we covered three cases where an IPP was considered. It did not make sense in one case.
It was a split decision for the two corporations in another case, and then it did make sense in a third case. In none of the cases was an IPP a total slam dunk where it’s like, yes, this is obviously incredible. It definitely added incremental value in some of the cases, but probably not enough on its own to justify hiring an advisor for that sole purpose, which is something that you would have to do at least for the IPP assets.
Dr. Mark Soth: We were also joined by Aravind who talked us through some cases based on his work on pension plan. It’s complex analysis and full of nuance, but we hope that walking through some of the nuance helped to build some intuition around when it may or may not make sense for people. HOOP is not an option for everybody.
It’s in Ontario for physicians, but the same principles would apply to any defined benefit MEPP with similar characteristics. Personally, I would get some independent formal analysis from a specific case before taking the plunge. I think there’s a lot of pieces at work there.
After this episode, I might have to give it some more thought.
Aravind Sithamparapillai: The complexities of HOOP also highlight, as Mark said, the importance of sitting down and doing the work. Even in this case, if you are a DIY investor with a low fee portfolio, there may still be a benefit. Make sure that you do sit down with somebody who’s done the work on HOOP to be able to think through this.
It’s definitely, I think, going to help doctors in general. I think this is a meaningful improvement, but it’s also going to make the management of the right or the optimal decision that much more challenging to think through. Some of the nuances will definitely necessitate updati
