You invested into your personal pension plan. You’ve had a productive and successful career and are now approaching your final year of work. You are looking forward to enjoying the last third of your life in financial independence! How is your Personal Pension Plan released back to you? Let’s walk you through a case example.
A 3P client, retiring Ob/Gyn physician, set up a 3P pension plan 15 years prior to retirement. She made the maximum contribution allowed from her past service buyback (about $100,000) and then contributed yearly to the defined benefit account (starting at about $33k per year and increasing to just under $43k as you turned 60). With some help from a booming stock market, she has accumulated $3.6M within the 3 accounts of your pension: the defined benefit (DB), defined contribution (DC) and additional voluntary contribution (AVC) accounts.
Now...what happens and what are her options?
Retirement savings plans (e.g. RRSPs and pensions) are government created investment vehicles that DEFER the taxes paid on those investments until retirement. The deferral in taxes allows retirement savings to grow unencumbered until retirement. Upon retirement, the government mandates that the retirement savings get paid out as income. Retirement savings plans have to be converted into an retirement income plan at or before the age of 71. The retirement income is taxed and the amount of income is based on the size of the retirement savings accumulated. The 3P Pension plan has three possible retirement savings components (Please refer to the ABC’s of retirement savings document for review): Additional Voluntary Contributions (AVC), Defined Contributions (DC) and Defined Benefits (DB). Let’s go through them one by one and then go over the nuances a bit.
Where your assets go depends in part on your age at retirement (i.e. before or after the end of the calendar year you turn 71), how much you have accumulated and some choices you get to make.
On a high level you can do the following with your retirement funds:
1. Buy an annuity from an insurance company.
2. Roll the balance into your RRSP/LIRA (or a RRIF/LIF if you are under 71).
3. Sustain the pension plan through retirement and have 3P provide the income you need.
If you choose to wind up the pension at retirement:
In addition to flexibility, an additional benefit of the discretionary income streams is a legacy: if you don’t spend these while living, they can be passed onto your surviving children.
Fortunately, you are able to mix and match according to your needs. For example, you could have an annuity in 1 account, a RRIF and a LIF in another.
Finally, there are tremendous advantages embedded in the option to continue your pension post retirement and allow it to administer your income, As such, we think it will present the best choice for most professionals because it offers:
1. Income-splitting with a spouse starting at age 50 (v.s. 65).
2. Intergenerational wealth transfer. If adult children are employees of the professional corporation, they can have all assets passed down to their own pensions without probate or taxes due (until they withdraw those funds from the pension at a later date).
3. Deduction of all management fees associated with the pension against corporate income.
4. Maintenance of the GST/HST credit.
5. Avoidance of a surplus tax hit. CRA income tax regulation 8517 stipulates the maximum amounts that can be transferred from a DC and/or DB pension to a RRIF/LIF or annuity. If your pension investments performed really well and you have a surplus well in excess of the actuary’s estimation of the pension obligation to you, that excess amount will be removed from the pension and delivered into your hands as a lump sum. As appealing as that sounds at first, you must realize that it will almost certainly trigger a massive (54.7% in BC) tax bill the following year! This isn’t a concern if the assets stay within the pension throughout retirement.
6. Cross-funding opportunity: another approach to avoid an enormous tax bill in the scenario of a over-funded DB account is to arrange for the DB account to fund the DC account several year leading up to retirement. The DC account is not subject to a CRA maximum. It’s just an effective way of spreading the funding amongst the accounts!
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