Are you a business owner or executive? Are you looking for an alternative to your RRSP to save for your retirement? Do you also want to save on your tax bill? If so, an individual pension plan (IPP) may be for you.
What is an individual pension plan and how does it work?
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, you can get the maximum pension that Canadian tax law allows.
If you’re a business owner or an executive, an IPP can create more contribution room over and above an RRSP. Here’s a breakdown by age:
Source: West Coast Actuaries (for illustration purposes only).
What are the criteria to set up an individual pension plan?
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).
How can an individual pension plan save you on tax?
If you own your business, an IPP can save you even more tax. That’s because the IPP contributions your business makes, plus any administrative costs, are tax-deductible.
An IPP may create a significant tax-planning opportunity for you and your business when:
- You first start funding the plan, through tax-deductible, lump-sum contributions known as “past-service funding”, and
- You retire, through tax-deductible, lump-sum contributions known as “terminal funding”.
In the first year of your plan, your business may be able to contribute a large, tax-deductible lump sum. This accounts 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. How? Since the history of your T4 income with your sponsoring company affects the assessed value of your initial contributions. When you’re approaching retirement,* you may be able to top up your IPP again through terminal funding. Terminal funding enables more tax-deductible contributions in the year of retirement.
(*Depending on your specific circumstances.)
These options let you use personalized tax planning to enhance your retirement. But beware that RRSP planning is limited once an IPP is established. In other words, you can’t have your cake and eat it, too. Contributions to an IPP will create a pension adjustment that will decrease (and all but eliminate) new RRSP contribution room. You’ll also need to make a non-taxable transfer from your RRSP account for a portion of the past-service funding.
Who is an individual pension plan for?
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, and
- your annual personal income requirements in your pre-retirement years are in excess of $150,000
If you don’t meet these criteria, you may still benefit from an IPP. For example, the IPP may be a compelling retirement solution if:
- your average T4 earnings from your business are only $50,000, but
- you’ve run that business for 25 years.
To see if an IPP is right for your situation, you’ll need to work with an advisor. Your advisor will then work with an actuary. They’ll consider factors such as:
- your age,
- your length of service and
- your income.
What happens to your individual pension plan when you retire?
When you retire or leave your employer, you have several options.* You can:
- receive a monthly pension from the plan,
- buy an annuity from a life insurance company, or
- transfer to a life income fund (LIF) or locked-in retirement income fund (LRIF).
- Consider potential tax implications if the pension exceeds the maximum transfer value (MTV).
(*Options are age dependent and based on the member’s provincial jurisdiction.)
The rules for IPPs are similar to those for RRSPs:
- 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 can wind up your plan early and take out the cash value. Seek additional tax advice when it’s time to decide which option to go with.
Is an individual pension plan right for you?
Deciding whether an IPP is right for you (and setting one up), isn’t a do-it-yourself project. It’s important to work with an advisor. Your advisor can work with an actuary to:
- determine if the IPP may be a good strategy for you, and
- choose the best fund(s) for your IPP.
Most advisors now offer to meet Clients virtually by video chat. Find an advisor today.
Watch and read more:
- What are the two main types of employee pension plans? (video)
- What is a RRIF? (video)
- 2 common myths about estate planning
This article is meant to only provide general information. Sun Life Assurance Company of Canada does not provide legal, accounting, taxation, or other professional advice. Please seek advice from a qualified professional, including a thorough examination of your specific legal, accounting and tax situation.