Summer 2005

by KEITH BUTLER

What is an Individual Pension Plan?

• An IPP is a registered, defined benefit pension plan with only one member. If the spouse is employed by the same or a related company, the spouse may be added to the same plan.

• A defined benefit pension plan provides a lifetime pension starting at a certain age. The amount of the pension is determined by a formula, and the contribution equals the cost of providing the pension at age 65.

• A RSP is a defined contribution plan where the contributions are determined by a formula. The pension is the sum of the accumulated contributions plus investment returns.

• An IPP must be sponsored and funded by an employer, although the plan member may assist with funding. This differs from a RSP, where employer involvement is not required.

• An IPP may be implemented up to age 69.

The IPP Candidate: Who Benefits?

• Clients who have the corporate resources to fund the IPP, have a RSP and are considered an employee receiving T4 income from an employer.

• If the individual does not have sufficient RSP holdings, past service contribution can be pro-rated.

• Dividends and investment earnings are not eligible.

• Typically, small business owners such as incorporated physicians are the most suitable candidates.

• The individual is usually at least 45 years old or older if he/she has a limited number of past years of service to the professional corporation.

IPP Advantages

• Employer contributions are tax-deductible and may be 25-70 per cent higher than maximum RSP contributions, permitting the plan member to accumulate more funds inside the plan, on a tax-deferred basis.

• Interest on funds borrowed for contributions are tax-deductible.

• Expenses such as setup and administrative fees are tax-deductible.

• IPP assets are creditor-proof.

• Significant past service contributions for previous employment years are possible even when RSP’s are maximized, providing further tax savings. Contributions for past service may be paid immediately in a lump sum payment or amortized over a period of up to 15 years depending on age of the plan member.

• Contributions made within 120 days after corporate year-end are deductible in corporate year.

• Contributions must be topped up if investment returns are insufficient to fund promised benefits.

• Tax deductible lump sum contributions at the time of actual retirement or plan termination are possible in most circumstances.

• Any remaining surplus on termination of the plan may be returned to the employee (taxable to the member).

• The former $8,000 RSP over contribution is still available under an IPP and is deductible immediately to reduce the qualifying RSP transfer.

IPP Disadvantages

• Start-up and maintenance cost (e.g., annual reporting, triennial valuations).

  • Administrative work is carried out by the administrator of the pension and an actuary ensures that the IPP remains compliant with pension regulations.

• The equivalent of a “spousal” RSP does not exist in IPP’s, highlighting the importance of reviewing income-splitting with your MD financial consultant. However, if the spouse is employed by the same or a related company, the spouse may be added to the same plan.

• Poor investment performance may require additional funding. Depending on the individual’s circumstances, this may be viewed as an advantage or disadvantage.

• Strong investment performance may reduce future contribution room — and therefore the additional tax deduction expected.

• Terminating the IPP and converting the plan to a Locked-in Retirement Account (LIRA) and, by extension, to an annuity, LIF or LRIF is a more intensive exercise than a transfer between RSPs or from a RSP to a RIF.

IPPs: How Do They Work?

• An IPP provides a lifetime pension starting at a certain age. The amount of the pension is determined by a formula (based on T4 earnings) and the contribution equals the cost of providing the pension at age 65.

• Contributions can be made for past service with the same or a related company for the years from 1991 to 2003. Past service contributions may be paid immediately in a lump sum payment or amortized over a period of up to 15 years depending on the age.

• The CRA requires that past service contribution, from 1991 to present, be offset by a transfer from the plan member’s RSP.

• The qualifying transfer is determined by calculating the pension adjustment that would have been applied in each year of past service assuming that the individual had been in a defined benefit pension plan during those years. The total of the pension adjustments for those years less $8,000 and any unused RSP contribution room equals the qualifying transfer.

• There is an obligation to contribute to an IPP if the member has T4 earnings.

• A member can retire at any time after age 55 (50 in Alberta) and up to age 69.

Keith Butler is a senior financial consultant with MD Management’s Newfoundland and Labrador regional office.

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