The Individual Pension Plan Option Requires Careful Client Education

Individual pension plans (IPPs) aimed at high net-worth business owners can be complicated and technical and need to be explained carefully to both financial advisors and their potential clients, say two experts in the field.

Stephen Cheng, managing director and senior consulting actuary at Westcoast Actuaries Inc.in Vancouver, says there has been some growth in the IPP market over the last couple of years, but most of it has been offset by retiring IPP members who wind up their plans and transfer them to locked-in investment vehicles.

IPPs are basically defined benefit plans set up for one employee and have many extra layers of complexity not found in their more well-known cousins – RRSPs and TFSAs.

IPPs are used for business owners or high net-worth professionals whose corporations fund the IPP and receive a tax deduction for doing so. The company can also contribute funds for past service, capturing the difference between defined benefit and RRSP funding limits. As the plan member gets older the past service contributions at implementation can be considerable, sometimes in the area of $200,000 or more. Unlike RRSPs where the limit depends solely on earned income, IPP contribution limits are set through the actuarial valuation process based on age and salary, as well as assumptions prescribed in the tax regulations.

Adding to everything else, annual federal and provincial reporting is required with an IPP as well as an actuarial valuation every three years.

Educating advisors

Cheng, whose actuarial firm handles IPPs, said his focus is on educating both advisors and accountants and their potential clients so they understand the IPP concept. Teaching clients about IPPs gives them the ability to determine whether the IPP is the right vehicle for them.

“One of the reasons the popularity of the IPP hasn’t gained much ground over the last couple of years is mostly attributable to the fact that people don’t understand them,” Cheng said. “When people don’t have the right information, quite often they make the wrong decision. If an IPP is not a suitable vehicle then people are not going to be happy because of the IPP’s restrictions and inflexibility.”

In addition to the federal requirements, different jurisdictions may also have their own rules and regulations. Ontario, for example, requires IPP sponsoring companies to contribute a minimum amount every year for their plans, whereas British Columbia and Quebec don’t, says Cheng.

Provincial differences

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“In B.C., there is no minimum funding requirement so IPP clients who make under $500,000 one year would only get a writeoff of 13.5%. So they postpone the funding because they have the luxury to do that. In Ontario, the legislation requires the corporation to put in minimum contributions each year and if there is a deficit, the company must make amortization payments to liquidate those deficits.”

Abby Kassar, vice president, High Net Worth Planning Services with RBC Wealth Management Services, says she feels IPP numbers are now growing in popularity and awareness and more business owners are looking into how IPPs work.

Of special interest is the ability of an IPP to provide greater retirement savings than an RRSP, especially since IPP contribution amounts are partly a function of age, says Kassar.

“So as you get older, the IPP limit will increase and exceed the RSP limit.” The typical age to open an IPP ranges from 40-50. While many business owners have spent all their years growing their businesses, they realize around this age that they need to start stashing away money for their retirements.

In addition to being more highly regulated than RRSPs, IPP holders may not have the same kind of flexibility to split income on retirement as they would with an RRSP and pension benefits are locked-in under legislation until retirement. At that time, the funds must be used to provide retirement benefits through products such as a life annuity.

So as you get older, the IPP limit will increase and exceed the RSP limit.

– Abby Kassar