Retirement Salvation

I was enjoying a quiet dinner with my old friend Sam Taylor when he suddenly asked how I was going to fund my retirement.

“It’s not an easy question,” I said. “I plan to work until I’m 65. Since I’m in pretty good health, I assume I’ll have to fund about 15 years of retirement.”

“You expect to live to 80?”

“My actuarial life expectation is 75 — but I’m planning for longer. I don’t want to run out of cash before I run out of years.”

“And Julie should outlive you,” Sam said.

“I think she will. She’s six years younger than I am and her life expectancy is five years more than mine. After I’m gone she should have 11 years of life left — which means I’m planning for 26 years of retirement in all.”

Sam shook his head. “Sounds like a lot of money.”

“True. It’s intimidating even to think about it. But I’m glad that I didn’t avoid the issue because without a plan I’d never be able to save enough. I have a friend who retired after a very successful career as a surgeon. He lived a good but not luxurious life. In a couple of years, he simply couldn’t sustain his old spending habits. He and his wife were forced to sell their condo and move to a trailer park.”

“What’s your plan like?”

” I actually have a two-fold program. First of all, since I love my work and I’m self-employed, I intend to keep at it as long as I can. That may be to age 65, or it may be to 68 or 72.”

“Why keep on working so long?” asked Sam.

“A couple of reasons. First of all, studies have shown that our self-images are strongest when we have a purpose. For many of us, work provides that purpose. People who do things tend to be healthier both psychologically and physically. And for every extra year I add to my working life, I need to save less. By working 12 months more, I’ll fund a year without using my savings — and hopefully I’ll generate a surplus for the future.”

“Interesting,” Sam said. “It’s a double hit, isn’t it? If you work until 70, you’ll only have to fund 21 years instead of 26. If you save $20,000 in each of the years from 65 to 70 you’ll have an extra $100,000 to play with. So you’ll have both a lower liability and more money.”

“It’s even better than that,” I said. “Say I have $1 million saved at age 65. If I don’t draw down on that for five years, assuming a 6% rate of return, I’ll begin my retirement at age 70 with an extra $300,000 in the bank. Add to that the additional $100,000 in savings from working, that gives me $1.4 million. So I’ve increased my wealth by 40% by working for five more years, while at the same time I’ve reduced Julie’s and my needs by about 25% — from 26 years to 21 years.”

Sam shook his head. “That sounds great — but I’m over 50 and I have nowhere near a million saved. What can I do?”

“It’s never too late. In fact, most people have very little saved until they reach their 50s. After paying for a decent lifestyle and setting aside money to help the kids with their education, the average Canadian doesn’t have the ability to save much. But some people use a secret weapon — an IPP, an Individual Pension Plan.”

“I’ve never heard of it.”

“IPPs are not well known, but they should be. An IPP is a great boon to business owners. It works like a traditional company pension plan instead of like an RRSP.”

“Now you’ve lost me,” Sam said.

“Think about your dad. He worked for a big auto company all his life. When he retired he received a decent pension, didn’t he?”

“That’s right. He received two-thirds of the average of his best five years’ salary. When he passed away, mom continued to receive a pension for the rest of her life.”

“Your dad had a defined benefit pension. Under that kind of plan, the pensioner is promised a payout that’s defined in advance. If interest rates go down, the company has to put more into the pension to ensure that the pensioners are fully paid. Today, however, RRSPs and most other retirement programs are defined contribution plans. They tell you how much can be contributed to the plan, but they don’t define the benefits coming out. You get whatever has accumulated.”

“So a defined benefit plan is a much better deal for the pensioner?” Sam asked.

“Exactly. An IPP allows a private company to set up a benefit-defined pension plan for its executives or even for a single shareholder. The company contributions are tax deductible, and if the company has to borrow to make its annual contribution, the interest is tax deductible.”

“I thought pensions were closely regulated. I know RRSPs are,” Sam said.

“IPPs must comply with Revenue Canada rules,” I explained. “The amount a company can contribute depends on your age, your length of service and your past salary. Nonetheless, for business owners who earn over $100,000 per year and are aged over 50, IPPs are a definite improvement over RRSPs. In fact, in many cases an IPP will provide about 50% more cash than an RRSP will.”

“How much would that be for someone like me?”

“Even if you have very little saved at age 50, in 15 years it’s likely you could achieve over $1 million in an IPP.”

“Wow!” said Sam. “That would make an enormous difference in my life.”

“Any business owner over 50 really owes it to himself and his family to investigate the IPP alternative. In fact, I think it’s a strong reason for unincorporated businesses to consider incorporating.”

Hank Bulmash, MBA, CA is a principal of Bulmash Cullemore, chartered accountants of Toronto. To obtain a free copy of his company’s “Businesslab Report on Individual Pension Plans,” e-mail hank@businesslab.ca.