All parties to an Individual Pension Plan (IPP) should have a certain Minimum Adequate Knowledge (MAK) of the program to ensure that the IPP complies with tax and applicable pension legislation. These parties, other than Westcoast Actuaries Inc. that provides the actuarial and administration services, may include:

• The person who is involved with the administration of the IPP at the company (employer / pension plan sponsor) level;
• The IPP member and if applicable, the member’s spouse;
• The investment advisor or financial planner;
• The person who handles the T4 reporting and/or filing of the T2 corporation tax return for the company.

Westcoast Actuaries Inc. strongly recommends that these parties be aware of the following facts about IPPs:

A. Eligibility for Pension Coverage

A pension is an employment-related benefit for employee(s) provided by the employer. The two key eligibility requirements are:

1. The employer (the IPP sponsor) and the employee (the IPP member) must have a bona-fide employment relationship.

2. Pension-eligible compensation is the T4-type employment income: salaries and wages; bonuses; taxable benefits and allowances; director’s fees; and distributions from an Employee Profit Sharing Plan (EPSP) that are reported on the T4 or T4PS forms. Self-employment income and dividend income are not pension-eligible.

B. Eligibility for Past Service Benefits

For the calendar years 1990 and after, any pension benefit provided by the employer in a given year would reduce the pension plan member’s RRSP deduction limit for the following year through the reporting of a Pension Adjustment (PA) on the member’s T4. Before an employer can provide past service pension benefits to, or make a past service pension contribution on behalf of an IPP member, the tax regulations require that the IPP member must satisfy the condition on “RRSP deduction limit lost”. This condition must be satisfied through one or a combination of the following methods:

1. A reduction in the member’s unused RRSP contribution room carried forward;

2. A withdrawal from the member’s RRSP on a taxable basis so as to free up the necessary RRSP contribution room (This method is rarely used as the member makes a taxable withdrawal from an RRSP – defeating the purpose of setting up a new IPP which is to achieve more tax sheltering.); and/or

3. Transfer the amount on a tax-free basis from the member’s existing RRSP account to the IPP. This is the most commonly used method to satisfy the condition and is referred to as a “Qualifying Transfer from RRSP to IPP”. Note – only the member’s own personal RRSP (i.e., the IPP member must be the annuitant of the RRSP) can be used. Spousal RRSP (i.e., a plan under which the IPP member is the contributor but not the annuitant) funds can not be used for this purpose.

If the “RRSP deduction limit lost” condition can not be satisfied, the employer must either:

a) Reduce the number of years of past service benefits being recognized; or

b) Postpone the recognition of past service to a future date until the RRSP funds have accumulated to the required transfer amount.

Some individuals may wish to have a selected number of years recognized immediately and have other past years recognized only when remaining RRSP funds can accumulate to the required transfer amount.

Recognition of past years of pensionable service at IPP implementation is voluntary and at the discretion of the employer. Bear in mind that for a plan that is subject to registration with the federal or provincial pension regulatory body, the company must contribute a minimum amount based on the amount of current service contribution and the amortization of a deficit amount.

Recognition of additional years of past service for the IPP member would also result in additional minimum funding obligation for the employer. The employer should take the mandatory minimum employer contribution into consideration to ensure that they are comfortable with the resulting mandatory minimum pension funding requirements. Please refer to Section H – Mandatory Minimum Company (Employer) Contributions of this brochure for further details.

C. Impact on RRSP Deduction Limit

For the Year the IPP is Implemented

In the calendar year the IPP is implemented, a connected person’s RRSP deduction limit for that calendar year is reduced by 18% of earned income for RRSP purposes for the 1990 calendar year, up to a maximum of $11,500.

A connected person is defined in the tax legislation as a person who owns directly or indirectly 10% or more of any class of shares of a company or who is not dealing at arm's length with such a person. The arm’s length test is used to include related family members such as a spouse, parent, child, etc.

This reduction in the RRSP deduction limit of a connected person for the year the IPP is set up applies only if the Pension Adjustment (PA) reported for the year 1990 was $0. If the IPP member who is a connected person had a Pension Adjustment (PA) reported for the year 1990, this reduction in RRSP deduction limit does not apply.

Example 1

The connected person’s 1990 earned income was $50,000. The reduction in RRSP deduction limit is $9,000 (18% of $50,000).

Example 2

The connected person’s 1990 earned income was $100,000. The reduction is $11,500 because 18% of $100,000 (or $18,000) exceeds $11,500.

For the 2005 year, the application of this special rule to a connected person would result in a $5,000 RRSP deduction limit for people at the maximum income level (i.e., $16,500 less $11,500 equals $5,000).

The RRSP deduction limit for a non-connected person for the year an IPP is implemented is not affected.

For Years After IPP Implementation

Any pension benefits earned will reduce a member’s RRSP contribution room. Each year while the IPP is in effect, a Pension Adjustment (PA) must be reported on the member’s T4. The PA reduces the member’s RRSP deduction limit for the following year.

A new IPP member in 2005 can expect to have annual RRSP contribution room of $600 in 2006 and in future years.

Please note that an IPP is a defined benefit pension plan, not a defined contribution pension plan. The PA for an IPP member is determined based on pension benefits being accrued, i.e., T4 income for the current year, and NOT based on the amount of pension plan contributions made on behalf of the IPP member. Therefore, an IPP member’s RRSP deduction limit or contribution room can not be restored by ceasing employer contributions.

D. IPP Investment Restrictions

Unlike a self-directed RRSP, the investments held in an IPP must follow pension fund investment rules prescribed by income tax legislation as well as the applicable federal/provincial pension legislation.

The main difference between pension and RRSP investments is the diversification requirement for a pension plan with respect to investments in individual securities such as stocks or bonds. An IPP can not invest more than 10% of the fund in a single security on a book value basis at the time the investment is acquired. This 10% limit does not apply to pooled funds and mutual funds as those funds are already diversified.

E. Locking-In

Pension proceeds are intended to be used to provide a lifetime pension. Therefore, pension legislation imposes a locking-in condition on funds originated from pension plans. Locking-in means that the member cannot receive a lump sum cash settlement from the pension plan. Upon retirement or termination, the member must elect one of the following options:

• an immediate or a deferred pension from the plan; or
• purchase of a non-commutable immediate or deferred annuity from an insurance company; or
• transfer the commuted value of pension benefits to a locked-in vehicle such as a Locked-In RRSP, Locked-In Retirement Account (LIRA), Life Income Fund (LIF) or Locked-In Retirement Income Fund (LRIF).

F. Beneficiary Designation

Pension legislation requires that if the member has a spouse (including a same-sex partner), the spouse must be made the primary beneficiary for pre and post retirement death benefit purposes. The IPP member can choose to designate another beneficiary or beneficiaries to receive death benefits only if the spouse signs a waiver form.

The IPP member can however designate a “contingent beneficiary(ies)”. Such “contingent beneficiary(ies)” shall become beneficiary(ies) in the event that the spouse predeceased the member.

G. Maximum Transfer Limit

If an IPP member elects to transfer the commuted value of pension benefits to a locked-in vehicle as a settlement option, the tax legislation prescribes a maximum non-taxable amount that can be transferred. The commuted value of pension benefits that is in excess of this maximum transfer limit must be either paid to the member in a lump sum or, if the member is not yet age 65, be left in the pension fund to provide a temporary lifetime and bridging benefit.

Because the IPP is designed to maximize benefits, terminating the IPP and transferring the member’s commuted value will most likely generate a significant taxable lump sum.

For further details on this maximum transfer rule, click here.

H. Mandatory Minimum Company (Employer) Contributions

If the IPP is subject to registration with the federal or provincial pension regulator, the company (employer) must make a minimum amount of pension plan contributions each year.

IPPs for connected persons and highly compensated individuals are exempt from registration with provincial pension regulatory authority in certain provinces. The exempt provinces are British Columbia (BC), Manitoba (MB) and Quebec (QC). Please note that Quebec’s exemption is only for connected persons; IPPs for highly compensated individuals in Quebec are still subject to provincial registration. Prince Edward Island (PE) has not proclaimed the proposed provincial pension legislation into effect, so IPPs in Prince Edward Island do not have to be registered provincially.

The minimum contribution by the Company each year is identified in the most recent actuarial valuation report for the plan and is generally the sum of the current service contribution for the year and the amortization of deficits under the plan over the periods prescribed by pension legislation for such deficits.

I. Potential Additional Liability on Plan Termination

If an IPP is subject to registration with the federal or provincial pension regulator, an additional liability on termination of the IPP may occur. While an IPP is active and on-going, the maximum funding contribution amounts are determined based on a set of actuarial assumptions prescribed by the income tax legislation. With an on-going pension plan, the maximum funding under income tax legislation overrides the minimum funding requirements under federal and provincial pension legislation.

For IPPs that are subject to federal or provincial registration, the pension plan sponsor must realize that the income tax funding restrictions for IPPs postpone certain mandatory minimum pension contributions to the actual pension commencement date for the member or the plan termination date for the IPP. After pension commencement, the income tax restrictions on IPP valuation assumptions no longer apply, and plan liabilities would increase as a result. At plan termination, the calculation of the lump sum commuted value for the IPP member is mandated by applicable pension legislation and may exceed the amount of IPP assets. These events can potentially lead to additional funding requirements by the employer.

The preceding information is intended solely for educational and informational purposes. Every effort has been made to ensure the accuracy of the information provided. As it is impossible to include all situations, circumstances and exceptions in a publication such as this, no person or firm involved in the preparation or distribution of this commentary accepts any liability for its contents or its use.

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