Wealth Strategies for Business Owners: Tax Sheltering - The Individual Pension Plan (IPP)

Business Owner Tax Sheltering: The Individual Pension Plan (IPP)

Within Canada, there are truly only a few tax shelters to take advantage of. Once the obvious ones are maximized, we’re somewhat corralled into investing the remainder in a non-registered account, whereby we’re taxed on interest, dividends and capital gains. The more widely-known tax-sheltering options are as follows:

1. Principal residence
2. RRSP
3. TFSA
4. Life Insurance

The principal residence is the most widely available and most commonly used, whereby we aren’t taxed on the capital gains upon sale of the residence. However, one is only allowed to specify one property under this designation. RRSP contribution limits are limited to 18% of earned income up to a maximum annual limit, indexed each year and cumulative over time. TFSAs aren’t based on income, indexed over time and are cumulative with an annual maximum. Life insurance is a bit more complicated with respect to the amount of money one can tax shelter (based on amount of insurance coverage, maximum allowable deposit), but can prove effective, especially as an estate planning tool.

That said, for business owners or key persons within a business, there is another compelling option available. The Individual Pension Plan (IPP) comes into play for individuals meeting certain criteria to take advantage of what is essentially a defined benefit pension plan, or perhaps thought of as an enhanced RRSP. IPPs can be established for one person, spouses, a small group of employees or family, though all participants in the IPP must be legitimate employees of the company that is sponsoring the plan. Ideally, IPPs are suitable for those age 40+, whose T4 income of $100,000+, their business is incorporated, and they’ve historically maximized their RSP and pension contributions.

To differentiate between an RSP and IPP the main differences are as follows:

1. Significantly higher contribution limits
2. Creditor proofing
3. Restricted collapsibility options (collapsible upon plan holder illness, disability or financial hardship)
4. Investment management fee deductibility to IPP plan sponsor
5. Estate planning transfer options (from one family member to another)

The higher contribution limits of an IPP versus an RSP is generally the main driving factor, with the gap widening once the individual is age 40+ and continuing to widen further with each passing year. This in turn means greater compounding of interest on a tax deferred basis. There is also the potential to make contributions for past service prior to the IPP’s existence, potentially back to 1991 or even further if the individual is non-connected (i.e. executives). In essence, the IPP is a contractual employment arrangement designed to guarantee its members an income for retirement. For withdrawals of an IPP, they occur either when the plan holder retires or when employment ceases. Options at that time are as follows:

1. Pay out the plan benefit
2. Transfer and invest into an annuity, LIRA, LIF, LRIF or RIF
3. Transfer to a new employer offering an IPP

So, what does the process of establishing an IPP entail? Firstly, you would engage with a firm/future administrator of the IPP who requests a quote from an actuarial firm to determine the amount that can be deposited to fund a benefit for a plan holder. The quote is then reviewed to assure that this makes sense for both the plan holder and sponsor (the corporation). Once determined and agreed to, the plan sponsor must designate an investment manager/financial advisor to register and manage the IPP, a trustee/custodian to hold the assets, and an actuarial firm to perform periodic required calculations and filings etc. The required IPP documents are consequently filed with CRA and provincial regulating authorities. CRA in turn provides a temporary seven-digit IPP registration thereafter. The sponsoring company can then make contributions for both past and current service, but the qualifying transfer (i.e. RSP, DPSP or pension plans) cannot occur until final approval. Upon final CRA approval a registration letter is sent to the IPP sponsoring company and its appointed advisors. The qualifying transfer can then be made. Beyond that, each of the appointed advisors has their ongoing role to play to manage the investments, determine funding, make deposits to fund the plan benefit, make the required filings etc., just as any defined benefit pension plan would.

There continue to be new challenges to address for business owners in Canada, however the IPP is still a silver lining that is often overlooked. IPPs are one of few benefits remaining to specifically aid business owners in retirement planning and tax sheltering, and the numbers tend to speak for themselves throughout the life of the plan.