When Philip Doublet brings up the prospect of retirement with his entrepreneurial clients, they often look like deer caught in a headlight. “They really haven’t thought about it,” says Doublet, principal consultant and coach at Calgary-based Entrepreneur Evolution Coaching Inc.
“The ideal candidate for an IPP is someone over the age of 40 and who has been paying themselves a salary of at least $100,000 per year.”
Part of the reason is that many people aren’t sure of their savings options – they may be using registered retirement savings plans (RRSPs) for the money they take out of their corporation, but they’re not doing much with all the cash that’s inside it.
One option that many business owners don’t know much about, but may want to consider using, is the individual pension plan (IPP), a registered, defined-benefit pension plan that’s designed for incorporated business owners or, in the odd case, key employees of incorporated businesses.
IPPs can provide a pension benefit for the entrepreneur, which the plan sponsor – otherwise known as the company – must fund on an annual basis. “The ideal candidate for an IPP is someone over the age of 40 and who has been paying themselves a salary of at least $100,000 per year,” says Todd Sigurdson, director of tax and estate planning at IG Wealth Management.
Benefits of an IPP
IPPs are a great savings vehicle for entrepreneurs because they provide the opportunity to reduce taxes within the corporation while also accruing excellent pension benefits.
Once an entrepreneur hits 40, they can contribute more money into an IPP than they would otherwise be able to with an RRSP. For instance, this year, Canadians can contribute $26,500 annually to an RRSP. With IPPs, a 40-year-old with T4 employment income of $151,278 or more would be able to make a current service contribution of $28,495. That number gradually increases as the plan holder ages, peaking at $44,721 at 64 years of age.
A business owner can have both an IPP and RRSP, however once the IPP has been established the plan member will not generate much more RRSP room. “Typically, the pension adjustment the IPP creates will eliminate all but $600 of their RRSP contribution room every year,” Sigurdson says.
When it comes to taxes, a company can lower its bill since contributions to the IPP are tax-deductible. The IPP also grows on a tax-deferred basis and is only taxable to the plan member once they start to receive benefits during retirement.
IPPs are also advantageous because they allow for past service contributions, meaning that businesses can make contributions for years missed starting from the date of incorporation (though you can’t go back before 1991 for “connected persons”). A portion of the past service contribution will have to be funded with a transfer of an amount from the plan member’s RRSP.
IPPs also provide creditor protection for IPP assets if an entrepreneur finds themselves in financial difficulty. “It’s comforting for business owners to have a certain percentage of their savings creditor proof,” Doublets say. “No matter what happens, that money can’t be touched.”
Withdrawing the investments
Entrepreneurs typically have three options when withdrawing from an IPP. The first is to take the monthly pension accrued. The formula to determine this amount is usually 2% of an entrepreneur’s average salary (up to the limits established by the Income Tax Act ), multiplied by years of service in the plan.
For example, if an entrepreneur’s average annual salary was $125,000 and they were a member of the IPP for 25 years, they would calculate 2% of that salary to reach $2,500 then multiply that number by 25 years of service to receive an annual pension of $62,500, or $5,208 monthly.
The second option is to transfer the pension benefit into an annuity, which would provide the same income stream yearly that the pension formula offers. By choosing the annuity option, an individual can terminate the IPP and no longer have to pay any administrative or actuarial costs, Sigurdson says. The plan holder can also potentially wind up the business, thereby eliminating annual corporate accounting filing fees.
The third and most popular option is to transfer the IPP to a locked-in retirement account (LIRA). However, the Income Tax Act imposes a maximum transfer value that limits how much money can be transferred on a tax-sheltered basis to the LIRA, based on calculations around the plan holder’s age and the lifetime benefit of the pension. The remainder of the assets in the IPP must be paid out as a taxable excess amount.
The after-tax portion of the taxable excess amount can then be invested in either a tax-free savings account if the individual has any TFSA room or a non-registered account.
“This option is the most popular as it provides the entrepreneur with the most control and flexibility over their retirement income,” says Sigurdson. “They are not restricted to a fixed pension amount.”
Setting up an IPP
In many cases, a business consultant, accountant or investment advisor will suggest setting up an IPP. While the entrepreneur may also introduce the concept, the accountant or investment advisor will be the ones to lead the process. They’ll work closely will an actuarial firm that can provide administrative services and actuarial valuations for the IPP.
As a consultant, Doublet considers whether an IPP might be a good fit for entrepreneurs by looking at their exit plans. If a business owner wants to sell the company in five years, then an IPP might not be their best bet. Alternatively, IPPs can be a great choice for entrepreneurs with a profitable company, retained earnings, and the desire to run their business for another 15 years or so. “It’s important to look at IPPs as one of the tools in a toolbox for long-term financial planning,” he says.