Pensions for physicians – an emerging solution for Canada

While nurses and other health professionals have had the benefit of classic defined benefit pension plans for many decades (the Healthcare of Ontario Pension Plan comes to mind), physicians have not had this privilege until very recently.

As independent business owners supplying their labour to provincial health programs, the absence of an employer / employee relationship between the provinces and the physicians precluded the establishment of a true registered pension plan. The best that physicians could hope for was using a registered retirement savings plan (RRSP) and it is interesting to note that the very first RRSP ever created was for the Canadian Medical Association back in the late 1950s.

The long march for ‘pension parity’ accelerated when provincial governments allowed physicians who operated as ‘sole proprietors’ from a tax point of view to incorporate as medicine professional corporations (MPC). The resulting employer/employee relationship, coupled with the payment of T4 income (eg salary and/or bonus), made it possible for the MPC to sponsor and fund a registered pension plan for the physician/employee. 

While many physicians decided to incorporate, and all indications suggest that the overwhelming majority of doctors use an MPC, many shunned T4 compensation preferring instead to receive dividends as their compensation. Prior to January 1, 2014, this provided a slight tax savings advantage over using T4 income. However, the pendulum swung back in favour of T4 compensation nine years ago and, perhaps more importantly, a 100% dividend compensation strategy prevented (and continues to prevent) physicians from setting up true pension plans. The imposition of additional taxes on MPCs that generate too much passive income makes this ‘corporate savings’ strategy, as opposed to using a pension plan, even more tax inefficient.

Given the relatively high incomes of physicians and the need for retirement savings solutions that cannot be accommodated by the RRSP rules, the financial industry started to come up with doctor-focused pension solutions ranging from a group RRSP to a Federation of Personal Pension Plans.

One association offering a group RRSP capped contributions at 18% of earned income, not exceeding the year’s RRSP limit or $30,780 in 2023. It offered an option to purchase an annuity in retirement.

Economies Of Scale

Other solutions include:  A multi-employer pension plan (MEPP) offering provided a defined contribution pension plan, thereby providing economies of scale in terms of money management and transferring the normal fiduciary responsibility that would rest with the MPC to a board of trustees. In another case, a Canadian bank and its financial subsidiary dedicated to doctors recently launched another MEPP, this time offering a DB pension, but one funded on a specified multi-employer (SMEP) basis. In other words, the tax-deductible contributions are capped by the annual DC money purchase limit ($31,560 in 2023). Both the MEPP and SMEP solutions remove the administrative burden of sponsoring a pension plan and transfer it to a board of trustee set up to administer these multi-employer solutions. Both use a single trust fund to pool assets contributed by the participating employers (eg the MPCs).

The SMEP is interesting in design in that it promises a DB pension, but funds it on a DC basis, meaning that if the investment manager is unable to deliver consistent returns, the board of trustees can reduce accrued benefits. This makes it DB pension in name only. In truth, it is more of a target benefit pension plan. Words are important when ‘selling’ a solution to physicians and one must wonder how the SMEP could sustain defined benefits if the economy moves into a long-term bear market where the returns on the fixed contributions become insufficient to fully fund the promised benefits?

The most recent newcomer is novel in approach and is called the Canadian Physicians’ Pension Plan (CPPP). The CPPP borrows from the philosophy of the group RRSP in that it represents a ‘federation’ of independent personal pension plans (PPP) each one sponsored by its own MPC.

Each physician interested in joining this plan would first register a PPP with the Canada Revenue Agency and then join the federation for additional advantages such as the gradual elimination of annual actuarial fees and economies of scale with respect to the investment management fees paid. PPPs are a combination registered pension plans that offer everything individual pension plans offer, but add two other components ‒ a defined contribution account and an additional voluntary contribution account.

Given the highly taxed nature of MPCs for successful physicians and in light of the TOPI problem (the tax on passive income introduced in 2018 by then federal Finance Minister Bill Morneau), the level of tax deductions available under each of these solutions is important when assessing the value added by these pension solutions.

The group RRSP has the lowest tax deductions since it is capped by the year’s RRSP limit. The DC MEPP and DB SMEP provide slightly higher annual tax limits since both operate under the money purchase limit.

Tax Deductions

At the very top of this hierarchy is the CPPP as PPPs are true DB pensions funded using DB rules. Most mathematical, actuarial modelling shows this increases the tax deductions by a factor of three, if not four, over the lifetime of the physician compared to group RRPS or DC MEPPs/DB SMEPs.

The reasons for this significantly higher tax deduction room stem from the panoply of special rules that govern classic DB arrangements. The ways in which an MPC can contribute more money on a tax-deferred basis to a PPP (and thus the CPPP) than under money purchase arrangements include:

• The ability for the MPC to recognize years of past service when the MPC paid T4 income to the physician.
• The ability in the first year of the PPP for the physician to also make an RRSP contribution that can be rolled into the PPP on a tax deferred basis (via CRA Form T2033).
• The ability to make annual contributions to the DB component of the PPP that exceed both the RRSP and money purchase limit, at all ages. For example, by age 64, a physician in the CPPP can contribute over $20,000 more that year than under a group RRSP or DC MEPP/DB SMEP.
• The ability to contribute the ‘PA Offset Amount’ of $600 to one’s personal RRSP every year thereafter in addition to the above contributions.
• The ability to make ‘special payments’ from the MPC if the rate of return of the assets inside the PPP are below 7.5%. This is particularly useful when large market corrections (COVID 2020 for example) enable the MPC to ‘buy low’ and then ‘sell high’ without incurring taxation with tax assisted dollars.
• The ability to make ‘terminal funding’ contributions if the physician decides to shift from T4 income to T4A pension income prior to the normal retirement age. A physician opting for this does not need to cease practicing medicine, simply to stop collecting a salary and rely instead on a mixture of dividends and pension income as their compensation.

Thus, when it comes to tax deductions, the CPPP also offers the MPC tax relief. It is important to remember that providing three times more tax relief is not the only consideration at play. The act of contributing ‘passive assets’ from the balance sheet of the MPC into the CPPP also generates other advantages, that should be quantified:

• This purifies the shares of the MPC should the doctor decide to exercise the lifetime capital gains exemption at some point in the future.
• This removes passive assets off the balance sheet that will no longer count as passive income when applying the TOPI test on passive income. This protects the MPC’s $500,000 small business limit allowance where corporation taxation is significantly lower than for regular active business income.

When the mechanism to contribute to the PPP is the sale of capital property owned by the MPC (from its non-registered corporate investment account), three additional beneficial tax consequences come into play. Only 50% of the capital gain created by the sale of capital property is taxable to the MPC, but 100% of the proceeds of disposition contributed to the PPP are tax deductible to the MPC. In other words, the MPC pays no tax on liquidating these investments to fund the pension plan. However, since tax is owing on 50%, but the contribution to the PPP represents 100% of the cash contributed, the MPC now enjoys tax losses that can be carried back three years (to secure tax refunds) or forward indefinitely against future taxable income. Last but not least, the other 50% of said capital gains creates credits to the MPC’s capital dividend account (CDA). Thus, the physician could supplement the pension paid under the CPPP with tax-free dividends.

While the rules described above would also apply to an MPC selling off assets to participate in a group RRSP/DC MEPP/DB SMEP, the value is multiplied because of the significantly higher contribution rules given to true DB plans.

Succession Planning

As is the case with most professionals and business owners, physicians also have families and the issue of how their pension assets will be treated upon their death is important. Pension legislation provides a spousal rollover such that upon the demise of the plan member, the assets in the pension plan can transfer to the care of the surviving spouse without any immediate taxation.

The question then becomes, what about if the physician has no spouse on death or both the physician and the spouse pass away at the same time?

Under the Income Tax Act (Canada), money purchase registered assets that aren’t able to roll over to a spouse (or a disabled child) are subject to a deemed disposition and are treated as ordinary income upon which personal tax becomes owing. This is particularly true of group RRSPs and DC MEPPs.

By way of illustration, if a physician accumulates $2 million in assets and dies, roughly $1 million will have to be paid to the tax authorities. In the DB SMEP, if one cannot pay a survivor pension and if the death occurs after the guarantee period (typically five years from the start of the pension when the pension paid is a joint and survivor pension), any surplus reverts to the communal pension fund and is lost to the MPC’s family.  So, if $2 million of surplus exists by the time the physician passes away and there are no guarantee periods payable to the beneficiaries, the entire $2 million is now an ‘actuarial gain’ to the DB SMEP and can now be used by other physicians.

In contrast, for the CPPP member, if there is a death without a spousal rollover, the $2 million surplus stays in the pension fund for that MPC. It is not shared with other physicians. It could remain untaxed if the children of the physicians were plan members if they received some T4 income from the MPC. Thus, the CPPP children/members get the use of the entire $2 million.

If the children were never made members of the PPP, they still get the $2 million, but they will have to report this income on their tax returns.

One should take heart in seeing how the financial industry is offering various pension solutions to Canadian physicians, given the tremendous contributions our doctors make every day to keep the rest of us healthy. That said, all pension plans are not created equally and a review of the various rules that govern each arrangement by qualified practitioners is essential if the goal is to maximize client wealth.

Jean-Pierre Laporte is chief executive officer at Integris Pension Management Corp. [email protected]