What is an Individual Pension Plan and is it right for me?
How do we measure success? For some it springs directly from their individual creativity. We are of course going to discuss business success here, rather than the more ethereal and many times equally elusive success that truly define us – that of family and life-long friendships. By the way, they are not mutually exclusive.
Seeing as how our focus is going to be on the financial measuring sticks of success, we will content ourselves with the most common of these – how many toys we have accumulated and how much money remains in the coffers at the end of the day. Although toys may provide a visceral satisfaction, they will never see us through our retirement. Exceptions to this rule we will leave to your own judgement.
One of the hard and fast rules of business success relates to the adage of paying yourself first and how often this basic rule is overlooked or ignored out of hand. Entrepreneurs have a singular focus and that is to nurture and grow a great idea. In the process of doing this, they very often forget the end game. The satisfaction of building it should be tempered by the need to benefit from it. The business’ real success will eventually be measured by its ability to usher the builder into a well supported retirement.
The norm is that the sooner we start to save, the better the chance to grow a decent nest egg. Like all rules, it truly is the exception that makes the law. In the case of the IPP – Individual Pension Plan – we have some lead time before we have to make a commitment. The beneficial rules of the IPP actually kick in after the age of fifty.
The IPP is a way of having a successful business pay us a benefit that will assure us a well-funded retirement. One of the significant differences between an IPP and an RRSP is the fact that the IPP requires an annual contribution – monthly contributions are acceptable – that is fixed at the time of underwriting, based on T4 income paid to the annuitant (the person for whom the pension is intended) by his/her own corporation.
This annual contribution from the corporation, unlike the RRSP, is not T4’d to the employee/business owner. However, it is an expense to the corporation and represents a deduction to the employer in regards to the corporation’s taxable income. These contributions, calculated on the T4 income of the annuitant, are in most cases significantly higher than that allowed for an RRSP.
RRSP maximum contribution for 2016 based on income of $140,945 = $25,370
IPP maximum contribution on the same T4’d income - $32,840.00
For the duration of the IPP contribution period, all assets in the pension trust fund are tax-sheltered. On dispersal, this now becomes income and is 100% taxable. The latter feature is very much in line with how an RRSP works, other than the advantage of much larger allowable contributions for the life of the pension.
The IPP, again comparable to the RRSP, allows for contributions based on past service. In the case of the IPP we can go back as far as 1991 and pick our 10 best years of T4 earnings for this calculation. Unlike RRSPs, all contributions including management fees and the plan’s annual actuarial fees, are deductible by the corporation. It is also works to our benefit that some of these fees are pre-set by the provider of the plan and are consistent as well as much lower than would be the case, if we retain separate legal and accounting services to do the annual review.
The IPP has several options pertaining to the age of withdrawal. The pension cannot start before the age of 55 and must be drawn as of the end of the annuitant’s 71st year. Unlike an RRSP, the IPP does not allow for a lump-sum withdrawal, but must be either annuitized or be rolled into another form of LIF – Life Income Fund - product. This acts as a long-term safety net to the annuitant, protecting him/her against premature depletion of their income funds.
The IPP is subject to the current and future pension legislation, as well as to actuarial valuations and the requirement for an annual filing with the CRA. Again, it is important to note that the costs related to this are an expense for the corporation. RRSP management fees are an after-tax cost and are not deductible by the annuitant. Also, a valuable feature of the IPP is its larger contribution allowance extending to past service (historic T4 contributions) and the fact that it offers full creditor protection.
An added feature of the IPP which can greatly benefit the annuitant is the CRA rule that specifies the annual compound return on funds for the pension plan. That mandatory return is currently over 7% per annum. Rather than seeing this as an unachievable target, we can look at this as a further opportunity to move money from our successful corporation to our pension plan. It is mandated that if our investments do not meet this target, the corporation is obligated to make up the difference. This will not be a factor in a good market year, but where there is a deficiency in investment returns, the corporation picks up the difference.
This formula allows us to set a defined target for the future pension, with the assurance that this target will be met. However, the corporation has the flexibility of revising this target, either upwards or downwards depending on the corporation’s financial circumstances. As the actuarial review is done on an annual basis, this issue can be dealt with at that time.
Just to review:
The IPP allows for much higher contributions that an RRSP;
The IPP is a defined pension plan with a set payout target;
The IPP allows past service contributions at this higher rate;
The IPP offers full creditor protection;
The IPP offers deduction of all fees and contributions by the corporation.
We encourage clients who have a history of paying themselves more than $100,000.00 per annum in T4 income from their corporation and/or those who are at the helm of a growing business, with a future of higher T4’d years anticipated, to consult a qualified professional to find out if this product is right for them.