RRSP limit too low? Consider an IPP

Individual pension plans enable high-income earners to boost their retirement income.

Gail Bebee 6 May, 2016 | 5:00PM
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RRSPs are an excellent tax-deferred savings vehicle for Canadian workers who make yearly contributions that fall below the annual RRSP limit. If you are a higher-income earner who would like to save more than this limit and still enjoy tax-deferral benefits, the individual pension plan (IPP) is a government-sanctioned alternative that might work for you.

An IPP is a registered pension plan with defined benefits that is set up and funded by an employer for a specific employee. An employer may offer an IPP as a benefit to attract talented senior-level employees. An incorporated professional or a small-business owner who sets up an IPP will realize superior tax-deferred retirement savings compared to an RRSP.

"Think of an IPP as a teacher's pension plan for business owners," says Trevor Parry, who is president of The TRP Strategy Group and has helped set up nearly 2,000 IPPs. "Your pension savings are locked in, creditor-proof and benefit from tax-deferred growth. On retiring, you receive a defined-benefit pension adjusted for inflation."

To qualify for an IPP, you must be an employee of an incorporated company and should earn T4-reportable employment income of $75,000 or more from the company sponsoring the plan. A self-employed individual will need to receive a regular salary from her corporation to generate qualifying income.

IPP tax advantages generally begin at age 40. For 2016, the annual RRSP contribution limit, no matter your age, tops out at $25,370. By contrast, for 2016, the maximum IPP contribution room (reached with an income of $144,500) increases with age from $26,300 at 40 to $41,500 at age 65, says Brian Cabral a certified financial planner at IPP consultant Gordon B. Lang & Associates Inc.

The employer can also make contributions for the employee's past qualifying employment back to 1991. The maximum contribution for such service is $67,400 at age 40, rising to $438,900 at age 65 and $724,700 at age 71. No spousal contributions are permitted, unless your spouse is employed by the sponsoring company.

All employer IPP contributions and any associated expenses are tax deductions for the corporation. Contributions are not taxable benefits to the employee. Consequently, the tax savings realized during an individual's working years can be substantial.

"The most important reason to set up an IPP may be behavioural," says Alexandra Macqueen, a certified financial planner and retirement-income specialist. "If an individual has trouble saving, an IPP is ideal because it is a forced retirement savings plan.

Unlike with an RRSP, contributions are mandatory," says Macqueen, who is co-author of Pensionize Your Nest Egg: How to Use Product Allocation to Create a Guaranteed Income for Life. "Knowing that a retirement income is in your future can provide considerable psychological comfort," she adds.

If you are self-employed, is an IPP the best solution for your retirement savings? This question is best answered by a financial advisor who is well versed in retirement planning for incorporated professionals and business owners.

If an IPP fits your personal circumstances, it is imperative to hire a consultant who is a qualified actuary with specific IPP expertise to set up and administer the plan, given the complexity of this investment product.

Actuarial calculations are required to determine the required employer contributions to produce the intended retirement income. Past-service contributions and the amount of any existing RRSP funds that should roll over tax-free to the IPP will need to be worked out. Note that once the IPP is set up, the RRSP contribution limit will be just $600 each year.

The IPP must comply with the relevant sections of the Income Tax Act and provincial pension regulations and be registered with the Canada Revenue Agency and the applicable provincial regulator. A trust must be set up to hold IPP pension assets and your company will need to hire an investment company to manage the funds.

The overhead costs of an IPP are higher than RRSPs. In addition to ongoing investment-management fees, there are annual consulting fees to pay for plan administration. Some consultants charge an all-inclusive annual fee, typically about $1,500. Others have a lower annual fee and bill extra to set up the IPP and complete the mandatory actuarial evaluation every three years.

If an actuarial evaluation determines that the plan deficit exceeds prescribed limits, the employer must make extra contributions. If there is a surplus, reduced contributions or a contribution holiday may be necessary.

At retirement, an optional final contribution, called terminal funding, can be made in certain circumstances to enhance the pension benefit.

Withdrawing pension income from an IPP is subject to the same rules that govern other pensions in the province of registration. Funds are generally locked in until age 55. Contributions cannot be made past age 71 and income payments must begin at age 71.

There are three main options for generating pension income from an IPP. The funds can be used to purchase a life annuity, which could be a joint annuity with a spouse. The most popular choice is to convert the IPP to a locked-in retirement plan. The IPP can also be continued into retirement where additional funding is possible. Any surplus not required to pay for the promised pension benefits will be paid to the beneficiary in cash, which is fully taxable.

IPP pension income is taxable on receipt. It is eligible for spousal pension-splitting of up to 50% from age 55. By contrast, RRIF income is not eligible for such income-splitting before age 65.

Upon the death of the IPP member, the pension can either continue as a pension that pays out a survivor benefit, or be wound up and rolled over to the surviving spouse's RRSP/RRIF. If there is no spouse, any remaining funds will be distributed in accordance with the applicable provincial pension legislation.

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About Author

Gail Bebee

Gail Bebee  Gail Bebee is an independent personal finance speaker, teacher and the author of No Hype--The Straight Goods on Investing Your Money. She can be reached at gbebee@gailbebee.com; her website is www.gailbebee.com.

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