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Should You Have An
Individual Pension Plan?
When you've topped up your RRSP's , or neglected your retirement savings too long, an Individual Pension Plan (IPP) can be a useful tool to shelter income tax free and build up an additional retirement income stream.
An IPP is a defined benefit plan (meaning one that is designed to pay out a certain amount in the future) set up for the owner/manager of a corporate business, their spouse if employed by the same corporation, and other employees chosen to receive this benefit. A legislated limit caps the "defined benefit" that can be received by an IPP beneficiary to roughly $1,835 per year of service, increasing to $2,000 per year of service in 2005. Proprietors or partners are ineligible for IPPs.
IPPs are especially useful to business owners and can be exactly tailored to their needs. Premiums are funded by the company and can even be borrowed, and the interest on the loan is tax deductible. Better yet, the premiums themselves are often greater than what can be contributed to an RRSP, are deductible to the company, the earnings inside the plan accumulate tax free, and the plan is creditor proof! Taxes are only paid when funds are withdrawn in retirement years, or under special circumstances such as, if due to a critical illness, the beneficiary needs the money immediately.
Annual contribution limits are a function of several variables, including the beneficiary's age, length of service to the company, past salary, and the number of years since 1991, the year IPP's were introduced. When the plan is set up, a one time contribution can also be made to "catch up". This can be a significant amount and represent tremendous tax-sheltering opportunity.
Note that though there are no restrictions as to the level of annual income, or a minimum age that is required to set up an IPP, most experts agree that individuals should earn an annual salary in excess of $100,000 and should be at least in their mid-forties to early fifties in order to benefit. Until then, RRSPs are considered to be the more effective retirement strategy.
Tax rules require IPP's to grow by 7.5% a year. If the growth rate is less, or if the plan value goes down, the company is obligated to make up the difference. On the other hand, if it grows more than 7.5%, the following year's contribution will drop.
In addition, before allowing or continuing registration, the Canada Revenue Agency (CRA) must be ensured that the beneficiary is a Canadian resident paying taxes in Canada, that the retirement benefits that will be paid out of the plan will be in because of service and earnings as an employee of the corporation. In addition, CRA must be satisfied that the corporation was not established solely for IPP purposes and that there is a bona fide employer/employee relationship. Any plan that violates these rules can be refused registration or be deregistered by CRA. The impact of this action is that all the assets of the plan would become immediately taxable to the beneficiary.
On the downside, setting up an IPP can be costly, expect $5,000 or more, to evaluate your situation, and ensure it meets CRA criteria, Provincial regulations, and for an actuary who must calculate the funding required to provide the "defined benefit". Annual costs include regulatory filings and periodically, the actuary must be paid to ensure the defined benefit targets are still achievable. As mentioned, any shorfall must be covered by the employer. It is also important to note funds are "locked in" until paid out according to the provisions of the plan.
Though not a requirement, IPP's should be managed by a professionals due to the complexity of the rules and the return and value requirements. If you do manage the plan yourself, eligible investments are the same as those that are eligible for any defined benefit pension plan, so can include investment funds, stocks, bonds, and GICs, among others. However, no single equity position can represent more than 10% of the plan’s book value. As well, the current foreign content limit of30% that applies to all registered plans is also imposed on an IPP.
In either case, assets must be administered by a trustee, which can be a corporation or three individual trustees (at least one of whom is at arm’s length). The trustee’s responsibilities include overseeing the filing requirements of the plan and ensuring all governing regulations and tax requirements are met. A Pension Plan Income Tax Return and Registered Pension Plan Annual Information Return need to be prepared and filed annually.
At retirement, individuals who hold IPPs have the option of continuing the plan, purchasing an annuity, or transfering the plan’s assets to an RRSP or RRIF.
Under the first option, the plan is maintained as is and the defined benefit pension is paid out on schedule. The downside is the defined benefit requirement which may mean additional contributions are required in the event the plan's value falls.
The second option is to use the plan’s assets to purchase an annuity from a life insurance company that provides for a consistent, annual income stream. Under this option, the actuarial risk is transferred to the life insurance company. Care must be taken to ensure the type of annuity purchased makes sense, for example, some annuities provide for the remaining capital on death of the annuitant to revert to the life insurance company. This could be acceptable or not, depending on other annuity provisions.
The third option is for the retiree to, subject to limits, transfer their pension assets to a locked-in RRSP or locked-in RRIF. Any amount in excess of the limit can be taken in cash as a taxable payment.
Obviously, IPPs are not for everyone. If you own a corporate business, are over 50, earn in excess of $100,000 per year and will continue to do so until retirement, then its definitely an option worth considering. For those individuals whose circumstances mean the disadvantages of an IPP outweigh its advantages, a viable alternative is to maintain an RRSP account and establish a non-registered investment account earmarked for retirement. It will not be as tax-efficient as an IPP, and it will not provide a defined benefit payment in retirement, but it will be cheaper, have greater flexibility, and funds will be more accessible.
© 2015 John B Voorpostel CPA, CA, CMB
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