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Changes to Individual Pension Plan Rules

The 2011 Federal Budget proposed significant changes to the rules governing the pension plan utilized by many business owners. Some of the new rules pertaining to Individual Pension Plans (IPPs) take effect immediately while others begin in 2012.

The Budget also indicated that the government is considering future adjustments to the rules pertaining to Employee Profit Sharing Plans (EPSPs), which many private businesses utilize as part of their compensation strategies.

“The proposed changes to the IPP rules make them more consistent with the rules applied to Registered Retirement Savings Plans (RRSPs),” says Chartered Accountant Jamie Golombek, the Managing Director, Tax and Estate Planning with CIBC Private Wealth Management in Toronto. “In aligning IPPs with RRSPs, however, some of the features that made IPPs an attractive alternative to RRSPs for many private business owners are being eliminated.”

Contributions for past service
New rules governing contributions for past service are effective as of March 22, 2011 – the date they were announced by the government in its original Budget.

Before: When setting up an IPP, business owners are permitted to make a contribution in respect of past service. To do so, the individual had to give up accumulated RRSP contribution room for earlier years or withdraw a portion of their RRSP assets (to the extent that the person made RRSP contributions in previous years) to fund the IPP. The portion of the past service contribution that had to be funded from an RRSP or by using RRSP contribution room was determined by a formula; if this portion was less than the total required contribution, any remaining amount was funded by the company by having the company make (an often substantial) tax deductible contribution to the IPP.

People who switched RRSP savings to IPP savings later in their working careers were often able to make past service contributions to their IPP that could be much greater than the amount they were required to reduce their RRSP assets by or accumulated RRSP contribution room. Golombek explains, “If a person’s past service contribution was calculated to be $350,000 and they had $400,000 in their RRSP, they could move a portion of their RRSP – for example, $150,000 – and top up their past service contribution by contributing $200,000 from their company, which was tax deductible for the business. They also retained $250,000 in their RRSP.”

Beginning on March 22, 2011: The cost of funding past service must be satisfied by transfers from RRSP assets or a reduction in the IPP member’s accumulated RRSP contribution room before new past service contributions will be permitted. Using the above example, the person would have to transfer $350,000 from their RRSP into the IPP. There would be no contribution from the business, and therefore no corresponding deduction for the business, and $50,000 would be retained in the RRSP.

“IPPs are likely to be less attractive for people whose RRSP savings are equal to, or greater than the IPP’s past service amount,” Golombek says. “Since there won’t be any deductions available to the company, and the total amount of registered savings won’t be materially larger, they may conclude that setting up an IPP isn’t worth the time and effort.”

People who cannot contribute the full past service amount from their RRSP and do not have RRSP contribution room will, however, be permitted to contribute the balance of that amount from their business, which will continue to be tax deductible for the company.

As the rules surrounding RRSP and IPP contributions can become very complicated, it is recommended that you seek advice from your Chartered Accountant.

Minimum withdrawals from an IPP
New rules pertaining to minimum withdrawals from an IPP will take effect in 2012.

Before: Some business owners established IPPs as a vehicle to receive the commuted value of their pension under a defined benefit registered pension plan. In these cases, the terms of their IPP may be designed to provide a much less generous pension in respect of past service, based on minimal employer earnings with the new employer sponsor or a lower benefit formula.

“The result was that much of their IPP’s value was a ‘pension surplus,’ which was not subject to any withdrawal requirements,” Golombek explains. “That allowed the business owner to defer more of their retirement savings for longer periods of time than was possible for people who were members of other registered pension plans or who were RRSP investors.”

Beginning in 2012: An annual minimum amount must be withdrawn from the IPP once the plan member reaches age 72. That amount is to be the greater of either the regular pension amount payable under the IPP terms or the minimum amount that would be required to be paid if those assets were held in a Registered Retirement Investment Fund (RRIF).

Employee Profit Sharing Plans
Many private company owners use Employee Profit Sharing Plans (EPSPs) to distribute the company profits to themselves and family members in order to reduce the profits retained in the company to $500,000, the maximum amount that qualifies for the preferred small business tax rate for Canadian controlled private companies (CCPC) in Ontario.

“In the budget, the government gave business owners a ‘heads up’ with regard to its intention to review the rules for EPSPs,” Golombek says. “There will be consultations with stakeholders before any rule changes are announced, but it seems likely that there may be some changes in the future.”