Is an Individual Pension Plan Right for you?
If you are a business owner or incorporated professional concerned about the most effective way to save for retirement, you may want to investigate Individual Pension Plans (IPPs). An IPP is a defined benefit pension plan, similar to those found in larger companies or government organizations, but for the benefit of only one, or sometimes two individuals. For those owner/managers and incorporated professionals who meet certain criteria IPPs offer significant advantages.
The following are some of the advantages that Individual Pension Plans have over RRSPs:
The company can contribute to the owner’s retirement fund at a significantly higher level than the individual could contribute to his or her RRSP. This is because the maximum contribution amount for an RSP is the same for all ages, whereas with an IPP it increases with age. An IPP performs best if the pension member is over the age of 40, ideally over age 50. For example, in 2016 the maximum RSP contribution was $25,370. For a 50-year-old, the IPP maximum contribution limit in 2016 was $32,841. This increases to $39,626 at age 60.
The table below compares the maximum RSP and IPP Limits for 2017.
Age RSP Limit IPP Limit
40 $ 26,010 $ 28,203
45 $ 26,010 $ 30,947
50 $ 26,010 $ 33,996
55 $ 26,010 $ 37,350
60 $ 26,010 $ 41,161
The maximum IPP contributions are based on a T4 employment income of $144,500. This amount is proportional for lower T4 income levels.
Additional Contributions for Past Service
For years that the owner was employed by the company and receiving salary, past service contributions may be possible. These contributions relate to years that the pension member was employed by the company and receiving pension-eligible income (i.e. salary). To take full advantage, it is usually necessary for the pension member to transfer a portion of his or her RRSP to the pension. This may be of particular interest to incorporated professionals who may have a significant RRSP and extremely high incomes earned in their corporation in the years leading up to retirement. For those who qualify, past service contributions are an effective way to transfer company surplus into deferred retirement savings for the owner on a tax deductible and tax deferred basis.
Additional Contribution at Retirement
Government tax regulations dictate that the pension actuaries must use the interest rate of 7.5% per annum in their pension calculations. This is to prevent using low interest assumptions to drive up IPP contributions. This could result in the pension being underfunded come retirement. Should this happen, there is an opportunity for “terminal funding” which allows the company to contribute even more into the member’s plan when he or she is ready to commence retirement.
Offset Any Investment Under-performance
It might be challenging for the performance of the pension assets to keep up with the 7.5% growth assumption that the pension actuary is mandated to use. Plus, there may be a downturn in the market to cause an even larger deficit. When the actuaries conduct their three-year regular performance review, the company can make even more additional contributions to make up for the shortfall. This is yet another tax deduction for the company and more tax-deferred retirement funding for the owner.
Additional contributions for past service, terminal funding and investment under-performance catchups are something RRSP’s do not allow for.
IPP costs are deductible to the business
The IPP is a company obligation and all costs – administrative, actuarial, investment management, and accounting are tax deductible to the corporation. In addition, should the company borrow money to make the IPP contribution, the interest on the loan, unlike borrowings to fund an RRSP, will be deductible for the business.
The Family Pension Plan
If the company is a family business employing second generation members, it is possible that retirement assets can be left tax-deferred upon the death of the parents. With an RRSP, there is a roll over provision allowing the spouse to transfer the balance of the deceased partner’s RRSP or RRIF to the surviving spouse’s account. Upon the second death, however, the balance remaining is taxable. With an IPP the assets belong to the company pension plan and any balance can remain for the surviving members of the plan, i.e. the children.
Spousal Pension Planning
Individual Pension Plans provide for the funding of a survivor pension for a spouse. The spouse does not have to be an employee of the company and the survivor pension provides a measure of security to a spouse who outlives the pension member.
In addition, there are provisions that allow the pension income to be split with the business owner’s spouse. Unlike RRSP’s where this split occurs at age 65, IPP pension income can be spit with a spouse at the commencement of retirement benefits, whenever that occurs.
Keep in Mind
All the above underscores the advantages that an IPP may have over an RRSP. Remember, however, that IPP’s are not for all and there are some considerations to keep in mind. Some of these are:
- Pension plans are inflexible, with no access to the funds while the business owner is employed and a member of the plan;
- Plans that fall under Federal or Provincial Pension regulations have minimum annual contribution requirements;
- Plan assets must be used to provide pension income so the benefits are locked-in;
- To fully benefit from pension current and past service contributions are based on T4 employment income (salary);
- Administrative costs and expenses are higher for IPP’s than for RRSP’s.
If you are a business owner or incorporated professional who can take full advantage of all that an Individual Plan has to offer, the benefits are substantial. A discussion with your financial advisor along with a pension actuary can help guide you in making the right choice in funding your retirement.