Are you a pension plan candidate?
An individual pension plan (IPP) can help you shelter more income than an RRSP - but only if you earn more than $100,000 per year and as an owner/manager are prepared to commit your company to meeting all obligations associated with IPPs.
Older is better for anyone setting up an individual pension plan (IPP). These packages have long been favorites of senior executives in the financial and stock brokerage industries as a means of accumulating tax-free investment income with tax-deductible contributions at a pace significantly faster than is possible through an RRSP. The eventual result, of course, is tax deferral and more retirement income.
In the early 90s it made sense to establish an IPP for individuals as young as 40, but tax law changes have increased the overall costs and pushed the advantage out until it works best for key executives or owner/managers over 50. But don't be put off by the terminology here. Some farmers meet these criteria.
An IPP is a defined benefit plan set up for the owner/manager of an incorporated business as the single member of the plan - and a single member's spouse if employed by the same corporation. Sole-proprietors or partnerships are not eligible for IPPs.
Similar in many ways to registered pension plans (RPPs) that some corporations set up for their employees, IPPs are tailor-made to the specific needs of one individual.
A defined benefit pension plan provides a specified retirement payout. Contributions made are set to achieve that amount of payout. The benefit is calculated by taking a certain percentage of pensionable earnings received during the years of employment with the employer.
The amount required to cover a defined benefit increases as the employee gets closer to retirement. That is where the age factor comes in.
After age 50, there is less time to accumulate investment income in the plan, and higher contributions are allowed to an IPP than would be allowed to an RRSP. Between ages 60 and 65, these amounts can exceed $45,000 per year. Based on certain criteria, it is also possible to contribute a significant catch-up lump sum in the year an IPP is set up.
Another advantage of IPPs is that they are generally creditor-proof and thus not subject to creditor actions against either employer or employee. Many RRSPs do not have such protection.
On the downside, setting up an IPP can be a costly and daunting task. To begin with, you face significant up-front costs to evaluate the appropriateness of an IPP to your individual situation as well as to meet all the complex registration requirements of both the Canada Revenue Agency (CRA) and the provincial pension commission that would have jurisdiction over the plan.
Funding the predetermined defined benefit at retirement through contributions and interest earned requires an actuary to do the necessary math based on your current age, salary, years of service with the corporation, past RRSP contributions and projected retirement age.
Also count on ongoing administrative costs to meet filing requirements with CRA and the provincial pension commission, along with actuarial valuations of the fund every 3 years.
IPPs have other limitations as well. Access to their assets is limited. If you run into financial difficulty, your funds are tied up more tightly than they would be in an RRSP. Under provincial pension benefits rules, IPP funds are locked in until retirement.
At retirement, the income can be paid directly from the IPP itself or transferred out to be paid from a life income fund (LIF), locked-in retirement income fund (in certain provinces) or life annuity.
As the employer, your corporation is also committed to making IPP contributions that may be required from time to time due to the actuarial valuation of the fund's investment performance. These contributions are required regardless of the corporation's profit - or loss - situation.
On the other hand, if your financial and tax advisors decide that an IPP is a viable route to take, there are other advantages to the higher allowable contributions.
A corporation setting up an IPP can deduct all required contributions and administrative costs.
An IPP might also be able to provide funding for past service back to 1991. This feature is influenced by CRA's proportionality rule, however, that permits contributions for past service only if there is an equivalent amount of current service.
Any surplus remaining in the fund on termination or retirement can be paid to the member, but is taxable. Alternatively, if an IPP is able to self-annuitize (rather than buy an annuity from a financial institution), it can pay out a lifetime income to the plan's beneficiary. This will shelter the surplus well into retirement. But some provinces do not permit this feature if on your retirement the IPP has no remaining active members.
IPPs are also transferable from a previous employer or holding company to a new employer or holding company.
Obviously, IPPs are not for everyone. If you own a corporation and your annual income will be $100,000 or more until your retirement a few years from now, then it might be an option worth considering.