By Jean-Pierre Laporte
Special to the Financial Independence Hub
There are approximately 1.2 million Canadians capable of saving for their retirement and mimicking the ‘gold plated’ pensions of federal civil servants and teachers. Are you among them?
It’s well-known in policy circles that traditional defined benefit (“DB”) plans are better for employees but worse for the employers that underwrite them.
Why? Because the nature of the pension promise itself builds in an assumption that there will be sufficient assets, on an actuarial basis, to replicate a certain level of income, well into retirement. If markets do well, the promise is met. If markets underperform, these DB plans require that the employer dip into its corporate pockets to make up the difference through ‘special payments’. Short of a corporate insolvency, the DB model offers a guarantee of financial security that does not exist in any other type of tax-assisted plans (such as the RRSP, DPSP, PRPP or Defined Contribution plans).
While the mention of DB Plans conjures up visions of large public sector behemoths like the Ontario Teachers’ Pension Plan or the Healthcare of Ontario Pension Plan, they also exist at the other extreme: small professional corporations created by a single individual to carry out a given profession. Recently, small business owners and professionals are turning to the Personal Pension Plan (“PPP”), a type of registered pension plan that offers both DB and Defined Contribution (DC) accumulation methods under a single roof, with the freedom to select between the two each year.
The reason why the PPP works so well at the individual professional corporation (“PC”) level is that the interests of the plan member and of the shareholder are perfectly aligned. In years of market underperformance the requirement that extra tax-deductible contributions (special payments) be made, is simply a transfer of wealth from the owner’s taxable corporate pocket to his/her tax-deferred personal pension pocket. Likewise, strong market performance can lead to a “contribution holiday” for the PC and an even safer retirement pension for the shareholder/member.
Upgrading from RRSP savings to PPP savings
The other reason why professionals are starting to upgrade from RRSP savings to PPP savings resides in the many additional tax deductions that pension and tax laws offer. The ability to purchase past service or to upgrade to an early retirement pension with additional benefits, impose funding costs on the PC that are fully tax-deductible but enjoyed by the shareholder/member. Annual deductions for investment management and administrative fees is another unique deduction that is forbidden under RRSP rules, but available to PCs who sponsor a PPP.
PPPs also offer additional value in the form of superior creditor protection, broader range of investment options and the ability to pass wealth tax-free from one generation to the next without triggering probate fees or a ‘deemed disposition’ on death. When all of these value elements are considered, the reasons to remain in an RRSP become scarce. Professionals and business owners who want to emulate the gold standard of pension plans now have the ability to do so through a PPP.
In addition, the costs of upgrading to a true pension plan are covered and funded out of the additional tax savings that the more generous income tax rules offer. In essence, the solution pays for itself because more wealth is kept within the corporation when higher tax deductions are claimed.
In fact, the size of the tax savings created by the adoption of a PPP can also be used to fund the cost of purchasing an exempt (UL) insurance policy. Since PCs can also write off any interest paid on corporate borrowings made to contribute to a PPP, they can further reduce the cost of acquiring the insurance strategy via leveraging, ending up with two sources of retirement income: the tax-free income from the life policy and the taxable pension income from the PPP.
Isn’t it time for you to join the ‘pension elite’ and save for your retirement using the same rules that civil servants and teachers have enjoyed for decades?