New business for Individual Pension Plans (IPPs) is just now starting to get back to normal after more than a year of confusion and misinformation about proposed government regulations, say representatives of two Canadian actuarial firms that deal with IPPs.
The problems started in March 2011 when the federal government brought in its budget proposing to change a major advantage of IPPs dealing with past service contributions. The budget was defeated and a federal election was called. The new Conservative majority brought in an identical budget in June with the same IPP proposal. However, different groups, including several actuarial firms, the financial planning advocacy group CALU and the Canadian Federation of Independent Business, met with government officials to discuss what they considered to be unfair changes to the IPP rules. While the Department of Finance agreed and made changes, it took until the end of the year for the legislation to become final. But before that happened, erroneous statements had spread among financial service and accounting firms that because of the proposed change on past service, IPPs were no longer a credible strategy for retirement savings.
The misunderstanding and uncertainty basically wiped out all new business for IPPs last year. Now with the rules clarified and, some say, much re-education of the financial services industry, new business is starting to pick up.
“The IPP business is pretty well back to normal [now],” says Stephen Cheng, managing director and senior consulting actuary at Westcoast Actuaries Inc. in Vancouver. “Last year, a lot of people waited on the sidelines for the rules to be clarified. When people are dealing with uncertainty … they tend to adopt a wait-and-see approach. I think people just needed to be educated as to how they would be affected.”
Trevor Parry, executive vice president at Gordon B. Lang & Associates Inc. in Toronto, says there is still more education that needs to be done.
“The [mistaken] perception among the accounting community – and I am going to say the public at large – is that past service is gone for the most part and [therefore] the reason to have an IPP is gone,” said Mr. Parry. “We’re still doing these plans but nothing close to what we’re used to.”
There are no official statistics on the number of IPPs. Based on statistics released by the Canada Revenue Agency a few years ago, there are between 12,000-15,000 IPPs in Canada. Mr. Cheng says about 60 per cent of Westcoast’s business is in IPPs, while Mr. Parry says about half of Gordon B. Lang’s total business is IPPs.
IPPs are basically defined benefit plans and are referred to as “designated plans” under the Income Tax Act. They are most attractive to those in the 45-and-up age group, often business owners or professionals whose companies fund the IPP and receive a tax deduction for doing so. The company can also contribute funds for past service, capturing the difference between defined benefit and RRSP funding limits. As the plan member gets older the past service contributions at implementation can be considerable, sometimes in the area of $200,000 or more.
Under the government’s proposed IPP rules in the original budget last year, those who had more than $406,120 in their RRSPs would have had to move the entire amount into the IPP. If the accumulated personal RRSP balance exceeded the value of their past service pension, their sponsoring company would not have been able to make a tax-deductible past service contribution. “So we saw that as immediately discriminatory because it said to people: if you have been prudent…you wouldn’t get any tax relief,” said Mr. Parry.
In the end, the government came in with a pro-rated approach to past service that many in the actuarial industry consider to be much more balanced even though the pro-rating tops out at 35 years for those age 53 and over. The portion of personal RRSP that a new IPP member must transfer to the IPP is the number of years of past service recognized divided by the number of years since age 18 (up to a maximum of 35 years). The key, said Mr. Parry, is that past service contributions remain virtually unchanged, and that decreases in past service funding only begin when an individual has RRSP assets well in excess of $750,000.
When the first proposal came out in March 2011, Mr. Cheng said his company was expecting as much as one third of its new business would be affected (no current plans would be affected, nor was the legislation retroactive). But based on his new best estimates, the final rules affect only about three to five per cent of the population. “There aren’t a lot of people out there with more than three-quarters of a million dollars of RRSPs.”
Both Mr. Cheng and Mr. Parry say recent growth in the IPP industry in general has taken place in Western Canada. Mr. Cheng says one of the reasons for this is that British Columbia and Manitoba have allowed IPPs to be exempt from provincial pension registration. When plans are registered provincially there are certain employer obligations, such as funding a deficit over a certain period of years, as is the case in Ontario. However, in B.C. and Manitoba, if the employer does not make a contribution even if there is a deficit, they are exempt from those kinds of rules.
There are also fewer IPPs in Ontario these days partly because of the economy. But Mr. Parry says it’s also because of the provincial government’s administration of the tax system as it affects those who own their own businesses, or who have incorporated their professional practices and can direct their own compensation. He said higher tax rates on their income in Ontario has led some to take dividends instead of employment income, giving them “profound” tax savings.
Mr. Parry calls this a “very short term tax-driven strategy,” which puts the business owner in a riskier financial position by putting too much of the owner’s financial nest eggs in one basket.
Aside from discouraging IPPs, Mr. Parry says the move to tax those with higher salaries in Ontario will have repercussions among the greater Canadian population.
“If you have virtually your entire entrepreneurial class and professional class drop out of traditional income in favour of dividends, they don’t pay any CPP contributions. How will that affect the public pension plan if they are not being funded by an entire segment of the population? There are huge policy issues that need to be addressed.”