Reach Your Retirement Goals More Quickly with an IPP

Spenser

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Spenser McCaig

Westcoast Actuaries

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Scientists anticipate that the first person who will live to 200 has already been born.

Our consistently increasing longevity in turn increases the necessity for adequate savings to sustain an extended retirement. Finance and tax professionals have been incorporating Individual Pension Plans (IPPs) into their clients’ retirement plans for decades as a way to bolster the accumulation of wealth for their golden years.

IPP OVERVIEW

An IPP is a “defined benefit” pension plan established and sponsored by an incorporated employer for the benefit of business owner(s) or highly-compensated employees. A common IPP candidate is an incorporated professional or a small-medium size business owner who is seeking higher tax-deductible contributions to their retirement plan than those which are available via their RRSP.

“Defined benefit” means the employee receives a set amount of pension, payable for life at retirement, for each year they are employed. The contributions are determined as the amount necessary to sustain the lifetime pension. This is what sets the IPP apart from the traditional Registered Retirement Savings Plan (RRSP), which is a “defined contribution” vehicle with a fixed annual contribution rate. Most IPPs provide between $200,000 and $1,500,000 more deductible contribution room than an RRSP.

KEY CRITERIA

In order to benefit from this type of savings vehicle, there are some key criteria that an individual should meet. The IPP member should be at least 40 years of age and must receive T4 employment income from the sponsoring company; dividend income does not generate IPP contribution room. Anyone who meets these basic criteria and appreciates the tax advantage provided by their RRSP should consider the transition to an IPP to enhance their tax-incentivised retirement savings.

Generally speaking, the older the individual, the higher the level of T4 income and the longer the history of T4 income, the higher the IPP contribution advantage will be. Once an IPP is set up, the individual forgoes their future RRSP room in favour of the higher IPP contributions.

HOW THE MATH WORKS

IPP contributions must be certified by an actuary, a requirement for any defined benefit pension plan. In contrast to RRSP contributions, which are fixed at 18% of earned income each year, IPP contributions are generated in several different ways:

Current Service Contributions are the most comparable to RRSPs as they are accrued annually based on the individual’s income, specifically T4 employment income for the IPP. The IPP current service contribution rate varies with age, matching the RRSP rate of 18% at around age 40 and then growing with age up to approximately 30% at age 65.

Past Service Contributions are available upon the establishment of the IPP by recognizing the individual’s past years of T4 employment income from the sponsoring company. The individual must “purchase” past service years by transferring a portion of their existing RRSPs into the IPP. The larger the past service period, the greater the required RRSP transfer and the higher the past service contribution room is for the sponsoring company. The amount of past service will depend on the individual’s age and T4 history. Most IPPs generate between $100,000 and $300,000 of immediate deductible past service contribution room for the sponsoring company.

Additional Contributions for Asset Shortfalls ensure there can be a minimum amount of assets in the IPP at retirement. Actuarial valuations are performed every 3 years to review the sufficiency of the IPP assets compared to the amount of pension the individual has accrued. If the assets have under-performed the expected growth then the company is eligible to top-up the plan to the level certified by the actuary with additional deductible contributions. This continues even after pension has commenced to be paid at retirement.

Enhanced Contributions after Pension Commencement are an opportunity for companies seeking substantial deductible contributions, the amount of which is often in the neighbourhood of $500,000 to $1,000,000. This top-up becomes available once the IPP member begins receiving the pension income from the IPP.

HIGHLIGHTS

In many jurisdictions, including BC, there is no contribution requirement and therefore, the company has the discretion of how much of the available contribution room to utilize each year, while staying within the limits certified by the actuary. An IPP can be underfunded in years where the company does not have the cash-flow or the need for deductions and the unused room carries forward for use in future years. In addition to the flexibility in funding, IPP assets are also creditor-proof and the pension income is eligible for income splitting with a spouse.

In light of the recent tax changes – particularly with respect to the adverse tax consequences of retaining passive investments within a corporation – an IPP becomes even more useful for tax reduction. By setting up an IPP and utilizing the past service option, potentially hundreds of thousands of passive assets placed in the IPP account can mitigate the company’s exposure to the new passive investment rules and grow in the tax-deferred environment.

CONSIDERATIONS

To achieve these tax advantages, the IPP candidate must be prepared to accept some restrictions that are imposed on defined benefit pension plans. Pension assets are locked-in in most jurisdictions; the IPP member cannot draw on the assets until they commence pension at retirement. Moreover, the pension they will receive at retirement is a fixed annual amount. IPP candidates should be aware of these restrictions and ensure that they do not contribute assets to their IPP that they may need to access prior to retirement.

An alternative to paying the pension from the IPP throughout retirement is to wind-up the plan; this can be done at any time in most jurisdictions. IPPs are commonly wound up when the plan has become underfunded and the company no longer intends to catch up on contributions. An underfunded IPP can be wound up with most or all of the assets transferred to a Locked- In RRSP vehicle.

An individual who meets the criteria of an IPP candidate should consider adding an actuary to their trusted circle of professionals to enhance their tax reduction and maximize their investable assets. Ask your RGF advisor how Westcoast Actuaries, one of Canada's top providers of IPP services, can provide a complimentary IPP illustration for individuals considering incorporating the IPP into their retirement plan.

■ Spenser McCaig can be reached at spenser.mccaig@westcoast-actuaries.com • Tel. 604.730.1898 x 105

Spenser McCaig is an Actuarial Associate with Westcoast Actuaries Inc. The views expressed are those of the author and not necessarily those of RGF Integrated Wealth Management, which makes no representations as to their completeness or accuracy.