Individual pension plans hit by budget

One overlooked casualty of the decision to limit pension plan holdings in business trusts to one per cent of book value is individual pension plans (IPPs). These are personal plans often set up by owner/managers of small businesses and incorporated professionals like doctors to help fund their retirement. They are especially popular in British Columbia, where professionals have been allowed to incorporate for several years and their use has been increasing in other provinces.

In terms of size, IPPs are more akin to RRSPs than to huge employee pension plans, so they really don’t constitute a serious threat to government tax revenue. But they will come under the same restrictions as the big boys; no distinction is made in the budget proposal on the size of the plan or the number of members it has.

This creates a serious inequity. Unlike payments from pension plans with hundreds or thousands of members, IPP benefits are disbursed over a limited number of years, in the same way as RRIFs. That means the plans need to hold assets that will produce the cash flow required during that period. Income trusts have increasingly been a part of that mix.

The government’s acti may seriously limit the ability of IPPs to meet their obligations without depleting their capital prematurely, at least until such time as higher interest rates drive up bond yields, which could be several years from now.

The only good news here is that if you have an IPP that already has invested heavily in business trusts or other newly-restricted property, you don’t need to sell the assets, at least not yet. The budget calls for a 10-year transition period for direct holdings in business income trusts although for indirect holdings, such as mutual funds, the transition period is limited to five years.

However, if you’re already over the one per cent limit you won’t be able to add more. If you have such a plan, you should check with your broker to see if it owns any restricted mutual funds (those with more than one per cent of their assets in income trusts). These would include all income trusts funds as well as some balanced and dividend income funds. You will probably find that distributions from these funds are being reinvested in additional units. Going forward, it appears you will have to take such payments as cash. Otherwise, you will be illegally adding to the restricted holdings of the pension plan and will face a tax penalty. However, it is important to note that no penalties will apply until January 2005.

Unless Ottawa relents and exempts small pension plans like these from the rules, I expect some people with IPPs will look closely at the desirability of collapsing them and moving the assets into a locked-in RRSP. Ironically, by doing that the plan would no longer be subject to the restrictions proposed in the budget, even though the assets stay exactly the same.

This article originally appeared in the Internet Wealth Builder.