The best-kept secret in pensions

The benefits of setting up individual pension plans for top executives and business owners

Companies looking to add a benefit for top executives might want to look at a little known tax avoidance structure — individual pensions plans. IPPs were established in 1991 by the federal government to provide senior executives and business owners with tax relief and allow them to save more for retirement.

Establishing an IPP is a pretty sound business decision for entrepreneurs, executives and employers who have historically maximized their registered retirement savings plan and pension contributions and have the income to support a more aggressive tax deferral arrangement.

Here a look at some of the advantages of an IPP:

Tax deductibility. All contributions and expenses are tax deductible to the employer and are a non-taxable benefit to the owner or executive until they begin receiving the benefit. The pension benefit is equal to two per cent of the IPP member’s annual income to a maximum of $70,000 pension indexed.

Creditor proof. Assets held in the IPP cannot be seized by creditors of the plan member nor the plan sponsor on the condition the pension plan was set up in good faith and not just because of a looming bankruptcy.

Ownership of plan assets. At retirement, the member owns any actuarial surplus. The surplus may be used to upgrade pension benefits or pass the surplus tax-free to a spouse, heirs or estate.

Guaranteed lifetime income to members and their spouses. The pension plan offers a predictable retirement income. An actuary determines the current annual costs of the future retirement income. Eligible spouses receive 66.7 per cent of pension in the event of death of the plan member. Spousal pension benefits may be upgraded to 100 per cent at the time the member retires.

Past service funding. For executives and high earners, the pension plan funding formula is more generous than the RRSP limits. The pension plan allows individuals to make contributions for years of service prior to the setup of the plan. No other plan or individual investment can offer this benefit.

Recruiting top executives. It can be tough to lure a senior executive from another company if that executive is already in a regular defined benefit pension plan with generous retirement benefits. Traditional executive candidates in this situation may feel they cannot leave their existing defined benefit pension plans before retirement because the Canada Customs and Revenue Agency (CCRA) tax rules will prevent them from transferring the full value of pension credits to a locked in RRSP. Employers can avoid this obstacle and attract these key people by creating an IPP for them and then transferring their old pension plan to the new IPP without a tax hit.

Terminal funding. One of the most attractive features of the IPP is the possibility of terminal funding. While CCRA restricts the benefits that can be pre-funded, the pension plan can be amended at retirement to provide the most generous terms possible. Some of these include: full consumer price indexing, early retirement pension with no reduction and bridge benefits.

Who qualifies for an IPP?

Individual pension plans are usually best suited for:

•a key executive or owner of a corporation;

•individuals aged 40 and older; and

•individuals earning a base salary of more than $100,000.

To qualify for an IPP, a plan member must have T4 income and be an employee of an incorporated company which is taxable under the Income Tax Act.

An example of an IPP

Here’s an example of what an IPP might look like. Take a company, founded in 1991, that had no pension benefit plan. The president is now 62-years-old and has been maximizing her RRSP contributions every year at $13,500. If the company creates an IPP for her and she makes a qualifying transfer from her RRSP, this year $132,000 of additional deductible tax-sheltered room will have been created (see table on right.) Next year the amount that can be sheltered in her IPP will be $24,000.

It’s important to note that RRSP limits are scheduled to increase to $18,000 maximum per year in 2006, then every year afterwards RRSP limit maximums will increase with the industrial wage (about 1.8 per cent.) But IPP tax deferral limits are more generous by comparison. IPP tax deferral room increases each year by about 7.5 per cent due to the aging of the individual the IPP was set up for.

Peter J. Merrick is president of Merrick Williams Wealth Management in Toronto, a firm that specializes in creating executive benefit plans specifically in the areas of Individual Pension Plans and Retirement Compensation Arrangement. He can be contacted at (416) 861-9000 or [email protected].

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