Individual pension plans gaining steam

By Al Emid | February 18 2006 08:56PM

Individual pension plans can figure in tax and retirement planning for individuals who have made full registered retirement savings plan contributions or need tax-advantaged solutions for special situations such as sale of a business, explained Louise Guthrie, assistant vice- president, tax and regulatory services at Manulife Investments.

Numbers obtained from the Canada Revenue Agency prove their increasing popularity. Effective Dec. 31, 2005, the CRA had 8,297 active IPPs on its books, compared with 6,500 at yearend 2004. This include approximately 1,450 in force, but inactive IPPs.

“They are defined pension plans that provide maximum benefits. As the name suggests there is usually only one person in the plan,” she said at a recent continuing education seminar in Toronto.

Past history may have contributed to confusion associated with the product. During the 1980’s an early form of IPPs colloquially called “Top Hat” plans became popular but the government had not set clear ground rules.

Interest rates were high, she recalls. “So actuaries were projecting out the cost to fund these things (to pay) 14 to 15%,” meaning contributions had to be large by standards of the time. “Millions and millions of dollars were being tax-deferred so Revenue Canada (now the CRA) started to get a little concerned.”

That led to new rules including an assumption that the funding target could only be 7.5%, and that plans could not be funded with an early retirement assumption which would have affected allowable contributions. Planholders could retire early but had to pay as if they were going to remain at work until age 65.

These rules and other factors led to a decline in usage of the Top Hat.

The 2003 Federal budget increased contribution limits for registered retirement savings plans and registered pension plans, a factor that may have figured in the renewed popularity of IPPs.

“It meant that the amount that you could buy under a defined benefit plan also had to go up because these are all integrated amounts,” she said. The amounts were increased again in 2005. Ms. Guthrie attributes the IPPs increasing popularity to the two increased amounts.

IPPs offer advantages including creditor protection and higher contribution limits than for RRSP’s. The higher limits are a function of the IPPs status as defined benefit plans and differences in the calculation of contributions. The RRSP formula does not take into account the plan holder’s age while the IPP formula does include age, meaning that a 60 year-old person can currently contribute up to 30.1% of eligible income while a 45-year old person can only contribute up to 20.7%. Other advantages include tax deductibility for the employer of contributions made on behalf of the employee.

Regulations now provide for including early retirement in the calculation. “At age 60 they can have unreduced early retirement,” she explained. “Below that they can add cost of living increases to their retirement pension and you can have bridging benefits … until the Canada Pension Plan kicks in.”

Also important to self-employed individuals, proceeds from the sale of a business can be deposited into an IPP provided that the deposit occurs before December 31 of the calendar year in which the transaction takes place. The proceeds can be invested with taxes deferred on yield as well as on the deposits. “(On such occasions), this is an excellent way to keep registered assets on a tax deferred basis,” she said, adding that where a spouse inherits proceeds of an IPP, the transfer can be handled as a tax-free rollover.

Disadvantages include locking-in rules that vary between provinces. In Ontario, IPP funds become locked in two years after deposit. In New Brunswick, funds become locked in after five years of service or two years of plan membership. Disadvantages also include expenses such as initial set-up fees which increase if past service contributions are a factor, annual expenses, filing fees and an actuary’s report every third year.

Self-employed individuals can set up IPPs provided they have employee status in an incorporated company, even where the individual is a professional services corporation. “You must be incorporated. That is key number one because there has to be the employee-employer relationship,” she explains. Calculation of contributions is based on earnings documented on a T4 slip, and excludes dividends. IPPs also allow for contributions for past-service credits although for self-employed individuals using professional service corporation, the calculation will vary from province to province, depending on the year in which a specific province allowed personal service corporations.

These factors mean that younger and low-paid individuals would not find IPPs cost effective. “Ideally you are earning over $100,000 or more and over age 40,” she explained. “The older you get, the better these are ….” At age 50, an individual can deposit $6,000 more into an IPP than into an RRSP.