Trends in Individual Pension Plans

The following is taken from the "Registered Pension Plan—Frequently Asked Questions" section of the CCRA Web site:

There is a new trend where certain Individual Pension Plans are being established primarily to accept a transfer of funds from a prior registered pension plan. What is the CCRA's opinion of these plans?

We have noticed a trend in which individuals near normal retirement age leave large employers and establish their own corporation. The individual is hired by the corporation, and the corporation sponsors an individual pension plan (IPP) for the individual that recognizes the prior service under the public sector pension plan. Once the IPP is established, the full commuted value of the individual's prior pension is transferred to the IPP, as the transfer rules of the Income Tax Act do not limit transfers from one defined benefit plan to another. We are concerned that while some of these IPPs may be acceptable, many will not meet the requirements for registration under the Act.

The primary purpose of every registered pension plan must be to provide retirement benefits to individuals in respect of their service as employees. This requirement is reflected in the Act as a condition of registration. If it is determined that a plan is established for a reason other than this primary purpose, it will not qualify for registration under the Act.

The first issue we have with these arrangements is the legitimacy of the employee/employer relationship. Our concern is that the reason the corporation and the pension plan are being established is to avoid the transfer rules of the Act. If there is not a bona-fide relationship that has the employee rendering legitimate services to the employer, the plan will fail the primary purpose test.

Even if this relationship is established and nominal earnings are received, there may still be an issue with the primary purpose test. The Act only permits a pension plan to base retirement benefits on the earnings received from an employer who participates in the plan. In most cases, the earnings with the new corporation are much lower than what was received with the prior employer, and therefore the benefits under the IPP are significantly lower than the benefits that the individual would have received from the prior plan. This creates a large surplus in the IPP.

When an individual forgoes a substantial retirement benefit by transferring the associated funds to a recently established IPP that provides a much smaller retirement benefit, it can be argued that the primary purpose test is not met. In these cases, we may conclude that the primary purpose of establishing the IPP was to facilitate a transfer of funds from a prior plan that would have been limited by the Act had it been transferred to an RRSP. The conclusion that the primary purpose condition is not met is further supported by the fact that following the transfer, the IPP holds significant surplus assets rather than providing retirement benefits of a level comparable to those that would have been paid from the prior plan. As mentioned earlier, if the primary purpose of a plan is for any reason other than providing retirement benefits with respect to the individual's service as an employee, the plan will fail to qualify for registered status.

If it is apparent at the time of registration that the IPP will not meet the primary purpose test, the CCRA will refuse to register the pension plan. Unfortunately, in many cases, it will not be apparent until a year or two later that the primary purpose test was not met. This situation can be more problematic for individuals as they may have already transferred funds into the IPP.

If it is determined that a registered plan does not, and never did, meet the primary purpose test, the plan's registered status can be revoked as of the original effective date. The consequences to the member could be financially devastating if the CCRA were to revoke the registration of the plan upon discovering that the purpose for incorporating a company was simply to establish a pension plan to hold the transferred pension for a specific member. The impact of this action is that all the assets of the plan would become taxable.

It is for this reason that we want to ensure that individuals are made aware of these concerns. We will be asking individuals for confirmation of the following:

• the company was established for a reason other than to establish a pension plan for the purpose of transferring benefits from a prior plan;
• there is a bona-fide employer/employee relationship between the plan member and this company; and
• the plan member expects to receive earnings at a level comparable to the earnings they received from the prior employer.

If this information cannot be confirmed, we will consider that the plan does not meet the primary purpose and it will not be registered.

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