Individual Pension Plans
My firm deals almost exclusively with entrepreneurs and owner-managers of corporations. As such, we have reviewed numerous Individual Pension Plan (“IPP”) proposals for our clients over the last few years. In this blog post I am going to review the basic characteristics of an IPP and then discuss proposed changes to the rules pursuant the 2011 budget.
IPP’s are defined benefit pension plans established by an employer for an employee. Typically the IPP is set-up by our client’s corporations for their own benefit, their spouses benefit or for key employees.
The following are some of the key features of an IPP:
1. The contribution to your IPP (think of it as a Registered Retirement Savings Plan “RRSP” with a different acronym) is made with corporate monies and the corporation receives a deduction for the IPP contribution against its corporate income. The key here is that you are using corporate monies and not after-tax monies to fund your IPP. For example, to fund a $22,000 RRSP contribution, a high rate taxpayer would need their corporation to pay them a salary of $40,000 to have the $22,000 to contribute to their RRSP, whereas a corporate contribution would only require $25,000 or so of corporate after-tax net income.
2. For an owner-manager in the sweet spot, say early to mid-fifties, that earns over a $100,000 a year in salary and has worked for the company since 1991, in many cases they are entitled to a past service contribution in the $100,000 to $150,000 range depending upon their prior employment history. This provides a tremendous opportunity for an owner-manager who has a small RRSP due to lack of funding or poor performance to immediately rebuild their retirement fund in one fell swoop. .
3. Upon establishing an IPP, you will cease to be able to contribute to your RRSP and a portion of your RRSP must be transferred to your IPP. Future pension contributions will be made to your IPP instead of your RRSP. Typically the contribution limits to the IPP are higher than to your RRSP. In addition, an IPP may provide for a catch-up contribution if the performance is weak.
4. IPP’s have restrictions on withdrawals, unlike RRSPs, which allow withdrawals at any time.
5. IPP’s can generally invest in the same investments as a RRSP; however, you cannot invest more than 10% of the book value of the IPP in any one security.
6. At age 71 your IPP must begin payment or be converted to a Life Income Fund instead of a Registered Retirement Income Fund.
Bill Kennedy, FSA, FCIA an actuary with W.C. Kennedy & Associates Inc. in Toronto suggests some of the following advantages IPP’s have over RRSPs:
1. The IPP current service contributions are significantly larger than the RRSP contribution limits. For example, a 55 year old has a 25% IPP contribution limit vs. the 18% RRSP limit providing for approximately a $32,000 IPP contribution limit, as opposed to a $22,000 RRSP contribution limit.
2. All assets under an IPP are creditor proofed.
3. The IPP contributions are not subject to payroll taxes.
4. IPP’s allow for a “top-up” if the return for the IPP falls below a certain threshold.
5. If the IPP is set up properly and circumstances permit (child in the business), the IPP may be transferred to the next generation keeping the assets tax-sheltered, as opposed to RRSPs which are taxable upon the death of the last spouse to die.
Bill suggests the following are some of the disadvantages of an IPP in addition to the withdrawal and investment restrictions noted above:
1. Cost of set-up and maintenance. Including the required triennial valuation, the yearly costs will average between $1,500 to $2,500.
2. Compliance with the Canada Revenue Agency.
3. If the IPP assets grow to be greater than 120% of the liabilities because of bullish markets contributions may be reduced or eliminated for the year.
Under the budget tabled June 6, 2011, (originally the March 22, 2011 budget) the past service contributions were to be restricted, as essentially any past service contribution was to be satisfied by current RRSP assets first, meaning in many cases, minimal amounts could be contributed by the corporation. However, a new Ways and Means motion has muted the original rules, such that in most cases, corporate owners should still be able to make a significant past service contribution.
Personally, where a clients RRSP has limited assets and they can catch-up in one fell swoop using corporate dollars, I feel an IPP has merit. Where a client has a large RRSP in place, I am less enthusiastic to use an IPP because of the complexity of the technical rules and the high ongoing administration costs.
The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.