IPP - Individual Pension Plans

Preparing for life after work. RRSPs, RRIFs, TFSAs, annuities and meeting future financial and psychological needs.
Stan
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IPP - Individual Pension Plans

Post by Stan »

I would appreciate any input on these vehicles for retirement especially with regard to tax benefits for drawing down retained earnings from a Canadian Corporation.
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Post by Norbert Schlenker »

Setting up an IPP requires an actuary. You will find much worth reading by googling "ipp actuary".

I've heard good things about Westcoast Actuaries but never dealt with them.

Greg Hurst likely knows more about this than the rest of us put together. How about chiming in, Greg?
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IPPs & Retained Earnings

Post by ghurst »

IPPs are a deep subject, and I prefer to save the depth for my fee paying clients.

But here are some points:

1. There is no mathematical advantage to establishing an IPP before ~5 years prior to your desired retirement (or exit from business) age. Actuaries seldom (never?) point this out, because it is contrary to their interest in providing you with services.

2. You may in fact be disadvantaged if you start your IPP too early, particularly if your IPP investment portfolio performs better than actuarial expectations. Surplus will limit your (your employer, actually) ability to make contributions. Also, actuaries are indifferent to how you invest your IPP portfolio, and few will give investment advice. Furthermore, investment advisors seldom understand how IPP funding really works...

3. You will lose income splitting option provided by spousal RRSPs after you set up an IPP.

4. If you are a business owner drawing dividends as income, you will have to change to salary (to the extent of maximizing the IPP benefit accrual) for purposes of funding the IPP.

5. An IPP is an excellent tool for transferring business equity (to the extent that an unfunded past service liability is established, and employer contributions are required for current service funding) to a tax-sheltered arrangement, particularly if you are at or near retirement age.

For a good primer on IPPs, go to Wescoast Actuaries website (but you won't find point 1 above).

End of free advice.

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Post by Stan »

Thanks to Greg for the "free advice". I would be glad to reciprocate if you have any need for some info on chromatography, neurochemistry, or running.

Stan
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Independent Pension Plan (IPP) - What do I need to know?

Post by Adanac Charger »

I am currently considering a job change away from Megacorp to a small, privately-owned business. The new company offers an IPP for executives.

Please provide your thoughts and comments on the advantages / disadvantages of an IPP.

I am 43, have about 300K in RRSP savings and no mortgage. I would like to retire no later than at 50.

Thanks!
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Re: Independent Pension Plan (IPP) - What do I need to know?

Post by DavidR »

Adanac Charger wrote: I am currently considering a job change away from Megacorp to a small, privately-owned business. The new company offers an IPP for executives...
check google for some information. NB - you need to search "Individual" Pension Plan, not independent pension plan. KPMG came up near the top.

http://www.kpmg.ca/en/services/enterpri ... Plans.html

Check out the FSCO link too.
http://www.fsco.gov.on.ca/english/pensions/ipps.asp
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Post by izzy »

Note that the item in the disadvantage column concerning lack of the ability to income split with your spouse appears to have been superceded in the last budget Also since an IPP generates pension income as opposed to RRIF income you do not have to wait until age 65 before you can income split-particularly relevant if you intend to retire young.
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Re: Independent Pension Plan (IPP) - What do I need to know?

Post by kcowan »

Adanac Charger wrote:I am currently considering a job change away from Megacorp to a small, privately-owned business. The new company offers an IPP for executives...
What kind of pension does Mcorp offer you?

How long have you worked for them?

What are your vested rights?

It seems to me that a seven-year runway gives you very little time to start over unless the Mcorp plan is really bad. Or the new opportunity is fabulous.

(Personal note: A friend left my Mcorp employer based on emotions and took his vested rights of $85k from his DB pension and used it to buy a cottage. Five years later (we were peers), I took an early retirement buyout that was valued at $783k and is actually still worth over $500k after 15 years of drawing the pension. My friend is still working. (I retired in 2002.) He might be able to sell his home and live in the cottage north of Toronto when he retires but it will be a struggle for him. So the message is to step back and fully value your choices.)
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Post by parvus »

Individual pension plans (IPPs) are attractive alternatives to RRSPs for those clients who are looking for higher tax-deferred contributions. But as Ashley Crozier explains, the ideal age to set up an IPP is an important consideration and unlike RRSPs, the sooner you start isn’t necessarily the better.

In recent years, the popularity of individual pension plans has been on the rise as many small-business owners have started to contribute to them. They are promoted as better than RRSPs, especially for those over age 40, because they offer higher tax-deferred contributions. The basics of IPPs were covered in a FORUM article published in March 2005 (“A Bigger Piece of the Pie”). In a nutshell, IPPs are registered defined benefit pension plans, typically with maximum benefits determined by the Income Tax Act. For simplicity, we assume one’s earnings are high enough to give the maximum benefits of an IPP (e.g., earnings over $100,000), but the concept is the same even if this is not the case.

An IPP creates a pension adjustment (PA) that eliminates all but $600 of the member’s RRSP contribution room, so it is a trade off for having the RRSP only. The advantages of IPPs relative to RRSPs are higher ongoing contribution room, even more contribution room at retirement (terminal funding) and the ability to make up deficits should investment returns be poor. An actuary determines the allowable contributions based on regulated assumptions, including 7.5 per cent projected investment returns. Exhibit 1 compares the maximum annual contribution room of IPPs with RRSPs for someone who is age 45 and shows the higher contribution room expected with an IPP.
Exhibit I
Comparison of expected tax-deductible annual contribution room for business owner born in 1961




Past service may also be recognized, although only since 1991 for most business owners. While this requires assets to be transferred from the individual’s RRSP or a forfeit of unused contribution room, it creates even higher contribution room for the IPP. The RRSP asset transfer is required to effectively reduce the historical annual RRSP contribution room to what it would have been had the IPP existed all along.

The RRSP transfer equals the sum of the PAs that would have been reported had the IPP been in place for the years of past service but based on the current limits (less $8,000, which is an arbitrary amount to facilitate pension improvements for any registered pension plan). For example, to recognize past service for 1991 to 2005 requires a transfer of $268,000 (15 years x $18,400 (the 2006 limit less $600) - $8,000). The extra contribution room created equals the liability of this past service less the RRSP transfer and ranges from $0 to over $150,000 depending on current age. The liability is calculated by an actuary and equals the cost of the extra benefit credited for the years of past service. This liability is the present value of the future retirement benefit and thereafter increases each year by 7.5 per cent (note that it will also be adjusted by any difference between actual average increases in Canadian wages and the assumed 5.5 per cent).

When to Start
Is there an ideal age to start an IPP? Given IPPs have higher contribution levels than RRSPs for those over age 40, it would seem the ideal strategy is to start an IPP as early as possible. Investment companies tout the financial advantages to getting an early start on RRSP contributions, but is there a similar advantage for IPPs? The key to answering these questions lies in the ability for IPPs to recognize past service and how the values are calculated as a result.

First, note the required RRSP transfer for past service equals the sum of the PAs that would have been reported, increased by average wages, but without interest. Assuming the contributions were actually made to an RRSP, the accumulated value exceeds the total deposits as long as the investment returns exceed average wage increases. The excess investment returns earned on the contributions are left in the RRSP and continue to be invested.

Second, by using the past service feature, the same years of service can be included in the IPP to give the same liability at retirement, regardless of when it is set up. The liability at age 65 for a plan that is set up at age 45 is the same if the plan were only set up at age 65 with recognition of past service from age 45. This is because the liability equals the present value of the pension that is to be paid and such pension is based on the years of service in the IPP.

Consider a business owner who is currently age 45 without any past service before now and who will have sufficient earnings each year for the maximum benefit. We then compare the strategy of starting the IPP today versus waiting until she intends to retire, assumed to be age 65. Exhibit II shows a summary of the contributions, IPP liability and total accumulated values. We assume 7.5 per cent average investment returns and 5.5 per cent average wage increases to avoid the complication of any surplus or deficit in the IPP, but the results are similar as long as the investment returns are positive.





If we compare only the amount of contributions for starting the IPP now versus the RRSP only, the IPP has higher total contributions to age 65 as illustrated ($892,000 versus $620,000). However, that is only part of the story if we assume the IPP is set up at retirement.

Note how the IPP’s liability and accumulated value at retirement are the same for both strategies; the option of waiting until retirement to set up the IPP with past service, however, gives significantly higher total accumulated values. This extra value comes from the investment returns on the RRSP contributions while they are left in it. The IPP contributions are higher when the set up is delayed, but that is to fund the investment returns that would have been earned had it been set up earlier. The extra contributions could be placed in a non-registered plan each year and earn (taxable) investment returns.

This example uses a 7.5 per cent investment return, which is the regulated return the actuary uses to determine the IPP’s costs. Even if the actual investment returns differ from 7.5 per cent, the accumulated value in Exhibit II of the IPP would be roughly the same. If average investment returns are lower than 7.5 per cent, then additional contributions are payable to the IPP to make up the shortfall and vice versa. The RRSP and total assets would, however, vary with different returns.

The Waiting Game
The financial advantages to waiting to start an IPP arise from the investment returns earned on the RRSP deposits from now until the IPP is actually set up. This timing is the opposite of how one gains advantage with RRSPs, where there is a cost to waiting. The upside to waiting is even greater when one considers the fees for setting up an IPP. Fees have dropped in recent years as more firms now provide IPP services, however, they still average $1,000 or more each year. Setting up the IPP at age 45 versus age 65 would result in $20,000 of fees over those 20 years.

The benefit to waiting to set up an IPP is even greater should average investment returns exceed average wage increases by more than two per cent, as shown in the fourth footnote in Exhibit II. In such cases, an IPP that is set up early would develop a surplus, eventually reducing contributions. If these superior returns are instead earned in the RRSP, there is no reduction in future contributions.

Many IPP members also find they are affected by the maximum transfer rules for pension plans. This only applies if one elects to transfer the value of their benefits to their locked-in plan, but most eventually do this even if only to stop the requirements under the IPP of regular filings and fees. This issue may be better managed with the shorter timeframe of only setting up the IPP at retirement.

Conversely, while there are financial benefits to waiting to set up the IPP, there are also some disadvantages. Waiting until retirement to set up the IPP means some contributions are deferred and the business owner needs to have the ability to ultimately make a large contribution at retirement. He or she can plan and budget for this, however, some may prefer regular forced savings.

There may be also situations where taxation may dictate not waiting to start an IPP, despite the financial advantages. One example is the tax deduction for making a contribution, especially for small-business owners. The timing of when contributions are made and the impact on tax rates should be considered. The impact cannot be generalized as this depends on the particular circumstances of each company.

IPPs and RRSPs give creditor protection to the accumulated funds, however, another possible downside to waiting to set up the IPP is lower assets are in these registered plans and creditor protected until the IPP is actually set up. There are various ways, however, to otherwise give protection from creditors. In addition, holding off on starting an IPP only has an advantage if average investment returns exceed average wage increases. Should average returns be lower than average wage increases , one is better to start the IPP now rather than wait.

The benefits to waiting to set up the IPP will exist so long as the pension rules remain the same. Should the maximum pension benefits or funding rules of IPPs become constrained in the future, with existing plans grandfathered, then waiting may not be the best strategy. So far there are no current concerns from Canada Revenue Agency or the Department of Finance that this may occur; in fact, just the opposite.

Finally, it’s not recommend that a business owner waits until he or she actually retires to set up the IPP. It takes several months to have a plan registered, so starting at least a year before the expected retirement date is wise. Otherwise, the funds may be paid to the plan but any withdrawals will be postponed until the processing is finalized.

IPPs can provide tremendous value for business owners who are looking for a solution that provides significant tax advantages and potentially higher pension benefits. Unlike RRSPs, however, more often than not your client is financially better to wait rather than rushing to set one up now, which could have a negative impact on their retirement savings.

Last edited by parvus on 17 May 2007 18:25, edited 1 time in total.
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Post by BrianMallard »

Individual Pension Plans are complex and candidly beyond the scope of this forum. It seems to me that this is a situation where you should look for a qualified individual to assist you in assessing what is best in your individual situation. I would suggest contacting Gordon Lang and Associates in Calgary. Gordon has extensive experience in this area and has been of immense assistance to my clients.
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Post by DanH »

This topic has been discussed here before. In this older thread, Greg Hurst provides some brief but wise tips on IPPs.
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Post by Adanac Charger »

From Keith... "What kind of pension does Mcorp offer you?"...

MCorp only offers a DC pension plan (2%). I am fully vested so I don't foresee any loss in moving away.

Searching on "Individual" vs "Independent" has yielded much more information. Thanks to everyone for your input.
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IPP individual pension plans

Post by JohnMorgan »

Any suggestions for reading material on this topic? Live in Alberta.
Thank you.
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Re: IPP individual pension plans

Post by DavidR »

JohnMorgan wrote:Any suggestions for reading material on this topic? Live in Alberta.
Thank you.
Previously discussed here:
http://www.financialwisdomforum.org/for ... p?t=105232
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IPPs

Post by JohnMorgan »

Ooops, sorry. Forgot the golden rule of searching FWRF before asking.
But thank you DavidR for pointing me in the right direction.
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Individual Pension Plans

Post by Doug »

I've recently found out about Individual Pension Plans. For some individuals, they are a much better alternative to RRSPs. I've done considerable internet searching on the topic, which has generated many sources of information. One characteristic that all the sources have in common is it is their self interest to sell this complicated and potentially lucrative (to them) financial product. Is anyone aware of a source that puts the consumer's interest first? I'm not adverse to paying for this, such as a book or an advisor.
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Post by Flights of Fancy »

Hmmmm. IPPs are not a "product" but an RRSP alternative which incorporated businesses can use to top up compensation for executives. Makes me wonder what sites you are reading!

That said, I am aware of one recent book on the subject, The Essential IPP Handbook, by Peter Merrick. You can visit his site at MerrickWealth.com
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Post by marty123 »

There were a few discussions on the topic:

http://www.google.com/search?ie=UTF-8&o ... rg%2Fforum
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Post by Doug »

That link was useful. Thanks.
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Post by Doug »

For the benefit of other FWF members, I have included the following links regarding IPPs. I'd like to thank Bruce Cohen and marty123 for their help.
http://www.westcoast-actuaries.com/
http://www.financialwisdomforum.org/for ... 68ff08dca8
http://www.advocis.ca/content/programs/ ... r-age.html
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Post by Doug »

I forgot to say thanks to Flights of Fancy.
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Post by Doug »

One of the links provided above is an article written by Ashley Crozier, and makes a case for waiting when it comes to setting up an IPP. I don't understand IPPs myself. For the sake of completeness, I am providing the following rebuttal to what Ashley Crozier wrote:

http://www.gblinc.ca/archive/advocis_letter_06.pdf
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Post by brucecohen »

Doug wrote:I don't understand IPPs myself.
Is it the concept you don't understand or the detailed implementation?

The concept is pretty simple if you think of it this way:

-- Before the big RRSP/pension reform of 1989 a major corporation could create a pension class that provided its senior executives with the best DB pensions allowed by law. This was impossible in a small or mid-sized owner-managed business that lacked enough people to form such a class and make the pension fees cost-effective. The '89 reform balanced the playing field by allowing little guys to create one-person DB pension plans for themselves and other key employees.

-- The RRSP is a defined contribution plan. The contribution is defined, not the benefit. So, the amount of retirement income is not pre-set. An IPP is a defined benefit plan. It's the benefit that's defined, not the contribution. So the amount of retirement income is pre-set. Unlike an RRSP, there is no dollar or percentage limit on contributions. Rather, there are limits on the pension to be provided and on the assumptions used to determine how much must be invested today to be able to meet that promise.

-- An IPP typically provides the best DB pension allowed by law. This includes a number of ancillary benefits. For example, inflation indexing, a very costly benefit. The '89 reform sought to better balance tax-sheltered retirement funding opportunities among those with good DB plans and those without -- not to equalize them.

-- Remember: DB sponsor contributions reflect the amount required to fund the promised benefit. Barring the existence of a surplus in the plan, the required funding increases as the plan member approaches retirement because there is less time for the money to grow. The RRSP limit, on the other hand, results from the Finance Dept's averaging over a 35-year career (IIRC) the funding required for the target pension. In effect, RRSP funding is averaged while IPP/DB funding is back-loaded.

So, for an older owner-manager -- typically one over 45 -- the IPP is allowed a higher level of tax-deductible funding than an RRSP. (The age at which DB funding surpasses RRSP funding depends on the allowable assumptions which change from time to time. Over the years I've seen illustrations with optimal IPP-start ages ranging from 42 to 50.)

In a nutshell, an IPP enables the owner of a successful incorporated business to provide him/herself with a DB pension that's equal to one for a senior corporate executive* and slightly better than those for civil servants.

* The RPP portion of the senior corp exec's pension, not the unsheltered RCA.
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Post by Doug »

http://www.theglobeandmail.com/globe-in ... le1249977/

This article makes the point that you will receive a tax deduction at the top marginal rate in an RRSP. In an IPP, the corporation will receive a tax deduction at the corporate rate, which is usually considerably less than the top marginal rate.
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Post by Doug »

If one has an Individual Pension Plan (IPP), the salary that is needed to maximize contribution room in 2009 is $122,222. Recently, the salary needed to maximize both RRSP and IPP contributions has been increasing each year. In 2010, the salary needed to maximize RRSP contribution room will be $122,222.

If one has an RRSP now but is considering an IPP in the future, what 2009 salary should one have to obtain maximal IPP contribution room in the future? For a future IPP that will include past service, it is better to have a salary in 2009 of $122,222, as this will maximize the past service pension amount.
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