Let's get straight to the point: As a business owner, your retirement planning needs to evolve. The traditional methods of income splitting and passive investment aren't as effective under the current Canadian tax rules. This is where the Individual Pension Plan (IPP) comes into play. It's a smart strategy specifically designed for entrepreneurs like you, looking to maximize your retirement savings and benefit from current tax advantages.
In this blog, we're going to break down how an IPP works and why it should be on your radar. It's more than just a pension plan; it's a critical tool to ensure your financial security after years of hard work. Stick around to learn how an IPP can fit into your retirement plan and potentially transform your financial future.
What is an IPP in Canada?
An Individual Pension Plan (IPP) in Canada is a defined pension plan benefit. It is primarily intended for business owners of incorporated companies and high-earning executives. The primary purpose of an IPP is to enable these individuals to maximize their retirement savings and retire happy.
In an IPP, a predetermined monthly benefit is paid out according to your age, years of service, and a minimum annual rate of return of 7.5%.
How Does IPP Work?
- The company contributes to the plan on behalf of the plan member and receives a tax deduction for these contributions.
- Contributions are calculated based on factors like the member's age, salary, and career T4 and T4PS earnings.
- Contributions can significantly exceed the limits of a Registered Retirement Savings Plan (RRSP), particularly as the member ages, making Individual Pension Plans (IPPs) highly beneficial for those over 45. An IPP, much like an RRSP, accumulates assets over time. However, it allows for a higher accumulation of assets (up to 65% more than an RRSP) and sets a predetermined monthly income at retirement.
- Unlike RRSPs, IPP assets are creditor-proof, and the plan member owns any surplus remaining in the plan once benefits are paid
Who qualifies for an IPP?
Ideal candidates for an IPP are typically business owners or incorporated professionals over the age of 45 with a T4 income exceeding $100,000. However, younger individuals or lower-income earners who have eligible years of past service may be candidates as well.
For small business owners, IPPs maximize tax-sheltered contributions and benefits for retirement. They offer asset ownership and protection and assist with business planning or company sale.
For corporations, IPPs boost executive compensation, aiding in attracting and retaining key individuals. All contributions and associated expenses are tax deductible. They aren't considered part of the individual's taxable income when contributed.
IPP contributions and limits
Individual Pension Plans (IPPs) are beneficial as they allow for substantially larger asset contributions and accumulations compared to Registered Retirement Savings Plans (RRSPs).
Annually, the amount saved in an RRSP is capped at 18% of an individual's employment income, with an annual maximum. In 2024, this maximum contribution is $31,560. Consequently, individuals earning more than $175,333 annually are disadvantaged, as they can contribute a smaller percentage of their income to an RRSP compared to those earning less.
On the other hand, contributions to an IPP are calculated to ensure a retiring business owner or executive receives a predetermined benefit. As such, the older an individual is, the greater the required contribution due to a shorter timeline to retirement. Furthermore, an IPP mandates an average investment return of 7.5%. This return is reviewed every three years, and if it falls below 7.5%, additional funds must be contributed to cover the deficit.
What is the difference between IPP and RRSP?
Both IPPs and RRSPs are valuable tools for retirement savings, each with unique features catering to different financial situations and goals. It's crucial to consider your individual financial circumstances and seek professional advice when choosing the right retirement savings plan. When optimizing your personal finances don’t forget to maximise your employees group retirement plan too.
Defined benefit plan, usually for business owners/key employees
Personal savings plan open to all individuals with earned income
Higher, especially for those over 45, can exceed RRSP limits
Based on annual income, with a maximum threshold set annually by CRA
Contributions by the company are tax-deductible; tax-sheltered growth
Contributions are tax-deductible; tax-deferred growth until withdrawal
Generally protected from creditors
Protection varies based on provincial legislation; not as robust as IPP
Older, high-earning individuals, business owners, connected employees (holding 10%+ shares)
Broader range of individuals due to flexibility and no company sponsorship requirement
6 main advantages of IPP
- Substantially larger asset contributions compared to RRSP. IPP can yield an annual pension about 46% higher than using only an RRSP.
- Protection from creditors, as long as it fully complies with provincial or federal pension legislation. The two exceptions to this protection, other than fraud, are:
- seizure of assets by tax authorities, and
- division of assets due to a divorce.
- Income splitting opportunity. Under the income tax act, the splitting of retirement income with a spouse is allowed unlike the splitting of business income with family members who aren’t active in the company. Therefore, IPP’s may help with post-retirement tax planning.
- An IPP value remains even after contributor’s death. If a member passes away or leaves their job prior to retirement, the value of the plan can be used to buy a steady income for retirement (an annuity) or to be moved to another retirement savings plan. If a member dies after pension payments begin, generally a spouse continues to receive an income. This way, the benefits can keep going or be given to someone else, following the person's estate plan or the rules of the IPP.
- IPP can offer additional benefits to boost the pension amount at retirement, including:
- An unreduced early retirement pension
- Post-retirement indexing equal to full Consumer Price Index increases
- Bridge benefits related to CPP and OAS payments
Wait, there's one more important aspect!4. Moving money into an IPP lessens cash in business, potentially reducing overall tax and taxable capital gain on share sales. It also supports succession planning, providing the owner with an independent retirement income, reducing dependence on share sales or a continued salary.
In a nutshell, the Individual Pension Plan stands as a compelling retirement solution, especially for business owners and high-earning professionals. It sets itself apart from RRSPs by offering higher contribution limits, tax advantages, and a guaranteed retirement income. The IPP not only allows for substantial asset growth but also provides creditor protection and estate planning benefits.
For a deeper dive into the specifics of Individual Pension Plans and how they can transform your financial future, consider reaching out to one of our benefits advisors.