While individual pension plans can be a sound solution for some entrepreneurs and executives, when it comes to retirement planning, one size never fits all.
Mike Lynch, corporate specialist with Lynchpin Wealth and Transition Management, says IPPs tend to be somewhat oversold, but notes they aren’t optimal for a majority of Canadian small businesses that don’t consistently earn a pre-tax income of $500,000 or more.
“When tax-exemption limits were $200,000 seven to eight years ago, many more businesses could justify setting up an IPP,” he says. “But now the government has significantly increased the taxable limits to $500,000, and very few companies fall outside that limit. Therefore for most small businesses, IPP contributions are deductible only at a 15% to 16% marginal tax rate. As a matter of fact, New Brunswick just announced its tax rates are going down even further to as low as 8%. Governments at both levels are sending clear tax signals to the business community at large that their personal and business lives can now be more readily financed without using complex tax planning strategies.”
Lynch says there are other simpler, controllable, tax-efficient strategies for business owners to save for retirement. “The only time my team looks at them is when we have medical, dental or other such specialists who consistently make high-tax corporate income and aren’t going to work once they retire.”
There could be huge tax inefficiencies for business owners who don’t wish to retire even after they turn 72 (time to RRIF the IPP income), he adds.
Those who don’t wish to fold up their shingles at 72, could, however, get off the company payroll and become paid consultants, according to Carol Bezaire, vice-president, tax and estate planning at Mackenzie Financial Corp. That is the age they need to start drawing down their IPPs.
Or, as Peter Merrick, CFP, president of MerrickWealth.com in Toronto and author of The Essential Individual Pension Plan Handbook suggests, they could give up their Canadian residency, liquidate the locked-in plan and pay just the withholding tax on that income.
“If implemented properly, and for the right reasons, IPPs are beautiful solutions,” Merrick says. “But for advisors who suggest them because they mean more assets under management, and don’t understand all the potential liabilities, the [product] could come back to bite them.
“There are always liabilities and responsibilities involved with managing registered pension plans. With other, more flexible, solutions business owners can avoid the complexity of having to register with the CRA, and different pension administrators.”
IPPs, Merrick notes, are a really good solution for creditor protection, which ironically tends to be its most undersold aspect.
Bezaire agrees IPPs aren’t for everyone. She suggests carefully considering the salary history of the client before setting them up. “They are not suitable if the corporation is paying out dividends and not salary to the business owner or executive, since the dividends don’t reflect on the T4.”
The nature of the business is the next thing to look at. “It should ideally be inching beyond the $500,000 mark. You don’t want to recommend an IPP for someone who loses a job in the auto sector and sets up his own shop during the transition. The company needs a track record of growth and stability — at least two to five years,” Bezaire adds.
Tina Tehranchian, CFP, branch manager and financial advisor at Assante Capital Management Ltd., routinely uses IPPs for her clients. She concurs that not everybody ends up being a good candidate or feeling totally comfortable with IPPs. “They aren’t for everyone, but can work really well for the right candidate. It falls to the advisor to determine the suitability.”
According to Tehranchian, IPPs don’t work well if your clients are under 40. To be eligible, they also need a T4 income of over $122,000. If their accountants are already using creative methods to save taxes, their T4 incomes may end up being significantly lower.
Another big difference between IPPs and RRSPs, she notes, is the funds in an IPP are locked. “That can be a sticking point for several business owners because businesses have fluctuating incomes, especially during these tough times. I have some clients who have been in a business for years and are having to take money out of their RRSPs. So you need to make sure they have other accessible resources they can tap into if business isn’t doing well.”
And with revenues taking a hit and most portfolios going south, in the case of a funding shortfall (the assumption is of a 7.5% rate of return), the company would find itself in the difficult position of topping up the IPP.
And therefore, IPPs may make more sense for companies whose revenues aren’t very sensitive to fluctuations in the economy. “For example, an advertisement firm will take the first hit if the economy goes south, and may not be such a good candidate,” Tehranchian says. “Although, even in these sectors companies may be on a growth path, so don’t generalize. Have a conversation with the client before setting up an IPP, and make sure they aren’t just looking at short-term boom times.”
When Merrick sits down with clients, the most important question he asks is what clients want to achieve. “We then look at what’s in our toolbox and try various combinations to arrive at the best solution in light of the client’s long-term goals.”
Once he decides on the best solution, the next question he asks himself: Where’s the fire escape?
“An advisor who wishes to be successful in the long run needs to spend time to understand the exit route if things don’t go as anticipated,” he says. “And IPPs are a really long-term investment.”