As clients approach retirement, they need answers on their superannuation benefits. Registered Retirement Savings Plans (RRSPs) and government programs (CPP/QPP and OAS) are two of the main sources of retirement income, but the third—company pension plans in the form of defined-benefit or defined-contribution plans—is often the most complex.
In order to provide clients with valid retirement income analyses, advisors must understand the terms and conditions, as well as the options available, in every person’s specific plan.
An Individual Pension Plan (IPP) is a defined-benefit plan that can be particularly complicated. IPPs have been popular retirement tools for business owners and Canadian businesses to attract and retain high-level executives.
They can be customized to provide better retirement funding for high-income earners since they provide higher contribution limits than RRSPs; protection from volatile markets; and tax savings on contributions for the employer.
IPP participants nearing retirement age will need some guidance on the maturity options available to them, especially because some rules have recently changed.
For example, the 2011 Federal Budget restricts past-service contributions to IPPs, essentially reducing the opportunity for employers to contribute new funds to the IPP when employees have large RRSP assets or carry-forward balances in RRSP contribution room.
An IPP is a good option for clients who:
Another change from the 2011 Federal Budget requires IPPs to begin paying out a minimum amount to members in the year they turn 72—no matter what the original terms. As of 2012, IPP members will become annuitants of their plan in the year they turn 71.
As is the case with Registered Retirement Income Funds (RRIFs), each year following the year IPP members turn 71, they will be required to receive at least the minimum annual pension payments from their plans.
The amount will be the greater of the regular pension payable to the participant during the year according to the plan’s terms, and the minimum of what would have been paid had the member’s share of the IPP assets been held in a RRIF instead.
There are three ways of maturing an IPP:
- Pay out pension income directly from the plan;
- Transfer the assets to a Life Income Fund (LIF) or Locked-in Retirement Income Fund (LRIF) in certain provinces; and under certain circumstances a RRIF in the province of Quebec; or
- Purchase an annuity.
Here is a discussion of each option.
1. Pay out pension income directly from the IPP
Since an IPP is a defined-benefit pension plan, it must provide members with a lifetime pension when members become annuitants. This pension carries a basic 66 2/3% survivor benefit with a five-year guarantee.
In other words, if the plan member dies, 100% of the pension will continue to be paid out for a period of five years from the date of the annuitant’s retirement and, thereafter, 66 2/3% of the pension will continue to be paid out to the surviving spouse.
Aside from this regular pension, plan members may be able to choose optional benefits. These options are stipulated in the plan’s terms and allow members to adapt:
- the amount of their pension incomes;
- the length of the guarantee periods; and
- the percentage of the survivor benefits to their needs.
As a rule, the longer the guarantee period and/or the higher the percentage of the survivor benefit, the lesser the monthly or annual pension income paid out to the annuitant. At the time of retirement, other modifications to the plan’s basic provisions may improve pension benefits for the client, including:
- early retirement before age 65 without actuarial reduction (under certain conditions)
- bridging benefits payable until age 65
- increase in the indexation of the pension in order to maximize the pension income to be paid out to the annuitant
These changes to the plan’s provisions may entail additional contributions, which will be tax-deductible for the company sponsoring the IPP.
Once the amount of the pension is determined, it must be paid out to the annuitant. In order to pay out a pension directly from the IPP, the plan itself—and not the company sponsoring the plan—must request the tax numbers needed to withhold deductions at source on the pension paid.
It is up to the plan’s trustee to shoulder the burden of administrative responsibilities when a pension is paid out directly by the plan.
When annuitants begin to receive pension income from their IPP, they no longer need to worry about the ups and downs of the economy, because if the plan generates a deficit the company sponsoring the plan is required to top it up. This option assumes, of course, that the company continues to stay in business.
An actuarial valuation is required for the IPP every three years. In the event of an actuarial deficit, the contributions and costs related to the IPP are tax-deductible and covered by the company sponsoring the plan.
Even after retirement, plan assets continue to grow tax-sheltered if the pension is paid out directly from the plan. Moreover, like other pension plans, IPPs provide full creditor protection as plan assets are exempt from seizure.
Pension income paid out by an IPP can be split with the member’s spouse, regardless of the annuitant’s age. Upon the annuitant’s death, the pension will continue to be paid out to the surviving spouse according to the survivor benefit percentage chosen.
In the absence of a surviving spouse, or when the spouse dies, the IPP will terminate and any balance distributed to the planholder’s estate.
2. Transferring IPP assets to a LIF (a RRIF in Quebec)
Another maturity option for IPPs is to transfer the value of the plan to a Life Income Fund (LIF) or, if the member is under age 71, a Locked-in Retirement Account (LIRA). Once transferred, the plan will be regulated by the appropriate provincial jurisdiction. Where provincial jurisdictions allow a Locked-in Retirement Income Fund (LRIF) or, if the member is under age 71 a Locked-in Retirement Savings Plan (LRSP), may be available as well.
In Quebec, special provisions allow that if the member of the IPP is a connected person—an individual who owns more than 10% stake in the company sponsoring the plan—the assets accumulated in the plan are not locked in. In this case, the transfer can be made to a RRIF.
This option allows more flexibility as the annuitant can use the age of a younger spouse in order to reduce the annual amount of minimum withdrawals. Also, there are no maximum amounts imposed on annual payments.
The option to transfer to a LIF, LRIF, or RRIF may provide the retiree with more control on the investment options within the plan after retirement, but it also entails terminating the IPP. One disadvantage to this approach is exposure to market fluctuations. If the plan is unable to meet the original payment schedule in the IPP, the employer is no longer able to make additional contributions.
While better investment performance could increase the annual payout from the LIF/LRIF, these plans have legislated maximum annual payments restricting the annuitant from participating in large increases in any one year.
It is important that plan members look before they leap into this option. Not all of the assets accumulated in an IPP are transferable to a registered account on a tax-free basis.When the IPP is terminated, a certain amount could be subject to tax. Plan members should play it safe and have this option properly assessed before making a decision.
In this case too, the pension income can be split with a spouse, based on certain age restrictions. At the annuitant’s death, the registered plan can be rolled over to the surviving spouse. If there is no surviving spouse, the balance of the registered plan is subject to tax and distributed to the estate.
3. Purchasing an annuity
The third maturity option for an IPP is to transfer the plan’s value to an annuity.
This annuity can be backed by life insurance and can provide for a guaranteed period of payment and a survivor benefit percentage. As a minimum, the annuity must provide for the same guarantees as provided for under the IPP—a five-year guarantee period and a 66 2/3% survivor benefit.
As these are registered funds, the annuity cannot qualify as a prescribed annuity for tax purposes. Once again, regardless of the annuitant’s age, the retirement income from the annuity can be split with a spouse. It’s important to note, however, that the terms of the annuity cannot be changed after purchase.
Whatever the preferred option, the important thing is not to forget to notify your clients ahead of time. Given that IPPs are trusts, the advisor’s role is to present trustees and IPP members with all the maturity options available in advance.
This will ensure they can make an informed decision and, above all, avoid exposing themselves to penalties for having members in their plan past the age limit.
Maureen Glenn, B.A. CFP, FLMI, is Manager of Tax & Estate Planning at Richardson GMP Limited. This team of in-house experts collaborates with investment advisors to deliver customized wealth management solutions designed to address tax, estate, insurance, philanthropic and succession needs.