We have seen renewed interest in Individual Pension Plans (IPPs) since measures to reduce the small business deduction for private corporations were introduced in the 2018 federal budget. This article provides an overview of what IPPs are and some of the benefits they offer for business owners and incorporated professionals.
What is an Individual Pension Plan?
An IPP is a defined benefit (DB) pension plan established by a corporation to provide pension benefits to one or more employees; typically ‘connected’ employees who own 10% or more of the company’s voting shares. IPPs are designed to provide the maximum pension benefit permitted under the Income Tax Act.
Who is an IPP suitable for?
Incorporated business owners and professionals who:
- are between 40 and 71 years old;
- receive T4 income (i.e., salary, commissions, bonuses) of $100,000 or higher;
- generate surplus income in the corporation, not needed for corporate or personal spending; and
- want registered retirement savings that exceed Registered Retirement Savings Plan (RRSP) and other registered plan limits.
What are advantages of using an IPP?
IPPs allow sponsoring corporations to make annual tax deductible contributions that are 30-50% higher than RRSP and defined contribution (DC) pension plan limits allow.1 They also offer:
- Sizable contribution opportunity for past service years upon implementation.
- Ability to add funds if a shortfall occurs.
- Additional tax-deductible contributions upon retirement, known as “terminal funding.”
- Pension income splitting from as early as age 50 (versus age 65 for Registered Retirement Income Funds [RRIFs] and Life Income Funds [LIFs]).
- Potential to preserve the small business deduction (SBD).
Under rules introduced in the 2018 budget, private corporations that risk losing the small business tax rate2 on active business income may particularly benefit by shifting passive investments to an IPP.
How are IPP benefits determined?
Like a regular DB pension plan, the amount of ongoing benefit payments during retirement is defined before retirement and is primarily based on age, length of service and T4 earnings.
How are IPP contributions determined?
Past service contribution (PSC): PSCs are optional, but create an opportunity to move funds exceeding normal RRSP contribution limits to an IPP. When an IPP is first established, an actuary determines the initial funding for past service years of employment, going back as far as 1991. These funds come from the transfer of personal RRSP assets and new contributions from the company, if required.
Current service contributions (CSC): Ongoing contributions required to fund the cost of future retirement income are determined every three years through an actuarial valuation, but may not be mandatory depending on the jurisdiction governing the IPP. If investment shortfalls create a funding deficit in the IPP, additional funding is possible.
What happens when you retire?
There are three main options to choose from when you retire or turn 71:
1) Maintain the IPP and receive lifetime monthly pension income from the plan
- There may be an opportunity to enhance pension benefits, such as early retirement benefits and indexed cost of living adjustments, by making additional tax-deductible contributions upon retirement (terminal funding).
- The underlying corporation must continue to sponsor the IPP.
2) Transfer the commuted value to a Locked-In Retirement Account (LIRA) and wind-up the IPP
- Minimum and maximum withdrawal limits are based on the locking-in provisions of the jurisdiction governing the IPP.
3) Transfer the IPP assets to an insurance company to purchase an annuity and wind-up the IPP
- There are various forms of annuities such as single and joint life.
- The cost of the annuity is based on age and interest rates at the time of purchase.
Under the wind-up options, some or all of the pension value may be ‘rolled-over’ to a LIRA or annuity to maintain tax-deferral. If the value of the plan is greater than the CRA’s prescribed limit, the excess is paid in a lump sum that is subject to immediate taxation.
What happens with an IPP upon death?
Before Retirement: If the plan member dies before retiring, the surviving spouse may transfer the commuted value to a LIRA (or an RRSP, in some cases) or use the funds to purchase a deferred annuity. If there is no surviving spouse, the IPP funds can be distributed to the plan member’s estate or other beneficiaries.
During Retirement: The pension from an IPP may be based on a single life or joint survivor basis (with a spouse or common-law partner) and may also include a guaranteed payment period with named beneficiaries. If the plan member dies before the end of the guarantee period, the full monthly pension will continue to be paid to a surviving spouse or other designated beneficiary for the remainder of that period. After the guarantee period, the surviving spouse will continue to receive monthly pension payments at a rate selected at the time of retirement. A joint survivor rate is typically 66 2/3% and can be as high as 100% of the IPP member’s pension. Upon the surviving spouse’s death, any remaining assets are distributed and fully taxable to the remaining beneficiaries or estate when the plan is wound up.
For more information, please contact your Odlum Brown Investment Advisor or Portfolio Manager.
1 Per Westcoast Actuaries Inc.
2 The 2019 small business tax rate is 11% (combined federal and BC) on the first $500,000 of active business income, but the $500,000 SBD is reduced by $5 for each $1 of adjusted aggregate investment income (AAII) above $50,000. The SBD is completely lost if a corporation reports AAII of $150,000 or more. AAII generally includes net taxable capital gains (excluding on the sale of active business assets), interest income, portfolio dividends, rental income and income from savings in a non-exempt life insurance policy.
Odlum Brown Financial Services Limited is a wholly owned subsidiary of Odlum Brown Limited, offering life insurance products, retirement, estate and financial planning exclusively to Odlum Brown clients.