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The changes proposed eliminate some of the advantages associated with IPPs |
Before the Conservative government was defeated in a non-confidence vote earlier this year, they introduced a couple of measures in the 2011 federal budget that targeted Individual Pension Plans (IPPs). These proposed changes are expected to be legislated at some point in the future and have left many experts wondering whether IPPs are still an advantageous way of saving for retirement.
What is an IPP?
Before we discuss the proposed changes, let’s take a look at what an IPP is. In basic terms, an IPP is a defined benefit registered pension plan (RPP) that is generally set up for one employee. IPPs are often set up for professionals who have incorporated or for owner-managers of a business. The spouse of a small business owner or other family member who is employed by that business may also be added to the plan. Contributions to an IPP are made by an employer and are meant to fund a pre-determined retirement benefit. For many individuals (generally, in their 50s or older), the use of an IPP can allow for greater contributions when compared to a Registered Retirement Savings Plan (RRSP). All contributions made during the employer’s taxation year, or within the first 120 days following year-end, are deductible in the current year by the employer. As well, fees paid by an employer to maintain the plan are deductible.
Why have IPPs been so popular?
In addition to the ability to make deductible contributions, there are several other key benefits associated with IPPs that have contributed to their popularity including the following:
- Correction of poor investment returns – With an IPP, there is the ability to make higher contributions in the future to make up for poor investment returns. In contrast, where there is poor performance in an RRSP, an employee must accumulate additional assets on a non-deferred basis to make up for a shortfall.
- Ability to defer retirement savings – Where the full commuted value of a defined benefit RPP of an individual is transferred to an IPP, part of the IPP’s value may be considered “pension surplus” which is not subject to any withdrawal requirements under current rules. In this case, an employee with an IPP is able to defer more of their retirement savings for a longer period of time than is generally possible for an RRSP investor or other RPP member.
- Terminal funding – Although one of the assumptions that must be used when funding an IPP is retirement at age 65, if an individual retires earlier, an additional terminal funding contribution can be made. It may also be possible to fund other benefits upon retirement.
- Past service contributions – Perhaps one of the more significant advantages of an IPP is the ability to make past service contributions. A past service contribution is generally a combination of an employer contribution and an RRSP transfer (assuming that the employee made full RRSP contributions). Tax rules prevent employees from doubling up RRSP and IPP contributions for past years of service. Specifically, where a past service contribution is made, an employee is subject to a retroactive past service pension adjustment (PSPA). What this means is that the employee is treated as if they were a member of the IPP for all of the past service years. As such, the employee has a pension adjustment (PA) for each of those years which has the effect of reducing their RRSP contribution room. Since most employees who consider an IPP will have already used their RRSP contribution room for past service years, the PSPA rules will mean that the employee is required to transfer an amount equal to their PSPA (i.e. PAs that would have been recorded on regular IPP contributions for the past years less $8,000) from their RRSP to their IPP before the employer can make a past service contribution. Note that the income related to the transferred capital can remain in the RRSP which is beneficial. An IPP is considered advantageous where the amount required to fund the IPP’s past service obligation is greater than the amount by which the employee is required to reduce their RRSP assets or accumulated RRSP contribution room.
- Asset protection – IPPs have provided better protection from potential business risks. For instance, an IPP is not a personal asset of an employee in the same way as an RRSP. However, due to bankruptcy reform, the treatment of RRSPs has become more consistent with the treatment of pension plans. As well, an employer is generally limited from accessing funds in an IPP or can be limited depending on the terms of the plan.
Proposed changes and their affect on the advantages of IPPs
The changes proposed by the Conservatives eliminate some of the advantages associated with IPPs. Under one proposal, the past service contribution must be first funded with all available RRSP assets or a reduction in the member’s accumulated RRSP contribution room before any new past service contributions are permitted. So, in circumstances where an RRSP has a value equal to the past service contribution, there will be no benefit associated with making a past service contribution, as all that will be accomplished is a transfer of assets from an RRSP to an IPP. If this measure is legislated without any modifications, it will apply to IPP past service contributions made after March 22, 2011. There will be one exception — it will not apply to IPP past service contributions made in respect of past service that was credited to an IPP member before March 22, 2011 under terms of the IPP submitted for registration on or before March 22, 2011.
The other proposed change includes the implementation of annual withdrawal requirements. Under this proposal, an IPP will be required to pay out to a member, each year after the year in which the member turns 71, the greater of:
- The regular pension amount payable to the member in the year pursuant to the plan terms, and
- The minimum amount that would be required to be paid from the IPP to the member if the member’s share of the IPP assets were held in a Registered Retirement Income Fund
It is worth noting that if the proposed withdrawal requirements are legislated without any modifications, they will apply to 2012 and subsequent taxation years. In this regard, for those IPP members who reach age 72 in 2011 or earlier, the required withdrawals will start in 2012. For those IPP members who reach age 72 after 2011, the required withdrawals will start in the year in which they reach age 72.
Are there any disadvantages associated with an IPP?
Although they may vary among provinces, there are some disadvantages associated with IPPs including the following:
- Locked-in rules – Depending on provincial legislation, access to IPP funds may be subject to locked-in rules and it will generally not be possible to access these funds prior to retirement. In contrast, RRSP funds are accessible before retirement – although withdrawals are subject to tax.
- Mandatory annual contributions – Some provinces require that annual contributions be made once a plan is put in place. This is an onerous requirement for an employer that is in a loss position.
- Higher administration costs – There are often higher administration costs associated with IPPs when compared to RRSPs, although these costs have come down in recent years. These costs include the set-up of the plan, annual filings and actuarial valuations that must be completed every three years.
- Spousal contributions are not permitted – In contrast to an RRSP, contributions can’t be made to a spousal plan.
Something to think about
A final change to consider when determining whether IPPs still make sense as an option for retirement savings is the reduction to corporate tax rates. This change is having an impact on owner-manager remuneration strategies in general and may reduce the value of using an IPP where it is more advantageous to retain income in the company. For an update on owner-manager remuneration strategies in today’s tax rate environment, see
“Owner-Manager Remuneration Strategies - Integration Revisited” in this edition of the Tax Factor.
In summary, the proposed budget changes, which are aimed at putting IPPs on a leveled playing field with other retirement savings vehicles, will eliminate certain advantages that IPPs have over other plans. When the budget changes are considered in conjunction with the drawbacks associated with IPPs and corporate tax rate reductions, one may wonder if an IPP is still a viable retirement savings vehicle. If you have any questions as to whether an IPP makes sense for you, contact your BDO advisor.
Next section: Framework For Pooled Registered Pension Plans
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