Individual Pension Plans – You down with IPP?
By Nizam Shajani, CPA, CA, MBA
An individual pension plan is a retirement vehicle commonly set up for owners of private corporations. The corporate set up is imperative as non-incorporated organizations such as partnerships and sole-proprietors would not be eligible for an individual pension plan in Canada.
The IPP allows small and medium sized business owners (including professional corporations) the opportunity for the same coveted retirement benefits often seen by government employees and larger organizations. This includes a defined benefit pension plan customized for an individual or group of individuals that are employed by the corporation. The plan should result in a pension that will pay a predetermined income based on years of service to the corporation.
The IPP must be funded by the corporation that employs the plan member and as such, the individual should be taking some remuneration by way of employment income and receive a T4, T4A or T4PS to substantiate this. As such, the plan is well suited for an individual who has employment income near the maximum RRSP deduction limit of $145,722. The plan works well for an individual over the age of 40 and has or is able to contribute the maximum amount to their RRSP.
Amounts paid by the company are tax deductible to the company (while the individual is not taxed until the pension is drawn on.) Fees associated with the plan are also deductible to the corporation, rather than a draw down on the investment portfolio of an RRSP – leaving more funds within the plan to grow tax deferred. These deductions include costs for set up, actuarial calculations and portfolio management fees. Where funds are borrowed to fund the IPP, the interest on the borrowings are also deductible, a deduction that is also not permitted with the traditional RRSP route.
Another significant advantage of using an IPP to the business owner is that the contribution amount is greater than permitted by the RRSP rules and contributions may increase as the business owner ages. The IPP also considers past services (since 1991) for immediate deductions or a choice to amortize the deduction up to 15 years into the future. This retroactive calculation can provide both a boost to the retirement plan as well as a sizable deduction to the corporation.
To initiate an IPP – the corporation establishes a registered pension plan in the name of the individual. A lump sum contribution can be made and annual contribution amounts are made to the plan based on an actuarial calculation.
As the pension amount is known in advance, the fund will have a target return on investment (ROI), usually 7.5%. If the plan does not achieve this target – the company has opportunities to contribute more to the plan.
Contributions to the plan can continue as long as employment income is received from the company, up to age 69. The pension may be accessible as early as age 50. To access the pension – the fund will need to be converted to a life annuity, transferred to a LIRA, LIF or LRIF, or receive an immediate or deferred payment from the IPP.
Some highlights of these considerations include the following:
- Life Annuity – will pay you as long as you live. Will pay your surviving spouse a portion of this amount (typically 2/3.) Can also select minimum guarantee payment to your estate should both you and your spouse pass. Can fund terminal benefits.
- Transfer the assets to a LIRA, LIF or LRIF – locked in versions of RRSP and RRIF. LIRA is a locked in RRSP and must be rolled into a LIF or LRIF or annuity. LIFs are the most popular choice as it grants the most amount of flexibility and assets go to your spouse or beneficiaries upon death. No overfunding permitted and no terminal funding.
- Payment from the IPP – Can receive an immediate or deferred pension payment from the plan. At death – the plan will go to your designated beneficiary, subject to tax. Can fund terminal benefits. If funds below 7.5% return, must top up. Also have to continue paying actuarial costs.
While this plan works well for owners of cash-rich companies to provide a comfortable retirement, there are drawdowns to the IPP. This includes required funding and no access to the funds within the IPP while employment at the company continues. A portion of the IPP will also continue to be locked in at retirement.
Another disadvantage includes ongoing actuary fees. The plan must be registered with the CRA and an actuary must provide initial calculations, and the fund must be audited by an actuary every three years.
The IPP can provide significant tax savings to the corporation while securing a comfortable retirement via a defined benefit plan. However, as there are complexities to this plan – the IPP is an ideal situation for a collaborative effort with your tax accountant, investment advisor and estate lawyer. The team at Shajani LLP CPAs would be happy to help you set up your IPP.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action.