IPP - Your Ultimate Retirement Savings Tool
Many Canadians have seen their RRSPs take a significant toll in the markets during this Global Recession. Most can do little more than hope for a quick recovery. But there is another option. It’s called Individual Pension Plan (IPP).
IPP stands for Individual Pension Plan. It is perhaps the least known, yet most effective tax reduction strategy available in Canada. IPP is a tax-driven registered pension plan catered to individuals who would like to accomplish more retirement savings than what an RRSP can offer.
For example: In 2004, a 50 year old who commences an IPP could have a maximum contribution of $113,300 compared to a maximum RRSP contribution of $15,500. Therefore the IPP has a tax deductible advantage of $97,800.
Start your own IPP, magnify your retirement income and save thousands of dollars in tax—what else could be better?
Who Should Start an IPP?
Business owners, their families, key executives, and professionals with Professional Corporations, provided that the sponsoring company is incorporated.
The key candidates for IPP are usually corporations that are looking for additional retirement savings opportunities for their business owners, incorporated professionals, or highly-paid executives, provided that they are at least age 35 and have a history of maximizing their RRSPs. The corporation makes the contributions to your IPP and it can deduct the amounts contributed against business income to obtain tax savings for the corporation. All costs associated with the pension plan are tax deductible to the company.
Age is the key determinant for IPP—the older the IPP member, the higher the contribution amount. IPP contributions first exceed RRSP contributions around age 35. However, the advantage on a current year basis is relatively small at age 35, so there are not many IPPs set up at that age, given the higher maintenance cost for IPP vs RRSP. Most IPPs are implemented for individuals who are between the ages of 45 and 60.
The ideal IPP candidate is over 45, has an annual income of more than $100,000 and plans to work at the same level until retirement.
How does IPP work?
The rules are complicated, the concept is simple. The Pension Act allows a corporation to set up an IPP for an owner or key employees. Funds are contributed to the IPP by the corporation from income or retained earnings. Those payments are a tax deduction for the corporation (the plan sponsor) and roll tax-free into the IPP for the plan members. The individual will eventually pay taxes when the funds are drawn out of the IPP during retirement, similar to an RRSP.
How is IPP calculated?
An IPP is a one-person, defined benefit pension plan. It is designed to provide a predictable retirement income. Funding contributions are calculated by an actuary, based on your current age, salary, years of employment with the corporation, past RRSP contributions, and projected age of retirement.
Your annual income at retirement age is calculated using:
- Your career T4 or pensionable earnings
- Your age
- Assumptions determined by the actuary, which are acceptable to CRA
Examples of Actuarial Assumptions:
In an IPP, the assets are expected to grow at 7.5% per annum. The annual contributions compounded at a 7.5% net annual rate of return will ensure your plan has adequate assets to provide your retirement benefits.
A valuation is required to be completed every three years by your actuary to ensure the plan is being funded properly to provide you with a pre-determined annual benefit at retirement.
Your corporation (plan sponsor) can contribute more to the pension plan if the triennial actuarial review identifies investment rates of return of less than 7.5% per year since the previous actuarial review. This tax-deductible additional funding can be made over a period of up to 5 years. If a surplus is generated in the plan, the sponsoring corporation may be required to take a contribution holiday.
Determination of Pension Benefits:
The benefits are based on 2% of indexed earnings for each year of service up to the maximum pension limit for connected persons for years of service after 1990. A connected person is defined in the tax legislation as an individual who own directly or indirectly 10% or more of any class of shares of a company or an individual who does not deal at arm’s length with such a person. The arm’s length test would make the spouse, parent or child of a connected person also a connected person.
An IPP can thus be established for your spouse, which could allow for income splitting before and after age 65. Assets in an IPP are also exempt from the claims of creditors in most circumstances.
For those who qualify, an IPP may be the ideal way to supersize retirement savings. Not only does it allow you to contribute more to your retirement fund than an RRSP, it offers significant tax savings and gives you greater control oer the outcome—sheltering your wealth from external factors that are beyond your control.
Advantages and Disadvantages of IPP
- A higher contribution limit (higher annual tax-deductible contribution limits for older people)
Unlike an RRSP, there are no preset contribution limits to an IPP. In fact, the older you get, the larger your contributions can be. This allows you to build retirement savings faster in a tax-free environment, which can result in a significantly higher pension income.
- Past-service funding (ability to top-up past service contribution)
When an IPP is established, past service contributions allow you to catch up for any previous years of employment with the company going back to 1991. This allows a cash rich corporation to move money into a tax shelter. A portion of your existing RRSP may also be used to start your IPP without penalty.
- Guaranteed retirement income (ability to make further tax-deductible contributions if there is a deficit)
If your RRSP loses money, you’re out of luck. With an IPP, the corporation agrees to make up any shortfall to ensure the defined benefit is met. An actuary will valuate the fund’s performance every three years.
- Any surplus is yours
If your IPP over performs, the surplus remains with the fund.
- Tax deductibility (interest on funds borrowed for contributions is tax-deductible, unlike RRSP)
Contributions made to the IPP are tax-deductible for the corporation. Interest and expenses associated with managing the IPP are also deductible.
- Creditor protection (more creditor-proof)
IPP benefits are protected from creditors.
- Higher investment standards
Like an RRSP, IPP assets can be invested in stocks, bonds, mutual funds, pooled funds, term deposits, and GICs. However, no individual security may exceed 10 per cent of the fund on a book value basis at the time of acquisition.
- Contribution opportunities for termination or early retirement
- Contributions can be made within 120 days after corporate year-end
- IPP funds are locked in (no access to funds while employed)
Unlike an RRSP, access to your IPP funds will be restricted until retirement.
- Higher start-up and administrative costs (initial set-up and on-going actuarial reviews)
Because the set-up and ongoing administration of an IPP requires the expertise of an actuary, start-up and annual operating costs are higher than those associated with an RRSP. These fess are, however, tax deductible to the corporation.
- No lump sum cash available; benefits are locked-in
- Mandatory annual minimum contribution except for exempt provinces (BC/MB/PEI/QC)
Is an IPP right for you?
An RRSP is still a wise savings strategy for young professionals just starting out. But if retirement is only 10 to 15 years away, now may be the perfect time to consider setting up an IPP.
IPPs are already the private pension plan of choice for more than 8000 Canadians, and their popularity is growing among upper-income business owners and professionals looking to retire on their own terms.
To find out if an IPP is right for you, speak to a knowledgeable financial advisor who can determine if you are a suitable candidate and ensure that the plan is properly established and maintained.
1. Individual Pension Plan (IPP)
2. Individual Pension Plan (IPP)
3. The IPP Advantage