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Doctors Helping DoctorsRetire Comfortably
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3P Pension: A, B, C's of Retirement Savings
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Pensions are very complex financial and legal entities. We have simplified this material to make the concepts more user friendly. For more details, please contact a pension consultant by emailing info@3pfinancial.com or go to the FINE PRINT.
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A, B, C's of Retirement Savings |
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Without retirement savings plans, retired individuals could become a burden on the welfare system, and their families. Without a reliable stream of income, many would inevitably lead impoverished lives. It is no surprise that our Federal government encourages retirement savings plans in its various forms: RRSPs and pensions.
Tax deferred growth and the power of compounding are the two key variables in all retirement savings plans. In other words, the government intentionally allow individuals to avoid paying taxes on capital gains, interest or dividend income in order to permit the power of compounding to do its magic (Exhibit 1 & 2), up until the age of 71. |
Exhibit 1: Tax Deferred Growth: Assumptions 8% Growth and 33% Tax Rate
Exhibit 2: Power of Compounding
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RRSPs (Registered Retirement Savings Plans) are the most popular form of retirement savings plan because they are available to everyone who earns a salary (or T4 income).
However, for most individuals, RRSPs are not the most attractive vehicle for retirement savings. Most large corporations and government organizations (including Federal politicians that meet the 5-year service requirement) use pensions as their preferred retirement savings plan. Pensions are more difficult to understand but are superior to RRSPs in many ways. It is important for 3P pension clients to understand the basics of retirement savings plans and then gain an appreciation of the vast differences and the inherent superiority of pensions over RRSPs. |
Basic Structure of All Retirement Savings PlansWe simplified retirement savings plans into four key components.
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Exhibit 3: Four Components of a Retirement Savings Plan
Basic Structure of All Retirement Savings PlansWe simplified retirement savings plans into four key components.
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RRSPs:
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Exhibit 4: RRSPs Four Components Summarized
Summary of RRSPsIn summary, RRSPs are an important retirement savings option. They are used by millions because they are easy to set up and are available to all tax payers.
RRSPs are plain vanilla retirement savings vehicles that do not offer the promise of a secured retirement cash-flow stream. RRSPs only utilizes Defined Contributions. Without a guaranteed retirement income, many retirees may experience 'Retirement Income Anxiety'. Consequently, many large organizations, including the government, establish defined benefit pension plans for their employees because they offer a retirement solution that provides certainty and peace of mind. |
3P Pension Plan:
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Exhibit 5: 3P Pension Plans Four Components Summarized
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A. Contributions- There are various ways to fund a 3P PENSION PLANS. 3P PENSION PLAN contributions are typically made 100% by the corporation.
At the start of a 3P PENSION PLAN, a client has the option to Buyback Past Services, double dip RRSPs and rollover existing RRSPs, explained below. Each year of the 3P PENSION PLAN, a client can elect to enter either Defined Benefits or Defined Contributions plan. Upon retirement, the client may be eligible for Terminal funding.
Special Payments- As can been seen in Exhibit 6, special payments made at market nadirs can create powerful growth potential. To learn more about Special Payments. |
Exhibit 6: Special Payments Illustrated
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b. Past Service Buyback (1 time)- Business owners who have owned an incorporated company for a number of years and were paying themselves T4 income (salary & bonuses), can increase the size of their pension by purchasing years of ‘past service’ under the PPP. To purchase past service, the actuary calculates the total past service cost first. Then, a determination is made as to the percentage of the total cost that is required to be paid by Qualifying Transfer, the existing RRSP assets held by the business owner. These corporate deductions can reach $200,000 or more.
c. Terminal Funding (1 time)- The 3P Pension Plan is a true pension plan solution. The ultimate pension paid at retirement is determined by a pre-determined benefit formula assuming retirement at age 65. However, if a business owner decides to start collecting the pension at an earlier age, under normal circumstances, the annual pension amount would have to be reduced to account for the fact that the funds would now have to be paid over a longer period of time. However, pension and tax laws do give a 3P Pension client the option of receiving an unreduced early retirement pension, indexed to inflation years before reaching age 65. By enhancing the pension promise in this way, a large deficit is created in the pension fund since more assets will be required to fund these ‘extra’ benefits of early unreduced pension and indexation. The solution is called ‘terminal funding’; a corporate contribution to the pension fund made when the plan is terminated or at the time the member retires. The terminal funding amount, which can reach as much as $600,000 or more, is also fully tax-deductible to the corporation sponsoring the 3P Pension. B. Growth- Pensions have its own pension investment requirements.
I) Investment limitations are more on the “concentration limits” rather than the type of investment. It is not possible to buy shares of your own company because that’s a related party transaction unless you qualify under one of the exemptions. However, you could use 3P PENSION PLAN monies to purchase shares of a local franchise for example, since those are private companies. II) No more than 10% of the portfolio can be held in anyone stock. When investing in a particular company, no more than 30% of the voting shares can be held by the pension fund as shareholder. Diversified financial products such as mutual funds or private equity limited partnerships are exempt from the 10% rule. C. Expenses- At first glance, there are added expenses in managing PPP vs. RRSPs. There are actuarial, trustee, custodian and administration costs. However, unlike RRSPs, ALL COSTS associated with operating a pension are tax deductible by the sponsoring corporation. This includes all MERs and performance fees. For many PPP clients, the corporate deductions available, over the lifetime of the PPP, will offset the extra expenses required to create and maintain a PPP. I) Setup Costs- Approximately $3000 to $5000 II) Maintenance Costs- Approximately $3000 per year These costs include Actuarial, Trustee, Custodian and Administration fees. III) Investment Costs- All management expense fees and performance fees are tax deductible. For example, a $2m pension invested in a retirement fund with 1% MER would be charged $20,000. At 13% corporate tax rate, that is $2600 in savings. D) Features- The Bells and Whistles i) Creditor Protection- Like all formal registered pension plans (in most provinces with pension legislation) the 3P Pension is provided with the highest level of creditor protection in Canada. The assets of the pension plan cannot be seized by creditors of the plan member (except spousal creditors under Family Law legislation) nor of the corporation sponsor. For most RRSPs, this is not the case in the normal course. Moreover, the annual contributions required of the company to the pension plan receive ‘super priority’ in the event of the insolvency of the corporate sponsor, and rank above the claims of secured creditors like major commercial lenders. This extra protection was granted after recent changes (2008) were made to the federal Bankruptcy and Insolvency Act. ii) Early Retirement Option- Option to retire as early as age 55 or as late as 71. iii) Pension Splitting at 55- This is unavailable till 65 with RRSPs. iv) Past Pension benefits to Adult Children- Where family members working in a family business participate in a single family PPP, upon the death of retired family members, PPP assets earmarked to fund the stream of pension benefits become surplus. The plan provisions can stipulate that any surplus in the pension plan belongs to the surviving plan members in order to fund their own pension benefits. Thus, instead of dealing with an RRSP “deemed disposition” and/or any probate fees, the same family members can pass wealth from one generation to the other without any immediate tax consequences. Obviously, taxes will eventually be owing on any pension benefits paid out to the surviving children/plan members when they reach retirement. These will be paid at the beneficiary’s marginal tax rate. Pension income can be split with the child’s spouse and the first $4000/couple is taxed more lightly (due to a federal pension credit). v) HST Refund: Since July 2010, plan sponsors as pension plan administrator can claim the HST refund if you are a Pension Plan Administrator. vi) Pension Credit- $2000 per person per year Pension Credit ($4000 per couple) vii) Post Retirement Survivor Benefits- On the death of a plan member after retirement, the survivor benefit is paid in accordance with the normal or optional form of pension selected at retirement. a. Where the member has a spouse at retirement, the normal form of pension is paid to the spouse who receives pension payments that are 66 2/3% of the member’s pension with a 5-year guarantee. Other joint and survivor and guarantee pension options exist as well. b. If the member does not have a spouse at retirement, or the spouse has waived entitlement to a survivor pension, the normal form of pension is where payments of survivor benefits are made to the member’s designated beneficiary(ies). This includes a named legacy trust or charity foundation. Other pension options exist as well. c. If there are no designated beneficiary(ies) at the time of the member’s death, the pension assets are paid to the member’s estate. |
Summary for 3P Pension Plan
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In summary, the 3P PENSION PLAN is a substantially superior retirement savings plan compared to RRSPs. They offer superior growth potential, superior protection and superior optionality.
3P PENSION PLANS have many more options that will help an individual build up their retirement savings (Exhibit 7). With the Special Payments, the 3P PENSION PLAN has a build in feature that allows individuals to add to their pensions during periods of poor market return. Fortunately, these are often the optimal times to invest in terms of market valuations. If you fully contribute to your defined benefits and Special Payments, you guarantee a predefined retirement income. This is a possible cure to your 'Retirement Anxiety'. The 3P Pension Group is proud to present our complete pension solution targeted at Professionals. 3P and its partners have created a cost effective and seamless pension plan that ALL Professionals should strongly consider. |
Exhibit 7: Comparin RRSP to 3P Pension Plan
