While many high-income earners still feel constrained by RRSP contribution limits, advisors whose clients include small-business owners and members of professional corporations are turning to individual pension plans (IPPs) to generate higher retirement income for clients and better tax savings.

In the 1980s, these were the popular “top hat” pension plans. But circumstances then changed and they fell out of favour. The 2003 budget, which increased pension limits to $2,000 a year of service, brought IPPs back to life. They account for almost one-third of the 19,000 private pension plans in Canada, says Louise Guthrie, assistant vice president of tax and regulatory services at Manulife Investments in Waterloo, Ont., and more than 4,000 new IPPs have been established in the past three years.
Increasing self-employment, as well as the relatively recent ability of professionals to incorporate, seems to be fuelling their growth.

An IPP is a defined-benefit pension plan registered with the Canada Revenue Agency and subject to the pension legislation of the province in which it is based. But because it is for a single employee, benefits can be designed to suit the needs of the individual concerned. Contributions are based on actuarial calculations designed to provide a pension equivalent to a maximum of $2,000 (based on 2005 rates) for each year of service. Contributions to the plan are made by the employer/corporation and are a tax-deductible expense for the employer/corporation.

Although IPPs may be set up by large corporations for individual senior executives, they are generally of most interest to owners of small businesses or members of professional corporations, such as doctors and accountants, who have maxed out their RRSP contribution limits.

Ed Collins, senior vice president and portfolio manager at Toronto-based First Asset Advisory Services, says that to qualify, the business sponsoring the plan must be incorporated. And it works best if it is a successful company paying significant taxes so it can use the higher tax-deductible contributions to shelter its income from taxes.

“This is really a tax strategy that has to be built into a comprehensive financial plan,” says Peter Merrick, president of Toronto-based Merrick Wealth Management Inc.

Generally, the employee should be making a T4 income of at least $75,000; an annual salary of $100,000 is the maximum eligible as the basis for calculating an IPP contribution, Collins notes. The employee should also be at least age 40, although some IPP specialists say these plans work better for somewhat older clients. Guthrie says employees over age 50 enjoy an annual maximum contribution at least $6,000 higher than the maximum contribution for an RRSP.

Collins explains that an actuarial firm will be needed to set up the plan and provide the required actuarial reports every three years.
Developing a good relationship with an actuarial firm is important, adds Guthrie. The services of an accountant and an investment manager will also be needed. But all fees charged by these professionals are tax-deductible for the corporation, Collins says. He estimates set-up costs of between $2,500 and $3,000, annual operating costs from about $500-$600 — the IPP is required to file annually with the CRA — and costs for the triennial actuarial report at between $1,000 and $1,200.

Collins also points out that three trustees will be needed to oversee the plan, and one of them must be unrelated to the business owner. The trustees would generally be the business owner and spouse, plus a trusted friend or advisor — perhaps someone recommended by the actuarial firm. As with other defined-benefit plans, the trustees have a fiduciary responsibility to make sure the plan is properly invested and the investment policy is followed.

Guthrie says investments eligible for RRSPs generally qualify for an IPP and can be managed in a way similar to a self-directed RRSP. Pension legislation requires that IPP investments are made according to the “prudent person” rule and the plan may not own more than 10% of the securities of any one issuer, says Collins. But, unlike RRSPs, he adds, the plans are creditorproof.

Merrick explains another key advantage of an IPP: when the plan is established, tax rules allow the employee to make a contribution for past service back to 1991 — or the date the employee started working for the company if later than that. And, Guthrie notes, for companies with excess cash, this is a great opportunity to move it from the company to a tax-sheltered IPP. For companies without excess cash, she says, past service obligations can be amortized up to 15 years. An IPP may be particularly attractive for business owners who have had to bonus out earnings to stay within the limit for the preferential small-business tax rate, she adds.