Individual Pension Plans worth consideration as retirement approaches

MONDAY, JANUARY 29, 2024

Private company business owners should consider Individual Pension Plans (“IPPs”) as they approach their mid 50s. IPPS are pension plans that allow individuals over age 50 to set aside significantly more retirement funds then RRSPs. The plans are particularly useful in these circumstances:

-        the business is likely to transfer to the next generation in the family

-        the business owner has a spouse with modest income in retirement

-       the funds are likely to be invested in interest bearing securities

-        the business pays tax at a rate of 26% rather than the small business tax rate of 12 to 13%.  The IPP contribution creates an immediate tax saving – and obviously a tax saving of 26% is twice as valuable as a deduction at half the rate.

In circumstances where the corporate tax rate is low and the funds are likely to be invested in growth securities the drawbacks to the plan may exceed the benefit.  For higher net worth individuals, it can work well if the pension assets are invested in the lower risk fixed income securities and the equities are placed in taxable account (Note:  this is also a good thing to keep in mind with RRSP investors – with more attractive interest rates now available it may be smart to ensure that your interest bearing securities are inside the RRSP and the taxable accounts hold the equity portfolio)

Benefits to the plans:

1.     IPPs allow companies to build pensions for business owners that have been earning employment income. Maximum contributions to IPPs exceed RRSP maximums for individuals in their 50s or 60s, by roughly 30%. In addition, companies establishing a plan are often able to make a one large lump sum into an IPP.  The result is a larger deduction now and more money growing on a tax deferred basis. Also, if the plan delivers less than a 7.5% return the plan must be topped up – creating additional deductible contributions and cash within the plan.

2.     If your income is going to be substantially reduced during retirement, a larger pension plan means more ability to claim deductions now and then withdraw at a lower rate.  And, pension income can be split with your spouse whereas corporate dividends cannot be split unless the entrepreneur has planned ahead for this by creating the right corporate structure. 

3.      Adding children to the IPP is available if your children are active in the business.  This can substantially reduce what would be a significant tax burden upon the passing of the individual that the IPP was established for.  The IPP can flow to the children as ongoing beneficiaries of the plan rather than paying a top tax rate of over 53%.  This type of planning is not available with an RRSP.

Drawbacks to the plans:

1.     The plans require actuarial reports every three years and, until they are wound up, the company must meet its funding obligations.  Compared to an RRSP there is more paperwork and costs.  And the business owner must be comfortable that the company will be able to fund the obligations.

2.     IPPs invested in equities result in capital gains that would normally be only half taxed becoming fully taxable when the funds are removed.  This is the same with RRSPs but because a larger amount is contributed to IPPs the issue is more significant.  In designing your investment strategy it can often make more sense to keep the interest bearing and higher dividend paying low growth stocks in the pension plan.

Please reach out if you have any questions.