The benefits of Individual Pension Plans
Canadian entrepreneurs are embracing Individual Pension Plans (IPP) largely because of the sizable initial contributions, and as such, large corporate deductions associated with plan set up. The tax relief is quite superior in most cases to what is offered through personal investment in RRSP’s.
However, there are several other additional benefits to IPPs which often go overlooked. Most significant among these are: additional funding on retirement, investment expense deductibility, Employer Heath Tax savings, and creditor protection.
The additional funding on retirement allows the company to make one large, final payment into the IPP. This amount varies by retirement age and length of service, but is frequently a large six figures, and can grow to over one million dollars. This funding provides two significant benefit enhancements to the plan. The first is additional indexing. Many plans have a builtin indexing provision, something not available in the standard RRSP.
Additional funding enhances this indexing level. Over the length of a plan member’s retirement, this can have a significant impact on the total amount of pension received. The second benefit applies only to those plan members who retire prior to age 65. The additional funding provides a benefit bridging provision for those who retire early. Enhancing both the reduced pension and CPP benefits is a distinct advantage for the early retiree.
In order to take advantage of the additional funding, the IPP must either be maintained on in retirement or the assets can be used to purchase an annuity.
Rolling the assets into a locked in retirement account (LIRA) or locked-in retirement income fund (LRIF), will result in a surplus which will cause the assets to be taxable in the participant’s hands in the retirement year. Even though the individual will have substantially more retirement assets available than by using an RRSP, the taxable liability associated with the LIRA/LRIF option could be deterring.
The deductibility of investment expenses can provide a significant benefit to a business owner setting up an IPP for themselves. At age 69, an IPP participant could find himself with well in excess of $1 million dollars in the plan. With a two-per-cent investment management fee quite common, that would translate in a taxable deduction to the sponsoring company of $20,000.
For a company that establishes a plan for its owner manager aged 45 at the time of plan set up, the company could expect to deduct in excess of $330,000 in investment expenses over the life of the plan.
In Ontario, Quebec, Manitoba and Newfoundland the provincial governments levy a payroll tax for health. Contributions made to an IPP are not subject to this tax. This means the savings in payroll taxes will in many cases offset the cost of establishing and administering the IPP.
Many business owners find themselves in need of greater protection for their assets than are provided by an RRSP. IPPs, by nature of the trust structure, provide a much greater level of creditor protection for the assets. Although not protected against divorce or fraud, IPPs will otherwise secure the participant’s assets for their retirement.
On retirement, an IPP participant has three options on how to handle the assets in his plan, rolling the funds into an LRIF, purchasing an annuity, or drawing a pension directly from the IPP.
Rolling the funds into a LIRA discharges any further obligations to the plan. A wind-up is performed and any surplus or deficit is calculated. Once any deficit is funded, the company no longer has any responsibilities to the pension.
The subsequent pension will be base of the performance of the assets inside the plan and standard maximum/minimum withdrawal calculations for LIRAs. The additional funding on retirement is not available under this option.
Purchasing an annuity will also relieve the sponsoring company of any further obligations. The pension will be based on the annuity rates at the time the annuity is purchased. This option will allow for an additional funding payment to be made on retirement.
The final retirement option is to leave the plan intact and begin withdrawing a pension from it no later than the end of the plan members 69th year. This optional still requires triennial valuations and the sponsoring company is still responsible for funding any deficits. This plan allows for the additional funding on retirement, as well as an indexed pension with known annual payments. If the company is willing to maintain sponsorship, this is usually the preferred option for pension payouts. Where the business is going to survive the retirement of the plan member this is often the recommended option.
IPPs require specialties in areas such as accounting, actuary evaluation, investment management, pension legislation, employment law and employee benefit plan construction.
Many employers and their accounting professionals will need to seek educational services to aid them in the IPP set up maintenance and wind-up stages. Therefore, it is worth the time and money to hire a skilled IPP consultant to assist in the design, implementation, maintenance and wind-up stages of an IPP solution.