If you A) own 10% or more of a company or B) earn more than $109,250 in 2007 you may be a candidate for setting up an Individual Pension Plan (or IPP for short). An IPP is best described as the Cadillac of defined benefit pension plans.
First some clarification: A "Defined Benefit" pension plan is when the benefit payments are defined – or in plain English: you know exactly how much you will receive in pension payments every month until the day you die. This is as opposed to a "Defined Contribution" pension plan – where you only know how much you put into the plan, and based on your investment selection you may have more money than with a defined benefit plan… or less!
Defined Benefit plans are slowly going the way of the Dodo bird as companies are finding that their pension payment obligations are much higher and longer than they bargained for – hence they have been able to transfer the liability of retirement savings to the employee by dismantling Defined Benefit (DB) plans and replacing them with Defined Contribution (DC) plans.
The advantages of a Defined Benefit pension plan are pretty plain to see. You will never have to worry about running out of money.
Your RRSP is a form of Defined Contribution pension plan however – and as such, you know how much you put in, but you will not have the ability to say with certainty that you will have $X per month until the day you die upon reaching retirement.
…unless you convert it into an IPP (Individual Pension Plan).
The name comes from the fact that the IPP is normally set up for ONE person only. You’ll note that I referred to the IPP as the "Cadillac of Defined Benefit Pension Plans" up above. This is because the IPP will allow you to create significant retirement savings tailored to only one person. Normally when a company was to create a defined benefits pension plan for its employees, it would create a plan that wouldn’t cost the company an arm and a leg – but at the same time provide enough retirement funding benefit to entice and retain employees to stay. As a result of trying to keep costs in line for the masses – a company would normally pick a run of the mill pension benefit formula.
An IPP, on the other hand, is designed for "special" employees – either owner/operators or highly paid executives – and as such, an IPP is a method of setting up the maximum possible defined benefit pension payment for only one person at a time. The difference it can make is SUBSTANTIAL. Assuming a static rate of return on the investments inside an RRSP and an IPP, your nest egg can be 40-80% higher with an IPP – and this is owed mostly to the fact that you can contribute MUCH MORE to an IPP account than you can to an RRSP account.
For example, while an RRSP will allow a 60 year old to shelter up to 18% of their previous year’s income up to $19,000 (for 2007), setting up an IPP will allow that person to shelter around 27% or $30,000.
An IPP will allow you to know how much money you will have every year until you die, while an RRSP will only let you know how much of a lump sum you have at the beginning of retirement – how much you use per year, and how many years you will have it for are based on market performance… and of course if you live to be very, very old – this can cause some problems.
Of course, there are extra costs and quirks associated with IPPs. One of the first things to note is that you must hire an actuary to determine exactly how much you can contribute to the plan, and the plan requires an actuarial evaluation once every three years on top of that. You can expect this to add up to approximately $1,100 per year (when averaged out or if using a flat annual fee service) – however, those costs are tax deductible (unlike administrative costs associated with RRSP accounts). The actuary is used to determine if the plan is over- or under-funded – and if it is under funded, you can actually top up your contributions in order to catch back up… and those top-up contributions are tax-deductible as well!
You can choose to convert your RRSP into the IPP, and you can also pay a lump sum to catch up for prior years of service. You can also continue to have separate IPP and RRSP accounts, but note that how much you can contribute to your RRSP is reduced since there is a maximum amount of money that can be contributed to your pension plan(s) in total.
And there certainly are disadvantages over and above the extra administrative costs as well. Namely, you don’t have access to the funds while you are working. Remember, it’s a pension plan now, and is governed under pension legislation. Also as such, you have some restrictions with the investments you are allowed to select – for example, you are not allowed to have any one security represent more than 10% of your IPP portfolio – this is also governed by pension legislation.
Here is an example of the difference an IPP can make to a 57 year old, who earned $150,000 since 1990 and has maximized his RRSP (which is now worth $500,000): by setting up an IPP he can collect an annual pension of approximately $91,000 per year versus $57,000 per year with an RRSP (assumes a flat 7.5% rate of return). Remember, the magic is really due to the increased contribution limits – not the investment portfolio differences.
If you want to learn more about IPP’s, there are a couple of places to look:
West Coast Actuaries provide an online quoting system if you are curious to see the effects of an IPP on your retirement funding.
Gordon B. Lang and Associates provides further information on their website.
Executive Retirement Plan is a website that provides further information on a variety of topics relating to retirement, but they specialize in providing IPP set up assistance to financial advisors for their clients.
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Preet, thanks for the great article. I had no idea that individuals could set up a defined benefit plan for themselves.
One of the criteria was that you must own more than 10% of a company. Can this be any company?
Hi MDJ, technically you need to either be a highly paid employee, or be a "Connected Person".
You need to be drawing T4 income from the plan sponsor – so if you owned 10% of Royal Bank but didn’t work there, you would not qualify for an IPP.
If you worked for Royal Bank and they agreed to sponsor the plan, you could setup an IPP without owning 10% of the company if you qualified as a "highly paid employee".
To say there are administrative hurdles to setting up an IPP is an understatement. This is a very good alternative to the basic RRSP for qualified individuals, and he/she should be prepared to be patient as the process to set one up is time consuming and the red tape can be exasperating–anything where the CRA is involved! Throughout the life of the plan there are many parties involved including the actuary, an independent trustee, and investment advisor (who may also be the custodian of the funds). Another actuary to add to Preet’s list is Canadian Western Trust (Disclaimer: I have no beneficial interest in this company but have dealt with them professionally).
Thanks for the additional insight – you are right, I made it sound like it was very straight forward to set up – but Leslie is right, it can be an undertaking in some situations.
Thanks for the link to Canadian Western Trust – I will check them out! :)