Why incorporated Business Owners should consider an Individual Pension Plan (IPP)

Written by Dean Moro BComm, CIM®, Associate Financial Advisor, & Carson Hamill CIM®, CRPC®, Associate Financial Advisor, Assistant Branch Manager

With changes to pension limits and the ability to include an individual pension plan (IPP) in a succession plan, IPP’s are an attractive registered retirement savings plan (RRSP) alternative business owners need to consider. Here we will discuss what an IPP is, the benefits and a few drawbacks of the IPP structure, and the planning opportunities available with this strategy.

• What is an Individual Pension Plan (IPP)
• Who can set up an IPP
• Benefits of an IPP vs RRSP
• Drawbacks of an IPP
• Options when you retire
• Planning Opportunities with an IPP
• Cross-border Planning
• Summary

What is an Individual Pension Plan (IPP)

An IPP is a registered, defined benefit (DB) pension plan, typically set up for one member. Available to business owners and qualified executives, an IPP can allow you to save significantly more than you would under current RRSP rules, while also providing an increased level of creditor protection. While lesser known in Canada, the IPP is an attractive savings vehicle high-income business owners and incorporated professionals need to consider. There can be significant tax planning advantages to the IPP, including:

• When you first start funding the plan, through a tax-deductible lump-sum contribution called “past-service funding.”
• Higher annual contribution amounts vs an RRSP
• When you retire, there can be a tax deductible, lump-sum contribution known as “terminal funding.”

As a defined benefit pension plan, an IPP provides security in that you’ll know how much you’ll receive in pension benefits each year. The annual pension you’ll receive takes into account your years of employment and the level of T4 Income you have earned.

Who can set up an IPP

To set up an IPP and become a plan sponsor, your company must be incorporated. To be a plan member, you must be an employee or shareholder of the sponsoring company and earn T4 (salary) income.

The IPP should be considered for business owners over the age of 40 who have been incorporated for a number of years and have been using salary as part of their compensation model. The higher your income and the longer you have been in business, the greater the benefits.

The IPP was designed specifically for high-income business owners and incorporated professionals such as doctors, dentists, lawyers & accountants, and other professionals who draw T4 income.

Benefits of an IPP vs RRSP

There are number of advantages of the IPP versus an RRSP, including the following:

Higher Contribution Limits

IPP’s allow for significantly higher annual contribution amounts than those allowed under an RRSP. For individuals over the age of 50, the contributions required to fund the maximum allowable benefit can be significantly more than the maximum allowable for an RRSP, allowing the business owner to save more for retirement in a shorter amount of time.

Also, because the IPP is a DB pension plan, they allow for a past service contribution, partially funded with an RRSP transfer, and a terminal funding contribution at retirement or upon the sale of the business.

All together, IPP’s allow for greater accumulation of funds than RRSP’s. More money is tax-sheltered, and more of the company’s money is tax deductible.

Tax-deductible Contributions & Administration Costs

Contributions to the IPP are deductible for the sponsoring company. In addition, all administrative expenses, including actuarial and accounting fees paid by the business, are tax deductible to the company. Lastly, the investment advisory fees for the IPP are tax deductible, whereas advisory fees for an RRSP are not.

If a loan is utilized to fund the IPP, the interest costs of the loan, and any administrative fees, would be deductible as well.

Cash flow flexibility

IPP’s offer some flexibility in how they are funded, allowing the company to manage it’s cash flow. Pension benefits can accrue using either a defined benefit or defined contribution method. Being able to switch between these two options provides the company with flexibility.

Also, contributions can generally be made up to 120 days following the company’s fiscal year end, allowing for prudent planning and cash flow management.

Income Splitting

Pension income from an IPP generally allows for income-splitting with a spouse as soon as retirement benefits commence. With a RRIF, you must wait until you are 65 years old to income split with your spouse.

Creditor Protection

IPP’s offer greater creditor protection by provincial legislation. IPP assets are safe from lawsuits, collections and other judicial proceedings. As per recent legislation, RRSP’s also offer creditor protection, but only in the case of bankruptcy.

Estate Planning benefits

RRSP’s are fully taxable following the second spouse’s death. If the RRSP holder is not married, the fund is fully taxable upon their death. With an IPP, if you have children employed in your business earning T4 income, they may be eligible to become members of the pension plan. In this way, the IPP assets can pass to the next generation without incurring tax or probate fees.

Other Benefits

In the event investment returns within the IPP are inadequate, IPP assets can be topped up. Investing conservatively can be a strategy to require the company to top up the plan and reduce retained earnings within the company.

Drawbacks of an IPP

There are some drawbacks to the IPP that need to be considered, including:

Pension Guidelines

The IPP is a pension plan, and thus, subject to provincial lock-in requirements. Also, the IPP is subject to minimum annual funding requirements.

IPP’s are costlier to maintain

IPP set-up and ongoing administrative costs can amount to thousands of dollars. IPPs require the services of an actuary who will conduct a valuation of the plan every three years.

For the business owner best suited for an IPP, the benefits should far exceed these administrative costs.

Decreased RRSP contribution room

Contributions to the IPP will reduce the amount you can contribute to an RRSP to nearly zero due to the pension adjustment. The pension adjustment equals the value of the IPP benefit earned in the previous year.

Less flexible retirement income options

Because the IPP is subject to provincial and federal pension laws, you may find your flexibility for retirement income planning is restricted. As a pension plan, an IPP is subject to provincial lock-in requirements.

Options when you retire

When you retire, you have a number of options available to you with an IPP:

1. Receive a monthly pension from the plan,
2. Buy an annuity from a life insurance company,
3. Transfer the plan assets to a life income fund (LIF) or locked-in retirement income fund (LRIF). The tax implications of this option need to be considered if the pension amount exceeds the maximum transfer value (MTV)

The options available depend on your age and the IPP member’s provincial jurisdiction.

Similar to an RRSP, you must start receiving income from the IPP by the end of the year you turn 71. And when you die, the plan assets go to your spouse or your estate. The plan can also be wound up and the cash value withdrawn, but there could be significant tax implications if doing so.

It is best to consult with your advisor and tax professional when determining the best option for you.

Planning Opportunities with an IPP

Family Business

Registered assets, such as an RRSP, create a tax liability when the plan holder dies. With an IPP, a family member who takes over the business can be added as a member of the existing plan. By keeping the plan intact, these assets can be transferred to the next generation to avoid triggering tax.

Sale of the Business

Setting up an IPP can be viewed as a strategy to reduce a company’s shareholder equity, which can help facilitate the sale of the business.

Early Retirement

While funding requirements are based on a retirement age of 65, a member of an IPP can retire any time after age 60. IPP’s allow for terminal funding, which can include unreduced early retirement benefits, cost of living increases and bridging benefits. These early retirement benefits can result in a significant tax deduction for the sponsoring company.

Cross-border Planning

For clients looking to retire outside of Canada, most provinces allow them to remove the locking-in aspect and move those assets. For those planning on relocating to the United States, a common strategy to use up foreign tax credits is to implement an IPP. Due to the tax treaty between Canada and the United States, and the use of foreign tax credits, you may be subject to Canadian non-resident withholding tax of only 25% or 15% (for periodic pension payments) instead of Canadian income tax as high as 53.5%.   

As always, speak to a qualified cross-border tax advisor who can advise you on using your excess foreign tax credits and the tax implications of receiving a pension as a non-resident of Canada. 

Summary

Generally, if an RRSP makes sense for a business owner, an IPP can make even more sense and should be considered. Higher contribution limits and large tax deductions for your company make them attractive for high income business owners. To determine if an IPP makes sense for you, consult with your investment advisor and tax professional and discuss whether an individual pension plan should be part of your retirement planning strategy.  

Next Steps

If you are a business owner and need assistance with your investments, estate planning, and portfolio management, please call or email us at Snowbirds Wealth Management, as we specialize in cross-border financial planning and wealth management. We work closely with experienced lawyers and accountants to ensure you have a team behind you.

About Snowbirds Wealth Management

Gerry Scott is a portfolio manager and founder of Snowbirds Wealth Management, an advisory firm focussed on the cross-border market. Together with Dean Moro and Carson Hamill, associate financial advisors with Snowbirds Wealth Management, they provide investment solutions for Americans living in Canada, and Canadians residing in the United States.  Licensed in both Canada and the US, they provide tailored investment solutions to minimize the tax burden when moving assets across borders.

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