What is an individual pension plan?
The individual pension plan (IPP) is a corporate sponsored registered pension plan. IPPs were created to allow individuals or small groups of people to invest and save to receive the maximum retirement pension benefit allowed by the Income Tax Act. IPPs are aimed at incorporated professionals, business owners and executives and are sponsored by corporations (the plan beneficiary is very often the owner). The sponsor makes tax-deductible contributions that will provide the plan’s members (the professionals, owners or executives) with a predetermined pension for life. Plan members can also contribute.
How do IPPs work?
In many ways IPPs are similar to RRSPs: contributions are tax deductible, the plan purchases investments and those investments grow and compound until they are needed when the plan member retires. The same sorts of investments can be used in both.
IPP contributions are based on age, earnings and how long the member has been with the sponsoring corporation. One key advantage of IPPs over RRSPs is that as plan members get older, they can contribute a greater percentage of their income to the plan. Like RRSPs, however, there is a maximum allowable annual earnings limit on which contributions can be based (and it is the same as it is for RRSPs).
An IPP can be set up as a combination registered pension plan offering the best features of the defined-benefit (DB) and defined-contribution (DC) structures. This provides flexible contribution options to the sponsor, who can make fixed contributions to the DC component and convert that portion to a DB plan when cash is available in the corporation. The employee can contribute to the DC component or to an additional voluntary contribution account. Employee contributions create a personal tax deduction similar to RRSP contributions and the fees can be paid by the corporation, ensuring the full contribution goes toward the employee’s retirement savings.
Even if the IPP is created after the business is launched, contributions can be made to the plan based on earnings in the years before the IPP was created (as far back as 1991) – even if the members maximized their RRSP contributions during those years (though some funds must be transferred from the RRSP to the IPP). This past service provision greatly increases the amount you can place in the IPP.
The result of these differences is that IPP contributions, and therefore sheltered growth, can be many times larger than what the same person could achieve using a standard RRSP.
Contributions can be made to the IPP based on employment earnings (salary, commissions and bonuses); dividends do not qualify. When the funds are needed in retirement, to start the pension, the member has a choice of retirement vehicles. These include an annuity or a monthly pension from the plan, or funds can be transferred to a life income fund (LIF) or a locked-in retirement income fund (LRIF).
Who are IPPs for?
IPPs are ideal for business owners, executives and owners of professional corporations. They work to best advantage for people over age 40 who have been with the corporation for at least 10 years, earn more than about $140,000 in employment income and have maximized contributions to their RRSPs.
The benefits of an IPP
Aside from its greater capacity for growth because of larger contributions, one important benefit of IPPs is that assets held within the plan are protected from creditors. Another key benefit is that because IPPs that are DB plans are prescribed to earn 7.5% in investment returns, the sponsoring corporation can make extra tax-deductible contributions if investment earnings are poor to ensure that earnings meet the 7.5% threshold.
In addition to contributions to the plan being tax deductible for the sponsoring business, any expenses involved in running the plan, including investment management and actuarial fees, are tax deductible too. Contributions by the employer are not considered taxable benefits to the employee/member.
If your company has an IPP, the plan may help you attract top-level executives who might otherwise be leery of leaving their current employer if it offers a good pension.
Another benefit that applies to family businesses is that assets can be left in the IPP for the benefit of the second generation, and so will not trigger income tax, as would happen with other assets on the death of the second spouse.
IPPs are complex and require considerable planning and work to set up – you will need an actuary, an investment advisor, considerable financial information and Canada Revenue Agency approval; it will take several months. Meet with your accountant to begin discussions about whether an IPP is right for you and your business.