Pension Basics For Self-Employed Professionals & Business Owners

I often hear physicians and other incorporated professionals lament that they don’t have a pension. Sometimes, that is tainted by a dose of pension envy. Unfortunately, that envy is leveraged by companies selling pension products. Products have benefits, but they come with costs and trade-offs. Self-employed Canadians actually have multiple options to plan for their retirement. Including pension products. Learn the basics of how pensions work and the options available to self-employed business owners. That way, you can make an informed logical decision guided by your goals rather than one based on envy or FOMO.

Pensions Are Part of Employee Compensation


The Pension Shell-Game

The first step to taking a logical look at pension options is to set pension envy aside. A pension is part of an employee’s compensation package. If an employer is paying money into a pension as part of the cost allocated to paying for their worker, then that is also money that could have been paid directly to the worker instead. Usually, the employee is also forced to contribute from their pay to participate.

It is all a shell game because all of the money comes from the employer. Whether part appears on the employee’s paystub or not. Still, that does have better optics, a feeling of ownership for the employee, and can be a retention incentive. The forced-saving and arms-length investment management may also foster behavioral advantages.


Self-employed business owners have no pension illusions. They have options.

For the self-employed, there are no illusions. We make money in our business and decide how to compensate ourselves.

medicus pension

For incorporated business owners, that usually means a mix of salary and dividends.

Paying dividends leaves more partially-taxed money in the corporation to grow and access later. Kind of like a pension except that the investment income is taxable and it is not 100% tax-deferral.

Paying a salary takes more money out of the corporation now, but allows you to contribute to fully tax-deferred and tax-sheltered pensions or pension-like registered accounts.

For unincorporated business owners, there is no choice. The profits of their business are taxed as personal income, they pay into the Canada Pension Plan (CPP) or Quebec Pension Plan (QPP). They also get room to fund their Registered Retirement Savings Plan (RRSP).

Basic Pension Terminology

Before getting into the options for pensions, you must understand some of the terminology that goes with them.


Defined Benefit Pensions

For a defined benefit (DB) pension, the employer/employee contributes to the pension plan. The money is invested, managed, and funded to target a defined benefit. For example, 2% of your salary per year of service. This means that there are actuarial calculations to define how much funding and performance is needed to meet that target. If you were to access the pension early, the annual income is reduced to reflect the shorter investment period and longer projected retirement drawdown period.

The employer assumes the majority of the risk. If the pension investments are underperforming relative to the predicted pension liability, then they must contribute more to keep the pension adequately funded. This is why this type of pension is hard to find anymore outside of the public service. Self-employed private corporation owners can use that liability to transfer more funds from their company to their pension plan. More on that later.


Defined Contribution Pensions

With a defined contribution pension, the employer may contribute a defined amount to the pension each year or it may match contributions by the employee up to a maximum. The eventual pay-out depends on how well the investments held in the pension do. It is very similar to an RRSP, except that the employer often has a limited selection of funds that you could choose from.

Just like with other investments, the risk and returns depend on what the pension holds. The largest impacts are usually from the asset allocation (stocks:bonds) and the drag caused by the fees. Higher management fees are generally associated with worse performance. Unfortunately, the investment fund selection may be limited due to whatever arrangement the employer has with the pension provider. If there is employer matching, then that may offset the fees. However, if not, then perhaps a self-directed RRSP with low-cost asset allocation ETFs instead may be a better option.


Commuting a Pension

If you leave an employer or The Terminator gets you, then there is an option to commute your pension. That means the pension is valued and the money moved out. For a DB pension, that involves an actuarial assessment and there are rules to value the pension based on how much it would cost to provide the benefit entitlement. A DC pension is more straightforward since it is just an account value.

The pension can be commuted to a new pension or Locked-In Retirement Arrangement (LIRA). For DB pensions, usually, only a portion can be commuted to a sheltered account. An additional lump sum cash payment could also be paid out. It would be taxable as income if you don’t have extra RRSP contribution room to shelter it in. For DC pensions, the involuntary contributions go to a LIRA. If there were excess voluntary contributions, then they could be transferred to an RRSP.


RRSP, RRIF, LIRA, & LIF

An RRSP is a registered account that is meant to be used to save for retirement. At retirement, or by age 71, an RRSP is converted to a registered retirement income fund (RRIF). There are then minimal required annual withdrawals.

A LIRA is an account that a pension was commuted to and the money is “locked in” the account until at least age 55. Some provinces allow the unlocking of a LIRA into an RRSP or RRIF. At retirement, the LIRA can be converted to a Life Income Fund (LIF) and possibly an RRIF.

pension basics

Independent Pension Plan & Personal Pension Plan

There are a few different flavors of registered pension plans (RPP). An RPP is governed by a specific set of rules. They are similar to the RRSP rules in some ways, like tax treatment. However, they have some differences in the investing rules, ownership, and creditor protection. We’ll explore that in the next section, but first the different flavors. For self-employed private corporation owners, the two main pension options are an IPP and the proprietary PPP variant.

An independent pension plan is a pension that is owned by a Canadian Controlled Private Company. It is usually for an individual but can be for a family employee/shareholder also. They are usually DB pensions but can be DC.

A personal pension plan (PPP) is a trademarked proprietary version of IPPs. It has a defined benefit IPP, a defined contribution IPP, and a voluntary additional contributions account. A PPP is a packaged product by Integris that comes with the actuarial, tax lawyer, and pension expert support to use the different PPP accounts as conditions warrant.

For an IPP or PPP, you need an actuarial to help with the required RPP filings, a brokerage that holds the IPP accounts, and investments held within those accounts.


Group Pension Plan & Multi-Employer Pension Plan

A group pension plan (GPP) is an employer-sponsored RPP. This is your classic defined benefit pension plan, like the teacher’s pensions or public servant pensions. Everything is held in trust by the pension and managed by the pension managers.

A multi-employer pension plan (MEPP) is a type of GPP that has multiple companies paying into it. The new Medicus Pension Plan from Scotia Bank is an example of this. It is vital to understand that this is NOT a type of IPP or PPP. The characteristics of this type of plan are very different from the IPP/PPP option. Or the RRSP option. You should park any pension envy that you have and logically compare this product to your other self-employed pension options.

Pension Taxes Investments & Dispositions


Pension & RRSP/LIRA Tax Treatment

All pension options have pretty similar tax treatment. The contributions are made with pre-tax dollars. Contributions to an employer-sponsored pension (IPP/PPP/GPP) are a business expense and also not income for the employee. With an RRSP, the contribution is deductible against income. So, it is not taxed.

The amount that you can contribute is also global. For example, contributing to a pension reduces how much RRSP room you have due to a pension adjustment. You could have a personal plus a spousal RRSP, but the contribution limits are shared by the contributor.

Investments within the pension grow tax-free and there is no tax on dividends or interest. There could be some foreign withholding taxes for dividends from funds or stocks domiciled in a country without pensions as part of their tax treaties with Canada. The biggest market is the US. Fortunately, RRSPs and pensions are exempt from US foreign withholding taxes.

When income is paid out of the pension, it is then taxed as regular income. So, pensions and RRSPs are basically tax deferral vehicles, with tax-sheltered growth along the way.


Investment Management

With an RRSP, LIRA, or IPP/PPP you have options for investment management. An RRSP and LIRA can easily be managed as self-directed accounts. Alternatively, you could use a good financial advisor to manage it, using your input. An IPP can also be self-directed for investment management in theory. However, it also requires actuarial assessments and annual filings. So, IPPs are most commonly used in conjunction with a financial advisor to help stick-handle some of those administrative tasks.

Employer-sponsored plans limit your investment management options. For a DC plan, there is usually a limited selection of mutual funds to choose from. For a DB plan, you have no choice. The investments are managed by pension managers.

Pension managers take a different approach to risk management than we do as individuals. They are building a portfolio to match the liabilities of the pension over an ultra-long time frame. In contrast, as individuals, we try to maximize the investment risk required to meet our goals. Balanced by enough stability to tolerate that risk and have our basic needs protected. We also do that over a time frame that matches our retirement and lifespan.


Investment Holdings

All pension types (IPP/PPP/GPP) have some differences in the investments allowed. They cannot have more than 10% in a single security. Importantly, a well-diversified mutual fund or ETF does not count as a single security – it holds many.

Pensions can also hold private equity. That is usually touted as a strength. However, the returns of private equity are more complex than promoted. They may not be superior when you account for the pricing issues and leverage. Alternatively, if you really want to, you could hold those assets elsewhere.

A large pension plan may hold some private investments directly, classically infrastructure, due to efficiencies of scale for managing that. However, remember that pension managers are looking at risk and return differently and that does not directly translate into what you experience as the return. The main benefit of good performance is that your pension income stream is safer. You may also have some cost of living adjustments if the investments consistently do much better than anticipated, net of fees.


Creditors & Ex-spouses

In the event of bankruptcy, pensions, Life Income Funds (LIF), and Locked-in Retirement Accounts (LIRAs) are protected from creditors in all provinces. Registered Retirement Income Funds (RRIFs) that have been converted from an RRSP have full protection in some provinces. Notably, in some provinces, an RRSP does not have full creditor protection unless it is holding insurance products with a designated beneficiary. Further, RRSP contributions within 12 months of declaring bankruptcy may not be protected.

In the event of a divorce, pensions or RRSPs accrued during the marriage are valued and form part of the assets that get divided between the splitting couple. For a self-employed professional, this includes a pension held by their private corporation. In practice, that usually means an equalization payment is made from the overall assets (not directly from the pension or RRSP).


‘Till Death Do You Part

What happens to the income stream and assets of a pension when the primary pensioner dies varies. Some pensions may have survivor benefits. In that case, the surviving spouse may receive a portion of the original pension income stream. It could be the full pension or it could be much less. Some pensions will value the pension and it can be commuted if the spouse dies before their earliest possible retirement age.

In the case of an RRSP, the full RRSP can be transferred to the surviving spouse. It could even be transferred to a qualifying survivor such as a dependent child or grandchild. It is important to have the spouse named as beneficiary (instead of the estate). Plus, file the terminal tax return and some additional paperwork properly. Overall, the net effect is continued tax deferral and sheltering.


The Final End-Game

When the pensioner dies without a surviving spouse, or the surviving spouse dies, the income stream of a pension ends. What happens to the residual assets that were providing that income depends on the type of pension it was.

For an IPP/PPP owned by a private corporation, the assets form part of the corporation. If the corporation is wound down due to the death of the self-employed corporation shareholders, then the pension value goes back to the corporation. There would be taxes and possibly probate depending on your corporate estate planning. Family businesses that are continuing, can simply have the pension continue within the corporation for the benefit of the next generation.

If it was a multi-employer pension plan (MEPP) or an employer-run group pension plan (GPP), then the assets simply stay in the plan to support the other members. Read that sentence again, if you are considering a MEPP.

An RRSP/RRIF would be considered part of the deceased estate. The residual, after-taxes plus probate, would be dispersed according to the will.

pension investing

Pensions Available To Everyone


Mandatory Canadian Public Pensions

When you collect T4 or T4A income, there are mandatory pension contributions to Canada Pension Plan (CCP) or Quebec Pension Plan (QPP). They are sometimes called payroll taxes. However, the CPP or QPP contributions are actually mandatory pension contributions.

Self-employed individuals pay both the employee and employer halves of the required contribution. So, there is no compensation shell game. The important concept is that you get a relatively safe, predictable income stream proportional to what you contributed. It is indexed to inflation with some survivor benefits. Overall, it is a decent risk-adjusted return and a defined benefit pension. However, the pension is small compared to what most self-employed professionals will need.


Registered Retirement Savings Plan

Collecting T4 or T4A income also generates RRSP room. The RRSP is functionally similar to a defined contribution pension. You get 18% of your income, up to an annual maximum as contribution room. For example, it was $30780 for 2022 – corresponding to an income of $171K. The maximum contribution increases with inflation each year. It will be $31.5K for $175K salary in 2023. Unused contribution room accumulates. Contributions are 100% tax deductible and unused deductions can be carried forward to a higher income year.

It is important to understand that an RRSP is an account type. A container. Like defined contribution pensions, you can hold a wide variety of investments within an RRSP which will ultimately determine its value at retirement time. You may choose to DIY invest to minimize the drag of fees on performance or use an advisor if you feel they will provide good value for the cost.

Self-Employed Pension Options

As mentioned above, income that you take as personally earned income opens the door to pensions. The earned income from a non-incorporated business is captured as the income that appears on your T4 or T4A slip. The graphic below summarizes some of the big major options to get oriented to. Then, take a deeper dive into the text below.

IPP PPP MEPP self-employed pensions

Using an Independent Pension Plan For Incorporated Business Owners

A self-employed incorporated business owner generates years of service for pension purposes when they pay themselves a salary. The main advantages of an IPP don’t really come into play until you are in your early 40s due to the balance between the actuarial calculations and costs. So, most private corporation owners would use their RRSP before then. The years of service and RRSP balance can be used to buy back years of service when opening the IPP. That usually means the transfer of some of the RRSP into the IPP and a lump sum contribution by the corporation.

The corporation makes direct contributions to the IPP each year as a deductible business expense. The amount it can contribute is usually more than an RRSP. For example, roughly the same as an RRSP in the late 30s and growing to perhaps $50K at age 65. This is due to the actuarial calculation of the cost to provide the targeted benefit. So, it will vary based on many factors.

Because it is targeted to a benefit, the corporation may be able to contribute extra when investments underperform a 7.5%/yr benchmark or be forced to take contribution holidays when the investments exceed that. So, the type of investments you hold and their expected return influence the utility of an IPP.

You can technically DIY invest an IPP. However, with the administrative complexity, most use an advisor. Those advisor fees will drag on the return a bit. However, if already using an advisor, then an IPP at least has other advantages and you are paying anyway. Ben Felix and Braden Warwick recently did a very in-depth analysis of the potential benefit of IPPs that assumes the same fees whether using an RRSP or IPP.


When could a PPP offer advantages?

A PPP has most of the exact same features as an IPP. An IPP could also be contorted to emulate a PPP. However, Integris does streamline the processes considerably. The CEO of Integris explains IPPs on the Beyond MD Podcast. After giving it some critical thought, I can see some potential advantages to using a PPP instead of an IPP.

The PPP service provides tax lawyers, pension experts, and actuaries all in one stop. The IPP is a complex instrument. So, that is an advantage for implementation. The PPP can also more smoothly shift contributions to use defined benefit mode when markets are lagging and DC mode when they are smoking hot. You could even potentially hold your bonds in the DB account and equities in the DC account. Those strategies should translate into more money shifted from the corporation into the pension.

The main benefit of the third “overflow” voluntary account is if you have a family business with young members that you want to participate in the pension. The actuarial calculation does not favor those under the age of 37 relative to an RRSP. However, they could park some of that contribution shortfall within the pension management structure this way.

Naturally, that PPP packaging comes with an extra cost. Whether that is worth it relative to using another actuarial firm and a financial advisor experienced with IPPs depends heavily on your circumstances and preferences.


Multi-Employer Pension Plans (eg. Medicus)

The Medicus Pension Plan(TM) is a MEPP that is targeted at self-employed incorporated physicians by MD Financial and Scotiabank. I hope from reading the sections on pension terminology and pension characteristics that you already understand this is completely different from an RRSP or an IPP.

A MEPP is a packaged product. There are other MEPP products that corporations can buy for their employees, but I am going to use Medicus as my example. I am neither for nor against Medicus and I cannot give specific details about it. That is the nature of opaque financial products. So, is the fact that they are made to be sold and generate income for the selling institution. What you need to consider is what the high-level pros and cons are. Consider how they align with your approach. Plus, how they compare to your alternatives.


Potential Multi-Employer Pension Plan Benefits

One big advantage of pooling investments with a group is that members would be drawing from the plan at different times. So, that spreads out the risk of retiring and starting to draw money during a market downturn causing investments to miss the ride back up. This sequence of returns risk (SORR) decreases a portfolio’s survivability and a group plan mitigates that. If on your own, you could mitigate SORR with asset allocation strategies, or flexible cash flow options.

Similarly, the investment horizon for a MEPP spans multiple lifetimes. In contrast, a self-employed individual typically has a horizon in the 25-50 year range for their pension. It shortens as you age, but the uncertainty of outliving your money also decreases with age. I am not sure how much of a practical difference this makes despite being touted as a benefit. I want to see my investments paying off in less than a 100-year time horizon.

The management model may be a benefit or a pitfall depending on your preferences. If you want to just give your money and have someone manage it with no decision-making required of you – then it is perfect. A pension manager will manage it. There are also some economies of scale. However, the fees are unknown and certainly vastly higher than a passive management strategy. An advisor has more transparent costs and you have input into the investment strategy.

A MEPP permits holding some assets that an RRSP isn’t allowed to. As previously mentioned, IPPs or PPPs have the same options. Perhaps, the one difference may be the direct management of private equity assets and infrastructure investments. Either way, you pay for the management and have manager execution risk.


Potential Multi-Employer Pension Plan Pitfalls

For Medicus, the initial contribution looks to be the same as an RRSP. It is a defined benefit plan. So, there will be actuarial calculations. However, it is a group that is being used. So, you will not benefit from the rapidly escalating contributions that an IPP/PPP is likely to have as you get closer to age 65.

The assets in a MEPP that support the target income stream are owned by the group. You can get a spousal survivor benefit. However, once the second death of a couple occurs the residual assets stay in the group plan to support other members. In contrast, an RRSP would be passed on to beneficiaries. Same with an IPP or PPP – either within your family corporation or as your corporation is dispensed to beneficiaries.

If the pension is overfunded, there could be cost of living adjustments. Within regulated guard rails. Conversely, if the MEPP is underfunded, benefits could be reduced. The product is sold as a reliable income stream. It likely is, with control of contributions and investments matched to the projected pension liability. However, there is some downside risk and a cap on upside potential too.

What if you have second thoughts? You can withdraw from a MEPP. That results in valuing your share of the pension and commuting it. Just like other DB pensions. There are rules about how to value it, but there is some potential for loss. For a MEPP, the commuted value may be reduced based on the funded value of the plan at the time you are leaving it. In contrast, with an IPP or PPP, all of the money gets back to you. Regardless of valuation rules and timing.

How I Would Weigh The Pension Options?

I have summarized the different pension options for self-employed incorporated professionals in the table below. These are just my personal thoughts. Feel free to put your own in the comments section. Also, pensions are a complex tangled mess across the country. So, if I have gotten something wrong, please call that out in the comments – along with a reliable reference. I plan to update the post accordingly.

incorporated pension options

If I use a highly competent advisor already

If I were using an advisor and paying them fees to handle paperwork and investment management, then I think an IPP or PPP would be a serious consideration for me in my 40s. Particularly, if I had a significant conservative part of my portfolio (like bonds) to hide in there and a large corporation. That way I could shift more corporate money into a tax shelter. In my younger years, I would just use my RRSP. At retirement, I would likely put a terminal lump sum into the pension from the corporation and then commute it to avoid ongoing excess costs.


If I am DIY investing

If using low-cost DIY investing, then I think it is a tougher decision. The advantages of an IPP may not be offset by the increased cost of investing using an advisor. Trying to DIY the IPP has execution risks if you miss filings or don’t handle some nuance properly. If I could make this really simple and turn-key, then I would consider it – but I am also a finance nerd. Further, the incremental benefit of an IPP over an RRSP depends on the returns. If I have an all-equity RRSP then I very well may exceed the 7.5% return frequently. Muting the benefit of an IPP.


If I am extremely hands-off & have pension envy

If I just want to give someone my money, not be involved, and I trust them to deliver the promised income stream, then a MEPP could be a good option. It may be even better if I have a very expensive advisor/fund cost model and the MEPP comparatively lowers costs through economies of scale. That would be impossible to know because the fees are opaque. It may leave less money for my heirs, but I could flex that “I have a DB group pension just like the civil servants, it has professional pension managers and owns infrastructure”. While quietly forgetting the fact that I still paid the bill for all of that. There are no free lunches, but it does help force some consumption.

28 comments

  1. There are 3 ways to manage financial risk: diversification, hedging and insurance. Pensions are usually considered in the insurance category. Pensions may be used to mitigate longevity risk, market risk and cognitive risk among others. Pension are used to manage risk: one shouldn’t necessarily expect that you will do better financially with a pension, as increased return is not a goal of pensions. All other things being equal, your return would probably be better outside a pension than inside a pension. However, taxation and government rules may mean all other things are not equal. But with mortality credits in a pension plan, one may get a higher income from a pension than other investment products.

    Personally, I’m not that interested in the pension options available to me. I don’t see a compelling need for me to have an insurance product to mitigate the risks mentioned in the preceding paragraph. Two exceptions are CPP and RRSPs, where the government has stacked the deck in their favor.

    Pensions are a form of annuity, so it’s reasonable to consider annuities in this situation. With an annuity, you’ve bought yourself a pension. When I’m in my late 70s and if income is an issue, I’d consider an annuity. At that age, the mortality credits would give my increased income. And also by that age, the effect of inflation on annuity payments will be less, due to the shorter lifespan.

    1. Thanks Park. I agree that you are deciding to probably leave some money on the table in exchange for other benefits with pension products. Another benefit that I don’t think I spelled out is that a pension (or annuity) can force you to spend in retirement. That may seem silly, but a lot of people who spend their lives saving and accumulating have a really hard time flipping the switch to spending. They die with massive estates. Taking forced payments could offer them utility while alive – even if they leave a smaller estate. I am getting much better at spending, but can definitely see this as an issue for those with significant assets.

      An RRSP or an IPP/PPP (if you can find a way to do it cost effectively) I think are the two options that I am most interested in. As you mention, some of the government rules help. Plus, you can see what’s going on. I have an aversion to opaque products because they tend to have the rules stacked in the seller’s favor. Still, I do know plenty of people who like them because the wrappers are shiny and they can be hands-off.
      -LD

  2. Thanks for the great write up. Must took hours just for the research.

    I always wondered about government pensions. They get 60% after 30 years service based on last 5 years of income. I guess it’s not free money and they have to contribute a significant amount of their income as well?

    I contacted Integris a few years back but was already skeptical due to PFI influence. My accountant advised to consider starting IPP late (60’s) and then close it after a few years to minimize cost.

    1. Thanks BC Doc. This post was a long time in the works. Government worker pensions are an interesting beast. It all comes from the employer really, but that is the government. With a business, there would be a tension between paying more for workers/benefits against not having a profitable business and therefore no jobs. That keeps a balance. With government, the only limit to pay more is the government’s ability to get credit and the politician’s ability to get re-elected. So, that intrinsic balance is looser.

      I am going to spend some more personal time looking at the IPP/PPP options. It is possible to open a self-directed IPP or PPP at CI Financial. However, if I were to consider it, then Integris or whatever actuarial company I used (there are a few that do this) would need to really make it seamless for filing etc while I move the money and invest it. I would also look at opening it for a few years and then commuting it when I actually retire.
      -LD

  3. I thank you greatly for your nerdiness and the fact that you give so much of your time to help professionals (not just doctors, I am a lawyer). Another factor you have not mentioned is that MEPPs usually allow/require the corporation to pay half the contribution, which is deductible to the corp and does not need to be withdrawn from the corp to deposit to an RRSP. This rather significant benefit is not available to RRSPs.

    1. Thanks IG -I am happy that I am reaching all sorts of professionals. We share the similar issues and need to help each other out.

      The corp deduction/withdrawal reasoning is used in the pitch. However, I don’t see that it actually makes a difference (unless the corporation is owned by someone else). You need to have paid the same salary to generate the RRSP or MEPP contribution room. Then, with the contribution – let’s say $30K. The corp could put the full $30K in the MEPP. That is $30K deductible to the corp. No corp tax and $30k withdrawn from the corp. For an RRSP, I could pay $30K salary – deductible to the corp. No corp tax and $30K out of the corp. The $30K RRSP contribution is personally deductible. No personal tax either. So, overall – no difference. The various pension options and RRSP are all 100% pre-tax (personal and corp) and the money all originates from the corp. One expense that is different, is that with an IPP/PPP the management costs are a corporate expense. With an MEPP, they are buried in the plan. With an RRSP, they are not directly deductible.
      -LD

  4. Excellent work as usual.

    A few years ago I spent $90 for the CSI IPP course online and got free projections from West Coast and GBL. I found it wasn’t very advantageous for retirement at 55. I encourage any one interested to do the same, especially now that PWL has boosted the IPP’s reputation.

    I’d like to explore rolling over RRSP to annuity at age 70. If I’m rich and healthy, maybe an ALDA. Between that and CPP, that eliminates several risks as Park points out.

    icudoc

    1. Thanks icudoc. That is definitely the way to do it. I embedded a link to the CSI course in your comment. Look at the math for your situation from an actuarial and consider if worth it. Also, consider the piece of mind and behavioral factors (they are very important).
      -LD

  5. This is a great post. Thanks for this.
    Would you consider doing another post adding in whole life as another comparison? I got interested in IPPs and started looking into them, but since after a bit my adviser has been trying to steer me towards whole life as being superior to IPPs in every way. Would love to see a comparison of that as a savings/pension vehicle.

    1. Hey RI,

      I have touched on it. I never thought to do a comparison with an IPP. I do not think it would be superior at all!! It is a much more fee laden product (with high commissions for selling it, incidentally). That would be okay, if it had benefits outweighing the underperformance. You would have a lower expected return than using an IPP with a balanced portfolio invested inside. Whole life is usually touted because of tax savings, but the fees and lower expected returns are left out of the discussion (and opaque if you did want to know). I would rather pay a bit more tax because I made a lot more money. I wrote a bit about whole life insurance and there are also some comments on that post.
      -LD

      1. Hi LD,

        Yes, I remember your previous post – it was a great, high-level way of looking at insurance. But I have heard multiple times from advisors about how whole life is tax-efficient – essentially hinting that you can get a tax deduction in the corp, and then borrow against it, all without ever paying any tax. I’m a bit skeptical that it actually works out that way, so digging into the weeds to understand where these advisors are leaving out information is helpful. Especially if they are marketing it as an investment product, comparing it as an investment product against other investment types (such as pensions, or just accumulating investments in the corporation)

        1. Hi RI,
          Whole life is tax efficient. However, so are capital gains from any investment. The expected return of an insurance policy is going to be low. Alternatively, I would rather invest in a more balanced way. Yes, there would be taxes, but I would also likely have a much higher return. I would rather make $100K and pay $25K tax, leaving me $75K than make $50K tax-free. The whole life argument focuses on the $25K of tax and ignores the extra $25K of after-tax profit. That is just an illustration of the argument (no one knows what returns will be), but risk and return are strongly related. Insurance is low risk (that is the point of insurance), but is also expected to have a low return. I would use insurance vehicles to insure against disasters I can’t plan for or handle, and investment vehicles for investing.
          -LD

  6. Loonie Doc, thanks for the post, which is well worth reading. The following may be stating the obvious, but I still think it’s worth mentioning. One good (IMO) pension option is delaying CPP/OAS benefits to age 70.

    About permanent life insurance, I find it somewhat opaque and complicated (that might say more about me than about permanent life insurance ๐Ÿ™‚ ). Regardless, the primary purpose of insurance is to manage risk. You pay an insurance company money, and in return, you transfer risk to the insurance company. With investing, it’s the opposite. You pay an asset owner money, and in return, the risk of the asset is transferred to you; you expect to earn a risk premium by owning the asset. Life insurance as an investment makes me think of having the foot on the brake and the accelerator at the same time.

    1. Thanks Park.

      I like that description of insurance vs investing liability. Those who take the calculated risks usually reap the rewards over the long run. The insurance company even makes the rules of the game.

      The “when to take CPP/OAS” is an interesting debate. Some suggest taking it early and spending it since life is uncertain. I can see that. However, I agree with you that delaying is good option if you aren’t skimping on life by delaying. The increase in income from delaying CPP would be hard to beat through taking on investment risks (about a 7% inflation-adjusted return and with little risk). Of course, if I had poor health, then I wouldn’t delay because the risk of dying early changes things.

      -LD

      1. I’m sorry if I”m posting too much or going off topic. But there are readers who might find this information useful.

        From p. 144 of Lifecycle Investing by Ayres and Nalebuff, “few insurance products operate with less than 30% overhead and profit margins”. That means an expense ratio of 30%. I have money invested in XIC, which provides Canadian stock exposure and has an expense ratio of 0.06%. Which am I more likely to make money from?

        https://humbledollar.com/2019/11/value-for-your-cash/#:~:text=According%20to%20the%20Society%20of%20Actuaries%2C%20close%20to%2040%25%20of%20permanent%20life%20policyholders%20lapse%20their%20policies%20in%20the%20first%20five%20years.%20By%20year%2010%2C%20that%20number%20is%20close%20to%2060%25.

        “According to the Society of Actuaries, close to 40% of permanent life policyholders lapse their policies in the first five years. By year 10, that number is close to 60%. ”

        If you’re one of that 60%, permanent life was a bad deal. OTOH, that 60% makes it a better deal for those who keep their policies.

        Jamie Golombek has made the case for permanent insurance, if the money is intended as an inheritance and would otherwise be invested in fixed income. I respect Jamie Golombek, so I suspect he’s right. But how many people are in that situation?

        1. Not at all Park. These are all great comments that add to the discussion. It is funny how whole life comes up as being sold for just about any topic from investing to RESPs to pensions. A testament to marketing. I also think that there can be some cases where whole life is useful, but it is sold for so many other reasons that aren’t great. That makes up the vast majority and gives it a bad wrap (rightfully in those instances). The policy lapsing data is a testament to people realizing it, but sadly after the fact. Whole life is like a marriage – a long-term commitment and expensive to get out of if you made a mistake.

          I have a small policy that I got years ago for a “fixed-income-like”, return not strongly correlated to interest rates, in my corporation that will form part of my estate. It is miniscule and I count it in my “fixed income” asset allocation even though I will likely never need to borrow against it. Still, I could do without it and have planned other ways instead. But didn’t know any better when I got sold it by my advisor at the time. Part of why I did it is because I thought interest rates could only go up at that point – we are now just getting back up to the rates when I bought it. I thought I was being clever, but really just another lesson about my ability to predict the future.

          I think that the one good usage I can see is if I had a family business or real estate that I wanted to pass onto my family and not risk them having to sell to pay taxes. I could insure to cover the tax bill. Of course, I could plan to have enough invested liquid assets to cover it (likely with a higher return), but the insurance would insure against the issue. Insurance to cover a risk (at a cost).

          Thanks for both reading and bringing really great comments and discussion.
          -LD

        2. Once again, off topic, but others might find this of use. When I invest in XIC, I’m investing in a highly liquid asset. After 10 years, I can readily sell it, with a reasonable chance that I’ll have made money. When I invest in a permanent life insurance policy, I’m investing in a highly illiquid asset; the 60% who let their policies lapse by year 10 are aware of that. There’s nothing inherently wrong in investing in a highly illiquid asset. But in investing, I try to only take risks that I get compensated for. If you’re taking on liquidity risk, you want a liquidity risk premium. I’ve never heard anyone talk about a liquidity risk premium, when it comes to buying insurance as an investment.

          1. Definitely. Divorcing your insurance is likely to be slow and costly ๐Ÿ˜‰ And you don’t get well compensated for taking it on – the sales person does though.
            -LD

    1. Yes. When CPP first came out it was a super-deal. There were lots of contributors and few pensioners. With time that shifted and they needed to make some changes to make it sustainable. They increased the contributions. Now, it is an okay deal – but readily sustainable.
      -LD

  7. This was an earlier comment from Park that for some reason wasn’t posting properly:

    “Do you get better returns with a pension? It is true that pension funds usually have better access to alternative investments than individual investors. And there are institutional investors (David Swensen was an example) who have done well with alternative investments. But many have not. Pension funds have a long time horizon, which helps in investing. But pension funds have to relatively closely match assets to liabilities, which may decrease return. There are individual investors not as encumbered by that need to asset liability match. I haven’t seen data comparing target date funds to pension funds, when it comes to investment return. I wouldn’t be surprised if the returns aren’t greatly different.

    What you do get is risk management with a pension. And an important part of that is risk pooling, a common feature of insurance. The money you contribute to a pension goes into that pool and stays in that pool, other than income distributions to members of the pool. So this greatly decreases the risk of running out of income prior to passing away. And you’ll likely get greater income by being part of the pool. OTOH, you take the risk of financial loss by being part of the pool, if you die earlier than the average person in the pool. And nothing you put in the pool will end up in your estate.

    CPP is a pension. MEPP looks like it is a pension. An IPP/PPP is a pension, but it is a pension plan for one person. It’s not possible to pool risk in that circumstance, although it has the advantage that it can end up in your estate. If you convert your RRSP to an annuity, I think you can make the case that that is a pension. If an RRSP is converted to a RRIF, I’m not certain that I would consider that a pension.

    Does a physician want a pension? A good reason to have a pension is to manage risk (longevity risk, market risk, dementia risk and CPP as the bonus of dealing with inflation risk). If you’ve got a large portfolio relative to retirement income needs, the case for a pension is weaker though. But government rules and taxes may make a pension a reasonable investment option.

    Does a physician need CPP? For most, the answer would be no. The amount of CPP income is such that its ability to mitigate risk is limited. Because I’m incorporated, I could avoid contributing to it, if I wanted to. But I want fixed income in retirement as a substitute for the fixed income of wages, and I’m primarily a taxable investor: the return on taxable fixed income is not good. The government treats CPP in an advantageous manner, such that CPP is a reasonable alternative to taxable fixed income in retirement. This assumes below average longevity is not an issue.

    Does a physician need an RRSP converted to an annuity – in other words, an RRSP pension? I may be wrong on this, but I don’t think many physicians choose the annuity option over an RRIF. If that is true, it means the risk management features of an RRSP pension aren’t that important to most physicians. But an RRSP converted to an RRIF is very popular among physicians, which makes sense based on the tax advantaged nature of RRSPs/RRIFs.

    I haven’t spent a lot of time on IPPs/PPPs, as they are less compelling in my personal circumstances. I have noticed the increased cost and complexity, although the advantages of an IPP/PPP may very well overcome those issues for many physicians. My guess – with the emphasis on guess – is that most physicians are attracted to IPPs not due to their pension properties, but rather the tax planning opportunity.”

  8. Life insurance is backed by Assuris, which is an organization that regulators require such companies to join. It doesn’t look like there is explicit government backing of insurance, although the regulatory requirement could be implied to mean that there is. If you buy life insurance as an investment, it usually is a long term commitment. As mentioned above, the case is made that life insurance is somewhat analogous to bond investing.

    So my interpretation is that if you buy life insurance to invest, it’s somewhat similar to owning a tax advantaged long term illiquid bond fund with an expense ratio of 30+% that exclusively owns corporate bonds issued by the life insurance industry. Are those bonds nominal or inflation indexed in nature? I don’t know, but my guess is that they are more nominal in nature.

  9. When it comes to bonds, I would assume that a bond is nominal in nature, unless it is explicitly stated that it is inflation indexed. I’m not aware that life insurance policies have such explicit inflation protection. Some might say that hyperinflation – such as in the Weimar republic = won’t happen in Canada. But there was material inflation in the 1970s in Canada. Will it happen again? I don’t know, but despite a Bank of Canada goal of 2% inflation, it was 6.8% in 2022. If there is similar future inflation to the 1970s, I think that the life insurance companies will put their interests over the policy owners.

    Long term nominal bonds can be an excellent way to hedge out the risk of long term nominal liabilities, and pension funds and insurance companies use them for that purpose. They mitigate the risk of a noninflationary stock bear market (that assumes bond liquidity) and also mitigate deflation risk. However, I’ve never heard anyone discuss long term bonds (nominal or inflation indexed) as a way to make money, but only as a way to manage risk. And among those who advocate the use of long term bonds, I’ve never heard someone advocate the use of long term corporate bonds over long term government bonds, especially when the long term corporate bonds come exclusively from one industry in the economy.

    1. I agree. I think an interesting point in this is about portfolio design. We use bonds in our own portfolios to manage risk. Not really to make income per se, but get some return while improving our comfort and behavior which, if we don’t, can drag down our real-life returns. Government bonds do that the best and an argument can be made to only use government bonds of various durations.

      When considering insurance as bond-like, its actual performance may be like corporate bonds of one industry. An interesting thought and good rationale. I am not sure what the data would show (and we’ll never get it because insurance returns are so opaque). Still, the opaque performance and pricing means that it may not be the best way to sooth behavior. The participating whole life policies often smooth out their “dividends” which may be a good thing, but I bet most people with whole life don’t really know what their returns are. The actual returns are tricky because they price the policies with a return for their underlying investments in mind, and whether you do better or worse is a function of how well the actuarial predicted what eventually happens. Plus, mysterious adjustments that they can make.

      Bonds (particularly government bonds) are best suited for their role in a portfolio. Insurance could work. You get some tax efficiency, but may not be getting as much benefit to your portfolio function as government bonds would provide.
      -LD

    2. I’m on a bit of rant here :-). Most of us have long term real liabilities, and not long term nominal liabilities. Long term government bond ownership works well in noninflationary stock bear markets, but bond illiquidity negates that, and long term corporate bond ownership may not work well in noninflationary stock bear markets. Finally, with fiat currency, deflation has not been a significant issue.

      There is a tax advantage to using life insurance to invest. But that advantage has a significant headwind to overcome. And it also assumes that the tax advantage persists. Tax policy 40 years from now will have changed, and the tax advantage may no longer exist. When you buy life insurance to invest, you’re taking on tax risk. A general principle in investing is to only take on risk that generates a risk premium. Are you getting such a premium, when you take on that tax risk?

  10. With insurance as an investment, you’re taking on credit risk, duration risk, liquidity risk, taxation risk and probably inflation risk. Are you receiving risk premia for assuming these risks?

    I doubt it. The underlying problem is that you’re asking a financial product to do what it’s not designed to do. The purpose of insurance is to manage risk and not to be an investment.

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