An Individual Pension Plan is a form of retirement account that can be set up by business owners and incorporated professionals, such as doctors and dentists. While it is similar to an RRSP, there are some significant differences. Read on to learn more about whether this type of plan fits the bill for you.
What is an Individual Pension Plan (IPP)?
An IPP is a registered private pension plan that allows a corporation to provide retirement savings to a key shareholder or vital employee.
IPPs are defined benefit plans. This means that they provide a fixed retirement benefit annually to the person designated in the plan. This is a key difference with an RRSP, which do not provide a specific regular payment – it’s up to the RRSP owner to decide how much to take out each year (subject to the requirements set out by the Canadian government).
Who qualifies for an IPP?
An IPP can only be set up by a corporation for the benefit of the business owner or a key employee. Spouses and children can also be included if they work for the company.
IPP for business owners
For business owners, an IPP can provide a significant advantage. The corporation can deduct IPP contributions as a business expense. On the named individual’s income tax return, the contribution is not taxable.
However, IPP contributions will have an impact on the business owner’s personal RRSP. The contributions reduce an individual’s contribution room through what is known as a “pension adjustment.” In other words, they cannot contribute the maximum 18 percent of income to their RRSP.
How can an IPP save you taxes?
The corporation can deduct contributions as an expense, reducing the corporate income tax payable. If the business owner did not have an IPP, it would not have this tax deduction.
Within the IPP, the owner can take advantage of tax-deferred growth. This is the same as an RRSP – tax must only be paid when the money is withdrawn.
Individual Pension Plan contribution limits
The contribution limits are a key difference between IPPs and RRSPs. With RRSPs, the Canadian government sets a limit of 18 percent of the previous year’s income, up to a maximum of $27,830 in 2021.
With an IPP, the government does not set specific limits because it is a defined benefit plan rather than a defined contribution plan. This means that an actuary must calculate the contribution that will be needed to provide the plan holder with the benefit payment for the rest of his or her life.
Younger individuals need smaller annual contributions to achieve the defined benefit on retirement. Actuarial calculations show that up to age 40 an RRSP has more contribution room; after that age an IPP requires bigger contributions.
Example of an Individual Pension Plan
Summer is a 40-year-old family physician in Mississauga. She has a professional corporation for her medical practice and wants to set up an IPP to fund her retirement. Summer would like a defined benefit payment of $10,000 per month when she retires at age 65.
She sets up the IPP and hires an actuary to calculate the contribution that the corporation will need to make in order to achieve the benefit of $10,000 monthly when she retires.
IPP Advantages and Disadvantages
Advantages:
- An IPP provides tax-deferred growth, just like an RRSP
- It is safe from creditors of the company. While creditors can come after other company assets, they cannot touch an IPP
Disadvantage:
- It can be expensive to set up and administer an IPP. Since it is a defined benefit plan, an actuary must be hired to calculate the contributions needed to support the benefit. Actuarial fees can cost up to $1,500 per year.
IPP vs RRSP
Let’s start with the similarities. Both an IPP and an RRSP are designed to provide tax-deferred savings for an individual’s retirement.
Here are a couple of differences:
- Deduction: An RRSP provides a tax deduction for the individual. An IPP allows the corporation to claim the contribution as an expense.
- Benefit: An IPP provides a defined amount of benefit when the account holder retires. An RRSP does not guarantee a specific benefit amount – the individual must decide how to make the fund last for the rest of his or her life.
How to set up an IPP
As we have indicated, it is more complicated to set up and run an IPP than an RRSP. With an RRSP, you simply go to your bank or financial advisor and open an account. For an IPP, you will need to call on the services of a lawyer, accountant and actuary. They will help you to establish the account and determine the annual contributions required to generate the defined benefit on retirement.
These setup and ongoing administration costs for this private pension plan need to be considered in determining whether it is worthwhile to establish an IPP or go with a simple RRSP account.
What happens to an IPP when you retire?
When you retire, there are three options for collecting your defined benefit:
- An annual or monthly pension payment from the plan
- The funds can be transferred to another registered retirement savings product
- You can purchase an annuity from an insurance company, which will provide a regular payment
If you die, your spouse is eligible to receive the benefit. Once you both die, and if there are funds left in the IPP, the remainder becomes part of your estate.
Is an Individual Pension Plan for you?
An IPP is only available to the owners (or key persons) of a corporation or a professional corporation. It is most beneficial to individuals with a high income. If you fit both of these criteria, speak with your financial advisor and see if it is the best option.
