Understanding the Ins & Outs of an Individual Pension Plan (IPP)
Having multiple income sources may be an essential part of preparing for retirement. An individual pension plan (IPP) offers certain benefits beyond more traditional vehicles, but there are some important considerations to make. Here’s what business owners and other eligible employees should know about IPPs and their potential for retirement income.
What Is an Individual Pension Plan?
An individual pension plan is a defined contribution plan. This registered retirement plan is offered through an employer, and investment earnings are tax-sheltered as long as they stay within the plan.
Contributions made to an IPP by an employer and associated administrative costs are tax-deductible for the sponsoring corporation. In addition, you are not required to pay taxes on money contributed to the account by the business, only on the withdrawals made in retirement.
An IPP offers the maximum pension benefits allowed under Canada’s Income Tax Act.
Who Is an IPP for?
An IPP is best for business owners or high-level executives - those who typically have a 10 percent or more stake in the corporation sponsoring the plan. Because of its higher contribution limits (compared to an RRSP), it can be a popular option for high-earners over 40 who are preparing for retirement.
The specific tax advantages of using an IPP to prepare for retirement will depend on a variety of factors, including your age, how long you’ve owned/held a stake in a business and your reported annual income.
To determine if an IPP is a smart strategy, you’ll want to work with your financial advisor. They may work with an actuary to better understand your unique position.
How Does an IPP Work?
To establish an IPP for yourself, you need to meet a few criteria. These include:
- You must be a shareholder, owner or employee of the sponsoring business
- You must earn income that’s reported on your T4 statement annually
As a defined contribution plan, you will know your income stream in retirement. Payments will begin after you have turned 71, and they will be calculated according to the plan’s terms or the IPP minimum amount defined by the CRA (whichever is greater).1
Funding an IPP
There are several types of funding available for IPPs. These include:
- Funds contributed for the current year of employment.
- Past-service funding - lump-sum contributions for previous years in which you’ve worked for the sponsoring corporation.
- Terminal funding - lump-sum contribution made upon retirement from the sponsoring corporation.
- Deficit funding - a special contribution the sponsoring corporation can make if the investment has underperformed.
IPP vs. RRSP
High-earners may be limited by the contribution limits defined by an RRSP. How much you can contribute to your IPP will depend on your annual T4 income and the years you’ve been a part of the sponsoring corporation. The longer you’ve worked and the more money you make, the more significant the difference in contribution limits an IPP will have over an RRSP.
Along with the tax deductions available to the sponsoring corporation, IPP assets have creditor protection under provincial legislation. RRSPs may be creditor protected, but only under certain circumstances.
In the event of your passing and your spouse's passing, your RRSP would be fully taxed upon transfer to a non-spousal beneficiary. An IPP, however, may provide your family with the ability to forego this tax or probate fees. Here’s how: If your child or spouse is also employed by the sponsoring business and earning income reported on a T4 statement, they are eligible to be a member of your IPP. This can make an IPP a valuable option for family-owned businesses.
It’s important to note that contributions made to your IPP will limit the amount you’re allowed to contribute to both your and your spouse’s RRSP. An IPP can be a beneficial retirement savings vehicle for business owners and company stakeholders. Work with your financial professional to understand the potential costs and benefits involved for you, your family and your business.
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