Changes to individual pension plans introduced in the 2011 federal budget could reduce the favourable tax benefit of these plans substantially in certain circumstances. Nonetheless, IPPs are expected to remain a viable retirement planning tool — albeit less attractive from a tax perspective.
IPPs, which are defined-benefit registered pension plans, are typically set up for business owners, incorporated professionals and senior executives, and may include spouses and other family members employed by a business. The plan sponsor of an IPP must be a corporation.
The budget had proposed two changes to IPPs, intended to eliminate certain inconsistencies between the tax benefits of IPPs and other retirement vehicles. The first change requires that annual minimum amounts be withdrawn from IPPs, similar to current minimum withdrawal requirements from registered retirement income funds, beginning in 2012. This change results from the fact some individuals had set up their IPPs to act as a transfer vehicle for the commuted value of their pension under a previous DB RPP. In such cases, the terms of the IPP may provide a much less generous pension in respect to past service; it may have a lower benefit formula; or a combination of both.
Consequently, much of the IPP’s value becomes pension surplus, which is not subject to the withdrawal requirements under existing tax rules applicable to IPPs. This allows IPP members to defer more of their retirement savings for a longer period vs other RPP members or RRSP holders.
To address this inconsistency, once IPP members reach age 71, they will receive a payout from their IPP equal to the greater of either their IPP pension or the minimum amount that would be required to be paid to the member as if the IPP assets were held in a RRIF. Says Jamie Golombek, managing director, tax and estate planning, with Canadian Imperial Bank of Commerce’s private wealth-management division in Toronto: “This change makes sense from a policy perspective. It is of little relevance, and does not give cause for concern.”
The second proposed change has become a bone of contention within the actuarial community. That’s because when employees make past-service contributions (PSCs) to their IPPs, the employees must now either give up accumulated RRSP room or, if they have made RRSP contributions in previous years, transfer a portion of their RRSP assets to the IPP based on a formula that is tied to certain actuarial parameters.
However, when the employees switch from an RRSP to an IPP at a later stage in their careers, the amount required to fund their IPP obligations for PSCs can be much greater than the amount by which they are required to reduce their RRSP assets or accumulated RRSP contribution room, thus providing them with a significant tax advantage.
The second proposal aims to eliminate this tax advantage by requiring that the cost of PSCs under the terms of an IPP be met first by transfers from the RRSP assets of the IPP member or by a reduction in the member’s accumulated RRSP contribution room before new, tax-deductible PSCs are permitted. This measure will apply to IPP PSCs made after March 22, 2011, and does not affect PSCs already credited to the IPP member prior to the budget proposal.
“This proposal is unfair and discriminates against individuals who have diligently accumulated retirement savings in their RRSPs,” says David Ablett, director of tax and retirement planning with Winnipeg-based Investors Group Inc. He argues that these individuals will now be required to use their RRSP investments to fund their IPPs. On the other hand, he says, individuals who have made poor RRSP decisions in the past will be rewarded because the company will then be forced to make up the PSC shortfall under the requirements of the IPP.
Trevor Parry, executive vice president and national sales director with Toronto-based actuarial consulting firm Gordon B. Lang & Associates Inc., agrees, saying this proposal effectively “punishes prudence.”
Prior to the budget, says Golombek, corporations were allowed to deduct a significant portion of the cost of funding IPP PSCs from their corporate income for tax purposes, going back up to 20 years. However, if the budget proposals prevail, he says, “One of the biggest benefits of establishing a new IPP would be eliminated.”
The maximum IPP contribution is established by an actuarial valuation that is done when the plan is set up, and every three years thereafter. Consequently, maximum contribution levels are not the same for individual plans and vary with age, earnings and length of service. What this means, says Parry, is that newly incorporated professionals with many years of past service prior to incorporation “will have to forgo much of the initial deduction that would have been available by establishing an IPP.”
As a result, business owners and incorporated professionals may choose “to take dividends as a form of compensation,” says Parry, “[which will result in] an abandonment of the Canada Pension Plan.”
On the other hand, says Dean Paley, senior financial planning specialist, with responsibility for tax and estate planning, with Edward Jones in Mississauga, Ont., incorporated professionals may intentionally invest the assets of their IPPs more conservatively to earn less than the 7.5% return prescribed by the Canada Revenue Agency for IPPs, forcing their company to fund any tax-deductible shortfalls.
Parry argues that eliminating the existing PSC deduction could hurt government expectations of recovering additional taxes if entrepreneurs elect to take dividends or deliberately allow their companies to fund any pension deficiencies.
Despite the proposed change to PSC guide-lines, says Ablett, there are still significant benefits to establishing IPPs, including a guaranteed pension, potentially higher contribution room than RRSPs and creditor protection. And firms can still benefit from making tax-deductible contributions. IE