Is an Individual Pension Plan (IPP) right for me?
While we have been educating clients about Individual Pension Plans (IPP) for over ten years, recently, IPPs have been getting a lot of media attention, thanks to the changes to passive income rules for holding companies and professional corporations. What’s all the fuss about?
An IPP is an effective way for a business owner or incorporated professional to save for retirement, shifting tax-deductible funds from the corporation to a pension, where they can be invested on a tax-deferred basis until retirement. This differs from an RRSP, where the individual can contribute funds and receive a tax deduction personally.
So why bother? First, in most cases where the business owner or incorporated professional earns sufficient income, the corporation can contribute more to the IPP than can be contributed to an RRSP. This can generate more tax-deferred income, resulting in modestly more assets in the IPP at retirement compared to the strategy of contributing to an RRSP and investing retained earnings in the corporation, as many entrepreneurs currently do.
For the purposes of comparison, we’ve presented two case studies below using the most conservative financial assumptions and not taking into account additional benefits, such as the deductibility of investment management fees, an advantage unique to the IPP versus the RRSP strategy.
Jane is a 52-year-old incorporated dentist who hasn’t paid herself a salary in the past but will begin to do so in 2018. She plans to pay herself $135,000 a year going forward. After we did the analysis, we determined that this year, Jane’s professional corporation will be able to contribute $30,779 to her IPP and next year, the contribution will rise to $31,344. This is more than the maximum RRSP contribution of $26,230.
Assuming Jane works until age 65 and the IPP earns 7.5% per year*, the IPP will have an accumulated value of $1,169,216. Compare this to paying yourself enough to make the maximum RRSP contribution and then investing the retained capital in the corporation. The value of those two accounts would be $1,068,932, which is $100,284 less than the IPP strategy.
Peter is a 55-year-old business owner. Peter has been drawing a salary of $100,000 each year for the last ten years and will continue to do so until retirement. He has also been making the maximum RRSP contribution each year until now. In this example, the IPP is eligible to “purchase past service”, which means that we can put an IPP in place that takes advantage of the previous ten years that Peter has been working for the company. To do so, Peter will be required to roll some of the assets from his RRSP into the IPP.
Once we crunched the numbers we determined that Peter’s company would be able to contribute a tax-deductible amount of $167,878 this year. Peter would be required to move $202,000 from his RRSP to the IPP. Next year, the company can contribute $31,017 and this amount will continue to grow.
When Peter retires at age 65, assuming the same 7.5% annual rate of return, his IPP will be worth $1,366,229. Compare this to Peter paying himself enough to make the maximum RRSP contribution and then investing the retained capital in the corporation. The value of those two accounts together would be just $1,270,303.
In addition to the financial advantages outlined in the two case studies, there are other benefits of establishing an IPP, such as:
- Tax deductibility of Investment Management Fees, whereas in an RRSP they are not
- HST claw back for the IPP
- Improved creditor protection
- Enhanced estate planning through the ability to pass the assets of the IPP to surviving children who work for the company
These benefits can accrue significant financial advantage over the life of the plan.
Investing the assets of an IPP
Large pension funds typically diversify their investment portfolios by adding exposure to different asset classes such as real estate, private debt, mortgages, private equity and infrastructure. This can help to reduce the volatility of the portfolio while enhancing the return. An IPP should be invested in the same manner as a pension plan – after all it is one! IPPs managed by Newport benefit from exposure to these same types of private investments. By diversifying across a broader number of asset classes, clients benefit from less risk and more consistent returns.
Who should consider an IPP?
Anyone who owns an operating company or professional corporation and draws a healthy salary from it, should consider an IPP. Ideally, the individual who stands to benefit the most would be at least 40 years of age with a history of earning more than $145,000 per year and contributing the maximum allowable amount to their RRSP annually. Get in touch if you are interested in learning more about how an IPP could benefit you.
* 7.5% is the actuarial assumed rate of return by CRA and is not an indicator of past or future performance. If the IPP fails to generate the assumed rate of return, additional ‘top-up’ contributions can be made – an option not available with the RRSP.