IPPs can charge up retirement income

Ideal for professionals, executives, business owners

The defined benefit pension plan has pretty much gone the way of the dodo. With one exception: the Individual Pension Plan (IPP). If you’re a business owner or executive, or an incorporated professional, such as a physician, dentist, lawyer, accountant, and so on, and you are over age 40 in your peak earning years, you might consider an IPP. Its many advantages for people in this group certainly outweigh its drawbacks. And as tighter rules for passive investments in private corporations have limited the availability of the small business tax rate, an IPP offers some business tax advantages as well.

An IPP is basically a defined benefit registered pension plan for a single employee rather than a group. The IPP pays out benefits based on a percentage of your prior annual employment income, and payments and funding are governed by the terms of the plan. The plans are regulated by the government and must follow precisely specified rules, like any other pension plan.

Higher limit than RRSP

The advantage of an IPP is that the allowable contribution limit is generally much higher than for an RRSP, allowing planholders who are 15 to 20 years from retirement to accumulate a much larger nest egg than they would through an RRSP alone.

An IPP is an investment account where funds grow inside the plan to provide retirement benefits. Like a pension plan, however, the IPP provides certain guarantees. And whatever you contribute is locked in until you retire. IPP contributions are determined by actuarial calculations to provide sufficient income at retirement.

IPP contributions accumulate and compound tax-free inside the plan, and IPPs allow for past-service contributions. That means you can get started with a whole lot more funding. To qualify, an IPP must be funded at least 50% by the employer, typically a corporation. The beneficiary of the IPP may also make additional voluntary contributions. An IPP may also be built so that the corporation agrees to cover shortfalls arising from poor investment returns, thus providing a guaranteed level of retirement income.

Creditor protection

An IPP also offers creditor protection should either you or your business face bankruptcy or be forced into bankruptcy protection. Under provincial legislation governing IPPs, your pension plan funding will be insulated from seizure by creditors.

Also of interest to many business professionals is the ability to participate in investment decisions in an IPP. This feature affords a level of flexibility and participation that is generally unavailable in group defined-benefit plans.

There are a number of IPP income options available at retirement, including payment of an annual pension by the IPP, transfer of amounts to an RRSP, or the purchase of an annuity.

Here’s a summary of the advantages of an IPP:

Tax advantages

Contributions are tax-deductible to the corporation.
Income earned in an IPP belongs to the planholder, not the business, and is therefore not included in calculating passive income for tax purposes. This may help keep the business’s passive income below the threshold that eliminates access to the small business deduction.
Interest costs on funds borrowed to set up an IPP are tax-deductible to the corporation, as are expenses and fees, such as actuarial, accounting, administration, and investment charges.
Contributions to the plan grow on a tax-deferred basis inside the plan until withdrawal.
Distributions can be arranged to be eligible for pension income-splitting between spouses at any time.

Savings advantages

Contribution limits for an IPP are usually higher than for an RRSP. Note, however, that IPPs are typically a replacement for RRSPs, as contributions reduce RRSP contribution room.
Top-up contributions can be made to an IPP in the event investment returns are not sufficient to fund benefits.
Past-service contributions can be made when the planholder has a long salary history with the corporation. Such contributions can be made as a lump sum or amortized over 15 years.
The corporation can top up a plan in the event of the planholder’s early retirement.
The planholder receives a predictable income stream at retirement.

Business advantages

Assets within an IPP are protected from seizure by creditors.
Corporate IPP contributions reduce shareholders’ equity, which may make the business more appealing to potential buyers in the event of a sale.

Getting IPP help

IPPs have much appeal for individuals, professionals, and business owner/managers who pay themselves a salary through a corporation. Note, though, that IPPs are legally classified as Registered Pension Plans and are subject to fairly complex and rigorous rules governing set-up, maintenance, and funding. Beyond the actual investments in the plan, this involves things like actuarial estimates, financial statements and disclosure, costs, asset values, and liabilities.

While IPPs have many advantages, they are definitely not a do-it-yourself type of product. You need the help of a qualified financial professional to set up and administer the plan, to ensure you meet regulatory requirements for contributions, holdings, and reporting.

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.

Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.