INDIVIDUAL PENSION PLANS (IPP’S)
In the autumn edition of the Artisan, we analysed the proposed tax reform for private corporations that will inevitably increase the tax burden on the approximately 1,200,000 family businesses and professionals across Canada. One particular point of contention for many is the change to restrict the earning of passive income through a corporation. Many of the affected individuals have been utilizing this preferred tax treatment on passive income for future investment in their businesses and to save for retirement. For those savers amongst us, one attractive way to shelter income for that retirement is the Individual Pension Plan (IPP). While we have highlighted IPP’s in the past, we thought this would be an ideal time to re-visit them.
An IPP is merely a defined benefit pension plan (meaning the plan member knows in advance the amount they will receive in retirement) for one individual that allows for increased tax sheltering and greater accumulation of registered assets for retirement. IPP’s can be ideal for some executives of incorporated entities, highly compensated employees, and especially business owners to provide a prudent retirement savings vehicle, particularly for those who may not have saved enough for retirement. In addition, there are significant tax advantages for the company, as contributions along with the administrative expenses are tax deductible, albeit with increased annual reporting and regular evaluations from an actuary.
Many advisors liken IPP’s to RRSP’s but with greater contribution limits. In reality they can be very complex and certainly not for everyone.
There are many considerations that need to be taken into account when considering an IPP. Age is one of the first factors to look at. With an IPP, contribution room increases with age, so the older the individual the greater amount of contribution room he or she has. On the contrary RRSP’s are held at a constant percentage of income (18%) and as of 2017 the maximum amount one can contribute in a year, regardless of their income, is $26,010. Therefore, while an IPP can allow for a larger amount of tax sheltered savings, to maximize the benefit of an IPP the individual should typically be in their 40’s or 50’s to ensure the contribution limits on the IPP exceed what they could save on their own through an RRSP. In addition, the individual should have a high annual income, specifically T4 income, not only to ensure he or she exceeds what their RRSP threshold would be, but also to ensure that the company can maximize the IPP contributions. In most cases annual income should be at a minimum somewhere between $120,000 and $150,000/yr.
IPP’s provide many other benefits such as income-splitting at age 50, spousal survivor inclusion, full creditor protection, cost of living adjustments post-retirement, succession planning opportunities and a vastly wider range of investment opportunities which include private equity and real estate. However, IPPs should be evaluated in context of the individual’s unique circumstances. For example, while there is an opportunity for a company to contribute to the plan for past service years this contribution is made first by a transfer of the individuals RRSP and defined contribution pension plan savings (if any), plus a reduction in any unused RRSP contribution room. This can limit the initial tax advantage for the company, but also has implications for the individual. Provincial and Federal pension laws apply to IPP’s and since the law stipulates that pension plan assets must be used to provide a pension, the funds are locked-in and inaccessible. RRSP assets on the other hand may be accessible, so these laws can also limit the flexibility in retirement income planning for the individual.
While the creation of an IPP comes with additional complexity vs. traditional methods such as an RRSP, the benefits can be substantial when implemented correctly. We would be happy to explore with you to determine if an IPP is good solution for you and your family.