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Retirement savings

April 25, 2018

Who are individual pension plans for and how do they work?

If you’ve hit your RRSP contribution limit and you fit certain criteria, an IPP is another way you can save for retirement while saving tax.

Are you a business owner or executive looking for an alternative to your RRSP to save for your retirement while saving on your tax bill? An individual pension plan (IPP) may be for you.

What is an IPP?

An IPP is a registered, defined-benefit (DB) pension plan typically set up for just one member – you. It can let you build your retirement income under a tax-sheltering umbrella, and get the maximum pension that Canadian tax law allows.

If you’re a business owner or an executive, an IPP can create additional contribution room over and above an RRSP, once you reach a certain age:

Age IPP RRSP
45
100%
18%
50
100%
18%
55
100%
18%
60
100%
18%
65
50%
18%

Source: West Coast Actuaries

If you own your business, an IPP can save even more tax, because the IPP contributions your business makes, plus any administrative costs, are tax-deductible. To set up an IPP and become a plan sponsor, your company must be incorporated. To be an IPP plan member, you must be an employee or a shareholder of the sponsoring company, and earn “T4 income” (salary that’s reported on your annual T4 statement).

An IPP can create a significant tax-planning opportunity for you and your business, both when you first start funding the plan and when you retire, through tax-deductible, lump-sum contributions known as “past-service funding” and “terminal funding,” respectively.

In the first year of your plan, depending on your specific circumstances, your business may be able to contribute a large, tax-deductible lump sum to account for net “past services” that have accumulated with your business. This means that an IPP can still be a powerful solution up to age 71, as the history of your T4 income with your sponsoring company affects the assessed value of your initial contributions. When you’re approaching retirement, again depending on your personal situation, you may be able to top up your IPP through terminal funding.

These options let you use creative tax planning to enhance your retirement. Please note that RRSP planning is limited once an IPP is established. In other words, you can’t have your cake and eat it, too, as contributions to an IPP will create a pension adjustment that will decrease (and likely eliminate) new RRSP contribution room. And note also that you will need to make a non-taxable transfer from your RRSP account for a portion of the past-service funding.

Who is an IPP for?

To find out whether an IPP would be right for you, and then to set one up, you’ll need to work with your financial advisor, who will in turn work with an actuary. They will consider factors such as your age, your length of service and your income. An IPP could be a good option for you if:

  • You’re 45 or older
  • You don’t belong to another pension plan
  • You’ve been with your employer or owned your business for 10 or more years
  • The earnings on your T4 are $75,000 or more

If you don’t fall into one or more of these categories, you may still benefit from an IPP. For example, if your average T4 earnings from your business are only $50,000, but you’ve run that business for 25 years, the IPP may still be a compelling retirement solution. In any case, you’ll need to work with an actuary to calculate how much you’re able to contribute to an IPP.

What happens to your IPP when you retire?

When you retire or leave your employer, you have several options:

The rules for IPPs are similar to those for RRSPs, in that you must start receiving income from your IPP by the end of the year you turn 71. When you die, any remaining value goes to your surviving spouse or to your estate. You could also wind up your plan early and take out the cash value, but please be sure to seek additional tax advice upon deciding which route to take.

As you can see, deciding whether an IPP is right for you, and ultimately setting one up isn’t a do-it-yourself project. It’s important to work with an investment advisor who can call upon the expertise of an actuary, while choosing the best fund or funds for your IPP. Your advisor can also work with an actuary on a free quote/illustration to determine if the IPP may be a good strategy for you.

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