When a member of an employer sponsored pension plan ceases employment, the member may receive a lump sum payment for the commuted value of their pension rights, exposing that member to a significant tax bill, as only a limited amount of the payment can be transferred to an RRSP.
There exists the possibility of using the pension payout to fund an IPP. Under the right circumstances this may permit the full commuted value (the full payment) to be transferred to the IPP. I said the right circumstances because, based on my reading of some of the current literature around this topic, there are many complexities arising from the requirements under the Income tax Act and the relevant pension standards legislation to permit such a transfer.
It appears the strategy is possible only where the individual secures new employment as an employer must sponsor the pension plan. The IPP’s primary purpose must be to provide periodic pension payment to individuals in respect of their services as employees.
The recent Federal budget proposed to prohibit IPPs’ from providing retirement benefits in respect of past years of employment that were pensionable service under a defined benefit plan of an employer other than the IPP’s participating employer or its predecessor employer. Any assets including the transfer of any assets (e.g. Lump sum payments) from a former employer’s defined benefit plan to an IPP that related to benefits provided in respect of prohibited service would be considered a non-qualifying transfer that is required to be included in the income of the individual for income tax purposes.
When I first read about the possibility of the transfers, the collective thought was these transfers would attract unwelcome scrutiny of the Canada Revenue Agency (“CRA”)if the new employer was not acting at arm’s length with the individual ( i.e. the incorporated small business owner I was referring to in my last blog on the subject of IPPs’). With the recent Federal Budget proposals, I am now surmising that the CRA can do more than just scrutinize.