The IPP advantage

“If an RRSP makes sense for a business owner, an IPP makes even more sense,” says Mark Lesniewski, president of IPP Inc., an actuarial and retirement plan consulting firm in Calgary.

According to Revenue Canada, there are as many as 10,000 IPPs in Canada today. But given that these pension plans are fast gaining traction, Scott Scobie, general manager of Canadian Western Trust, says there is a potential for them to grow to 300,000 by the year 2020, based on the growth seen in the last three to four years.

Advisors who acquire a working knowledge of individual pension plans can gather still more assets. IPPs allow business owners to save more than they can in an RRSP, which means the advisor’s compensation may also be higher.

Essentially, an IPP is a super-sized RRSP for successful business owners, incorporated professionals and senior executives, which typically allows them to put away more for their retirement — on a tax-deferred basis — than an RRSP would allow.

Take a lawyer for instance: A corporate lawyer can easily net upward of $300,000 a year, with very little in overhead expenses. But even if he were to max out his RRSP room of $21,000, it would still represent just 7% of his total income.

Lesniewski estimates an IPP contribution could be topped off at a little more than 30%.

An IPP’s upper limits are different for each clients and established by an actuarial valuation conducted once every three years. The older the IPP member, the higher the contribution amount, assuming comparable income levels.

Depending on the type of pension plan, age of client, years of service, and salary — in an actuarial best-case scenario — your client could put up to $3 million into an IPP, Lesniewski says.

An IPP, however, is designed to provide retirement income. It isn’t just a savings account or TFSA where you can take money in and out of the plan.”

With an IPP, like with any kind of pension plan, the idea is to average 7.5% growth performance over a three-year period. If underperforming, the actuary will require it be topped up, so the eventual benefit matches what was promised.

Scobie says the strategy is to invest conservatively, keeping performance at 3% or 5%, thereby forcing the company to top up. “In some ways you don’t want your investments in an IPP to do very well. If your intent is to take a bunch of retained earnings out of your company and pay the business owner, you actually don’t want to get good returns so you’re able to take more money out of the company, and get more tax deductions.”

Investment rules governing IPPs are more stringent than for RRSPs. A diversification requirement limits an IPP fund to no more than 10% of in any one security.”

IPPs especially make sense for entrepreneurs who haven’t been contributing to their RRSP accounts. “If you look at the history of a lot of entrepreneurs, they don’t have much of an RRSP. An IPP allows them to jumpstart their pension planning,” says Carol E. Bezaire, vice-president, tax and estate planning, Mackenzie Financial Corporation.

She suggests a good time to talk to such clients about IPPs is when you broach the subject of group RRSPs for their employees. “You can turn around and say, ‘what does your succession plan look like?'”

“Any time your small business owner has been in a successful business for a few years, you start looking at overall succession planning,” she adds. “Besides, IPP contributions not only reduce pre-tax revenues for the business — keeping them below the small-business level — they’re also a great way to maintain some of your key employees by adding an extra perk.

“As people get more successful, they find they have to take more salaries, bonuses, and it’s all taxable. Instead, if you can put that revenue into an IPP, they don’t get taxed on it until retirement. The company gets a tax deduction, and the owner gets the tax break.”

IPPs do not, however, indiscriminately make sense for all high net worth clients.

Three main variables, age, service, and earnings, determine who qualifies; age being the most important.

“In case of younger clients, the other two variables become more important,” notes Bill Keech, vice-president of IPP Inc. “As a rule of thumb, an IPP starts to make sense when you start earning $75,000 or more. The older you get, the more it costs to earn pension benefits. Under 40, it costs less than 18%, so from a tax-shelter perspective the client would be better off in an RRSP.”

In 2010, if you’re earning $128,000, you’ll be able to contribute a maximum of $22,000 to an RRSP. A 60-year-old, for that same year, would be able to contribute $34,500 to an IPP — almost 50% more. A 40-year-old, on the other hand, would only be allowed to contribute $23, 700 to the IPP.

Age	IPP	RRSP	IPP Advantage
40	$82,000	$21,000	+$61,000
50	$169,100	$21,000	+$148,100
60	$274,300	$21,000	+$253,300
Source: Canadian Western Trust

Ideal candidates, according to Bezaire, would be over 40, and with T4 income of over $122,000 (which allows a maximum $21,000 RRSP contribution).

Advisors can set up an IPP for single members and for a member and a spouse. For single- members, one-time setup cost is $2,500, for family it comes to $3,500. Administrative costs range from $1,150 to $1,300.

Scobie says while an IPP is beneficial for both employers and their high-income employees, advisors sometimes tend to overlook it because of its complexity. IPPs typically require three trustees. Scobie strongly suggests using the services of corporate trustees to manage IPPs. “Given a choice, I would never opt for an individual trustee. For one, lots of individual trustees don’t have the knowledge or the objectivity to act solely in the interest of plan beneficiaries. Being a corporate trustee, there are no emotional ties. A corporate trustee is also tied to higher standards, being federally regulated.”

IPPs can take time to set up since they face provincial and federal regulations, making them more expensive to set up than RRSPs. The cost of setup is, however, paid out of company money and used as deduction before tax.

In addition, Bezaire says income-splitting opportunities mightn’t be as attractive because one can’t set up a spousal IPP, like an RRSP. However, she adds pension income from an IPP can be split under the pension income splitting legislation, unlike an RRSP where you can’t split RRIF income until 65.

Scobie says advisors talking to their clients about IPPs should also be talking to their clients’ accountants as a source of potential new business. “Typically, in a small- to medium-sized business, these clients are busy and don’t have the time to consider the ins and outs of a pension plan, and so they hire accountants.”

While it may make sense for advisors to recommend IPPs for certain professional clients, what happens to the RRSP that is likely already in place?

The two can co-exist.

Ideally, some RRSP assets are transferred in a tax-free rollover to the IPP. But once you start contributing to an IPP, Bezaire says the RRSP contribution limit goes down to $600 a year.

For clients who wish to retire outside of Canada, most provinces allow them to remove the locking-in aspect. For example, if a client is accruing pension benefits in Alberta, that benefit would be locked in, but he or she decided to move out of the country, they’d be allowed to take that whole amount. It would then be subject to the tax laws of the country they move to.

According to Keech if an individual moves out of the country, it is normally expected the corporation was wound up too. “In that case, he’d wind up the IPP as well, and deal with a transfer of assets, with federal tax treaties coming into play.”

WHO QUALIFIES

• a key executive and/or owner-manager of a corporation;
• receives employment (T4) income from the company;
• put in considerable years of service into the corporation;
• over 40 years old;
• earning a base salary of more than $75, 000; and
• in essence, requires more tax sheltering than is available in an RRSP

BENEFITS

• an IPP allows the (older) plan holder to contribute more than an RRSP would allow.
• Being pension plans, IPPs are creditor proof. As per recent legislation, RRSPs too enjoy creditor protection but only in case of bankruptcy.
• The IPP account holder can guarantee their retirement income as it is a defined benefit plan, as opposed to an RRSP where retirement income largely depends on market performance.
• significant contributions can be made for services prior to plan implementation
• monies borrowed to fund the IPP, set-up costs and ongoing administrative expenses are tax deductible to the employer
• IPP assets may be topped-up if investment returns are inadequate to fund the IPP benefits
• early retirement can be funded by a lump-sum tax deductible contribution
• the corporation has 120 days after its year-end to make an IPP contribution

LIMITATIONS

• IPP is a pension plan and subject to provincial lock-in requirements
• IPPs are subject to minimum annual funding requirements
• the business has to be an ongoing concern
• Setup costs are higher than an RRSP because IPPs are more highly regulated.

(07/08/09)