November 07, 2021Money Lifestyle Entrepreneurs Professionals
IPPs can play a valuable role in a business owner’s retirement
You’ve worked hard to build a thriving business in your corporation. You deserve the same success in retirement, and an individual pension plan (IPP) may be able to help. Interest in IPPs has been growing. That's because an IPP may be able to provide higher retirement benefits than an RRSP for small business owners or incorporated professionals who meet specific criteria.
As a business owner, you may need to supplement your retirement savings accounts. This could be because you’ve maxed out contributions to your Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA), or you aren’t a member of an employee pension plan.
What’s an IPP?
“An IPP is a defined benefit pension plan, often set up for one plan member. For example, when you own and work in an incorporated business, the corporation could fund an IPP to provide you with a pension when you retire,” says Jamie Golombek, Managing Director, Tax and Estate Planning, CIBC Private Wealth. “An IPP may also cover other significant employees, including your spouse or common-law partner, or children, if they work in the business.”
How does an IPP work?
“Like an RRSP, contributions would be made to the IPP and the plan assets would grow tax-deferred to provide retirement income to you,” explains Golombek. Unlike an RRSP, however, the amount of retirement income an IPP provides is predetermined. An actuary will calculate how much your corporation needs to contribute to the IPP to ensure there are sufficient assets in the plan to provide the accrued retirement income.
When an IPP is first established, your corporation may be able to contribute an initial lump sum amount to fund benefits related to your past service in the business. To do so, a portion of the past service benefits must first be funded by your own RRSP assets, or a reduction in your accumulated RRSP contribution room, before past service contributions are made by your corporation.
RRSP vs. IPP—which one may be better for you?
“Whether you should stick to an RRSP or take advantage of an IPP depends on your personal circumstances,” says Golombek. “In some cases, an IPP may offer several advantages over an RRSP in a retirement plan.” Here are a few potential benefits:
- Higher contributions – The amount that can be contributed to an IPP is often higher than the amount you could have contributed to your RRSP. This is particularly true if you are over age 40 and earning significant employment income.
- Top-ups – IPP funds may be topped-up in years of poor investment performance. If investment returns aren’t enough to meet the plan obligations, the corporation may be required to increase its contributions to the IPP to make up for the shortfall. Most provinces (notably Ontario very recently) don’t require IPPs to be registered with them; that’s why no additional contributions are mandated by the relevant province. Additional top-ups are available at the onset of the IPP as well as after retirement. All of these top-ups are tax-deductible to the sponsoring corporation.
- Additional contributions for previous years - IPPs can be backdated to incorporation or date of hire. This can result in significant additional contributions, in some cases as high as $500,000+ at the onset of the IPP.
- Forced retirement savings – IPPs may act as a form of forced savings to help ensure funds will be available during your retirement years. Some IPPs even have mandatory contribution amounts depending on the jurisdiction of the plan. Funds in an IPP are not available until retirement, which generally starts at age 50.
- Preserving lower tax rates in a corporation – Corporations with $50,000 or more of certain passive investment income in the previous year may lose access to a lower tax rate on active business income that is eligible for the small business deduction. As income earned in an IPP doesn’t belong to the corporation, that income won’t be taken into account in calculating this $50,000 threshold.
While there are actuarial fees to maintain an IPP, they’re tax-deductible to the corporation that pays them. The deduction may mitigate any additional administration costs charged in your IPP.
Given the potential advantages, it may well be worth considering an IPP as part of your retirement plan. If you’re interested in learning more about how an IPP could benefit you, contact us anytime.