Incorporated businesses looking to add a benefit for their valued executives might want to consider a little known tax-avoidance structure called the individual pension plan (IPP), an alternative to registered retirement savings plans. They are sanctioned by the Canada Revenue Agency and offer the best tax and retirement savings solution for individuals 40 years and older who have a T4 income of more than $100,000 and have historically maximized their RRSPs and pension contributions.
The existing RRSP legislation was created in 1957, at which time inflation and indexing were not taken into account. As a result, RRSP contribution limits are woefully inadequate for high-income earners. In 1991, the federal government remedied the situation by enacting the IPP legislation to compensate high-income earners disadvantaged by RRSP rules.
The IPP is a sound business decision for executives and business owners who have historically maximized their RRSP and have the income to support a more aggressive tax deferral arrangement. Here are some of the advantages in owning an IPP:
Tax deductibility: All contributions, interest and expenses are tax deductible to the incorporated practice and are a non-taxable benefit to the person the IPP is set up for.
Creditor proof: Assets held in the IPP cannot be seized by creditors on condition that the pension plan was set up in good faith – not just because of a looming bankruptcy.
Ownership of plan assets: At retirement, the business owner/executive owns any actuarial surplus. The surplus may be used to upgrade pension benefits or pass the surplus tax-free to their spouse, heirs or estate.
Guaranteed lifetime income to members and their spouses: The pension plan offers a predictable retirement income. An actuary determines the current annual costs of the future retirement income. Eligible spouses receive 66.66% of pension in the event of death of the plan member. Spousal pension benefits may be upgraded to 100% at the time the member retires.
Past service funding: For business owners and executives, the individual pension plan funding formula is more generous than RRSP limits. The pension plan allows an executive to make contributions for years of service prior to the set-up of the plan. No other plan or individual investment can offer this benefit.
Terminal funding: One of the most attractive features is the possibility of terminal funding. While CCRA restricts the benefits that can be pre-funded, at retirement, the pension plan can be amended to provide the most generous terms possible. Some of these include: full consumer price indexing, early retirement pension with no reduction as well as bridge benefits.
IPPs versus non-IPPs
Imagine you are 55 years old and have owned an incorporated business since 1991 with a T4 income of more than $100,000 and a marginal tax rate in Ontario of 46.41%. You are serious about saving for retirement and plan to do so in the next 10 years. By creating an IPP this year, you will be able to defer $114,743 immediately from company and personal income taxes. This money will then compound tax-free. The next year, you will be able to contribute an additional $24,122 into an IPP and contribution room will increase by 7.5% annually until retirement (the investment chosen for this example are bonds earning 7%). When you reach 65, you will have accumulated $632,384 in the IPP.
If you decide not to create an IPP and choose to take this same amount of money out of your business, after having paid the personal marginal tax rate of 46.41%, for the purpose of saving for retirement, then your financial situation becomes much different. The first year after taxes, you will be left with $61,490 to invest. The following year, after taxes, you will make a $12,927 contribution to your non-IPP; and this contribution will grow at 7.5%. At age 65, you will have an accumulated value of $276,435. Based on the stated assumptions, this particular your IPP will be $355,949 greater than your non-IPP.
Don’t expect your regular financial adviser or benefit consultant to be well versed in IPPs as there are many pension, tax, legal and investment rules and they are complex. There may be only a half dozen firms cross Canada who specialize in the creation, implementation and maintenance of IPPs. It would be well worth it for you to explore if they are right for you.