All about IPPs – 2021
This is an exclusive tax series brought to you by Tax & Estate specialist, Doug Carroll BBA JD LLM(tax) CFP TEP
Greater flexibility for entrepreneurial retirement savings
As a successful business owner, you likely maximize your annual registered retirement savings plan (RRSP) contributions and still have more to invest. So, is there is a way for you to make even more use of tax-sheltered retirement savings tools?
As it turns out, the Income Tax Act allows you as the owner of a corporation to set up an individual pension plan (IPP) for yourself as an employee of the business. By doing so, your corporation will be able to make larger tax-deductible contributions, which in turn means larger deposits into retirement tax-sheltering for you as employee.
Larger contributions with an IPP
You are entitled to RRSP contribution room based on 18 percent of your previous year’s earned income. There is a dollar limit to that, which is indexed from year to year. The 2021 limit is $27,830, reached at 2020 income of $154,611. Any RRSP room you do not use in a year can be carried forward to make contributions in future years.
Unlike this direct calculation of RRSP contribution room, an IPP is a ‘defined benefit’ arrangement where the amount to be contributed is based on what must be paid out of it.
An actuarial calculation is required to make the IPP contribution determination, based on factors such as the employee/pensioner’s age, past and projected future employment income, and the amount and terms of the eventual pension to be paid. Up until about the age of 40, the RRSP rule will allow more contribution room, but an IPP allows increasingly greater room as you move beyond that age.
More detailed administration
An individual RRSP can be set up with fairly simple administration and low cost, but an IPP has more complexity and higher cost. Fortunately, most of the fees involved in arranging an IPP are deductible to the employer corporation.
A trustee must be appointed to manage IPP assets under a formal pension agreement, and there are more regulatory and tax filings. As well, an actuarial report is required to be prepared at the beginning, and triennially (every three years) thereafter.
As a conscientious business owner, you will want to do a careful cost-benefit analysis with your investment advisor and tax professional. With larger start-up and periodic maintenance costs, an IPP will likely only come into consideration for those at or near top tax bracket. It is certainly possible though to establish one while at a lower income level, in anticipation of moving up in income as the business builds.
Unlike your own RRSP where you can decide whether or not to save, an IPP is legally binding on your corporation as employer.
On startup of the IPP, it is possible to fund past employment service as far back as 1991. The allowed amount is calculated by an actuary, then funded by:
- Transferring-in existing RRSP holdings,
- Making a deductible employee/personal contribution up to the amount of unused RRSP room, and
- Making a deductible employer contribution for the remainder.
Ongoing, those mandatory annual contributions by your corporation/employer are also deductible. As with RRSP contributions, there are no immediate income tax consequences to you as employee when those IPP contributions occur.
The triennial actuarial test may reveal that more than enough has accumulated in the plan to meet the pension obligation. This would usually be a result of investment returns exceeding expectations. In such a case where there is surplus, the employer/corporation’s funding will be temporarily reduced or suspended until things are back in line.
On the other hand, if the triennial test indicates a shortfall then the employer/corporation will be required to make further contributions. This built-in top-up feature allows an IPP to be replenished if you hit a tough patch in your investing, as compared to a RRSP where a decline in value does not entitle you to more contribution room.
An IPP can usually invest in the same types of investments allowed for RRSPs. The rules are a little more restrictive, however, in that no more than 10 percent of the assets may be in any one security. This restriction does not generally apply to mutual funds, which themselves hold a basket of securities.
Pension payout time
There are three options on retirement:
- Pay the pension pursuant to the terms in the pension agreement,
- Use the IPP value to purchase an annuity from an insurance company, or
- Commute the value and transfer to a locked-in registered plan. If the commuted value exceeds the allowable transfer limit under the Income Tax Act, the excess amount will be taxable.
As a final point, IPPs may be entitled to greater creditor protection as compared to RRSPs, depending on province. This may be an important issue for an entrepreneur looking to balance business and personal financial risk.
The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This material is for informational and educational purposes and it is not intended to provide specific advice including, without limitation, investment, financial, tax or similar matters.