By Ron Walsh
An individual pension plan, or IPP, is an employer-sponsored, defined benefit pension for one person. IPPs have gone in and out of favour over the past 25 years. Recently, the federal government’s proposed tax changes for Canadian controlled private corporations (CCPCs) have sparked renewed interest in these plans.
IPPs: A brief history
In the mid-1980s, seeing that existing retirement plans discriminated against business owners and the self-employed, Ottawa pledged to boost RRSP limits and introduce IPPs. When IPP legislation took effect early the following decade, it wasn’t as generous as promised. But IPPs gained popularity, only to decline in the 2000s, after bureaucratic changes to the rules reduced their flexibility. In 2011, the feds made two more moves against IPPs, shrinking contributions for past service to an employer and requiring minimum annual withdrawals starting at age 72.
Who uses IPPs?
The typical IPP user is an individual 40 or older who has T4 income over $145,000 and is:
- the owner of a business with sustainable profitability;
- an incorporated professional; or
- a high-level executive.
IPP, CCPC or RRSP?
Canada has a low corporate tax rate on business income: 13 per cent on the first $500,000 (subject to limits) and 26 per cent on the balance. In recent years, that has motivated people to accumulate private funds in a CCPC rather than in an RRSP or an IPP. However, the proposed changes to the taxation of CCPCs may make it more expensive to invest within these corporations.
Creating an IPP
Usually the employer – not the employee, who is the beneficiary – contributes to an IPP. However, both parties can share the cost. Setting up an IPP requires a trustee, but they play a limited role.
To create an IPP, the user needs a T4 history with their employer. An actuarial study is required and an IPP application must be sent to the Canada Revenue Agency. The CRA usually makes registration retroactive to the application date.
Typically, the contribution limit for an IPP is higher than for an RRSP, which is fixed at 18 per cent of earned income. IPP limits increase with age. For example:
|Age||Percentage of earned income|
You can make special contributions to an IPP. For instance, when you establish the plan, extra past service contributions may be available. But remember that limitations apply and such opportunities were greater before 2011. There’s also an additional “terminal funding” opportunity upon retirement.
How IPP contributions work
The first funds into an IPP are usually for past service. In most cases, those funds must come from an RRSP, so an adequate RRSP balance is required. The employer must make all other contributions.
Actuaries will compute the past service amount, which reflects age and years of service.
For the employer, contributions are usually voluntary. The deadline for tax-deductible contributions is 120 days after corporate year end.
IPPs and income tax
IPP contributions up to the limit, as well as ongoing administration costs, are tax-deductible for the employer. If the employer borrows funds to contribute, the interest is deductible. The employee doesn’t deduct anything and they can’t contribute to an RRSP.
Upon the IPP user’s death, benefits keep going to the surviving spouse and possibly other beneficiaries. There is no automatic deemed disposition on death.
An IPP is governed by pension, as well as income tax legislation. Employees can’t withdraw funds from an IPP as they would from an RRSP and they must use an IPP to fund regular pension payments after retirement. Also, investment criteria for pensions apply.
If investment returns from an IPP fall short of the regulated 7.5 per cent annual target, the employer must top up the plan. But if returns exceed that target, the employer reduces contributions.
From an investment strategy perspective, some tax bias comes into play when allocating the portfolio. This means holding low-risk, low-return assets in an IPP – creating more opportunities for top-up contributions – and keeping other assets in non-registered accounts.
What if there’s a pension surplus?
Any pension surplus in an IPP belongs to the beneficiary. Previously, a surplus could stay in the plan indefinitely. But now the minimum retirement payment requirement means that a surplus will increase annual pension income.
An IPP can continue after retirement, but we don’t recommend it. You can also convert IPP funds to an annuity, a locked-in retirement income fund (RIF) or a life income fund (LIF), which is similar to an RIF.
Continuing an IPP, post-retirement, isn’t practical because it also means continuing the corporation and meeting actuarial requirements. However, you can make additional contributions in some limited cases.
If you start an IPP, be prepared to submit annual tax filings and to pay higher annual administration costs than for an RRSP. You’ll also need to file a tri-annual actuarial report. CRA filings are usually managed by the actuaries.
Unlike RRSPs, pensions are generally creditor-protected. But to keep an IPP going, the user must maintain a high T4 income.
Because employer IPP contributions aren’t included on a T4, they may not be considered as income for alimony and/or child support calculations.
You can commence retirement income from an IPP after age 55, but you must do so by age 72.
And don’t forget: the CRA sometimes audits IPPs.
The pros and cons of IPPs
Each person’s situation is unique, so assess yours carefully before deciding for or against an IPP.
An IPP offers greater contributions, and therefore greater tax deferral, than an RRSP. As a pension, it protects assets from creditors, and its administration costs and interest expense on borrowed contributions are tax-deductible. Also, IPP contributions can be made within the employer’s taxation year or within 120 days after year end.
An IPP is more costly to create and maintain than an RRSP. It also offers less flexibility than having funds in a CCPC or an RRSP, withdrawals included.
How Walsh King can help
Walsh King assists our corporate clients in evaluating the appropriateness of an IPP for their unique situation.
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