For many business owners and incorporated professionals, including doctors and dentists, an Individual Pension Plan can allow higher contributions than a Registered Retirement Savings Plan. But how do you know if an IPP is right for you? Pierre Letourneau, Business Succession Advisor, TD Wealth, joins Anthony Okolie to help demystify this valuable retirement tool.
- If you're a business owner, a key employee of a private corporation, or an incorporated professional like a doctor, dentist, or lawyer, you may be wondering how to save for retirement beyond an RRSP. That's where Individual Pension Plans come in. It's another way to help you prepare for your financial future and can potentially help you manage taxes. Pierre Letourneau, Business Succession Advisor at TD Wealth, joins me now to break down what people need to know about the Individual Pension Plan. Pierre, thanks very much for joining us.
- Thanks for having me, Anthony.
- So first off, what is an individual pension plan? Who is it designed for? And how exactly does it work?
- Sure. So an Individual Pension Plan, or IPP for short, is a registered pension plan that's created for a specific individual. And as you mentioned in your introduction, these plans are really designed for business owners, incorporated professionals like dentists, doctors, accountants, lawyers, or in some cases key employees of a small business corporation. So those are the individuals that will benefit from this.
And how does this work? Well, the pension plan is created by the employer, which is a corporation, the sponsor corporation. And they create the plan and register it with the CRA, and then they usually engage an actuary to determine what the funding requirements are to meet the pension obligations of the pension plan.
Then once that's all set up, they start making contributions to the plan. Those contributions are then invested within the plan. In terms of investment options, it's very broad. It's similar to an RRSP. So the funds can be invested in cash, cash equivalents, fixed income, equities, mutual funds.
ANTHONY OKOLIE: So no restrictions.
- No restrictions, no, ETFs, a bunch of different options. Once these funds will be invested and grow, and then once the individual is ready for retirement, then the plan will provide a pension benefit, a retirement benefit to the individual at that point in time.
Now, there's a few different ways that the individual can receive those benefits. And there's really two general ways. One is as a life annuity. So receiving a pension benefit on a monthly basis for their lifetime.
And then the other option is to withdraw the funds from the pension plan and transfer them to a locked-in retirement vehicle, similar to an RRSP where there's a minimum withdrawal from that vehicle. So starting at age 72-- you can withdraw ahead before that. But 72 is the latest you can defer.
And then the difference with an RRSP is that there's a maximum amount that you can withdraw on an annual basis. But you control as the individual then ends up controlling those investments and having a bit more flexibility in terms of how those funds are going to come out and be used for them in retirement.
- OK, so now that we know how it works, what's the criteria to set up an individual pension plan?
- Yeah. There's a lot of factors that really provide a benefit to an individual and factors that you'd want to meet for it to make sense. First and foremost, the employee has to be receiving T4 income from the corporation, so employment income. And this is really meant for employees that are receiving a higher income, so at least $150,000 to $170,000 or more in terms of employment income, and that's where it starts making sense.
And then the last or another factor is age. So these plans are more beneficial for older employees or employees that are 40 and older. And the reason for that is, at that point when the individual is older than 40, you can make larger contributions to the IPP than what you could make to your RRSP. So it provides the employee with a larger nest egg for retirement and more funds invested in a tax-deferred environment.
- Now, can you have an individual pension plan and an RRSP? Or do you have to choose one over the other?
- Yeah, usually, the IPP replaces the RRSP. As I mentioned earlier, in an IPP, you can make larger contributions. And any contribution on an IPP reduces your RRSP contribution room. So if you're making full contributions to the IPP, there's no longer an ability to contribute to your RRSP.
Now, if you had RRSPs accumulated from previous contributions, they can remain in place. But in some cases, if depending on whether you earn that contribution while you were an employee of that corporation, you may be able to roll those assets into the IPP. The benefit of that is that it provides you with some simplicity instead of-- it allows you to have just one account instead of two.
- And how does an IPP help you manage taxes?
- So that's a good question. So one of the things is that the contributions that are made by the employer corporation are tax deductible and aren't taxable to the individual. So the individual won't be taxed on those contributions until they start receiving the pension benefits.
And then the investment returns, as well, too, are tax deferred. So there won't be any tax. That will grow on a tax-deferred environment and then be taxed when it's pulled out, so just allows the individual to have more assets working for them because they haven't paid taxes on those assets yet.
Another advantage, like I mentioned, is you can actually, with an IPP, potentially contribute more than the RRSP, so more-- again, more assets that are in a tax-deferred environment. And then for business owners, one of the rules-- so business owners have an incentive of building a nest egg within their corporation. So they earn an active business income. They pay lower corporate tax rates on that.
Now, if they pull that money out of the corporation, they pay personal taxes on that. So they want to invest those funds within the corporation. The issue is that we have passive investment income rules that can impact the tax rate on active business income that the corporation earns if those passive investments are too large.
Well, the benefit of the IPP is any investment income within the IPP doesn't count as passive investment income for the corporation. So it actually may help the corporation in terms of managing its own taxes because it's a different entity. The pension plan is outside of the corporation.
- Are there any potential downsides or risks to opening up an IPP?
- Yeah, there's certainly some disadvantages. First off, there's costs to setting it up and costs to maintaining it. So actuaries are involved throughout the life of the plan because they need to make sure that it's fully funded. So there's an evaluation that needs to be done every three years usually. And so there's costs associated with that. There's also, like I said, income tax rules, pension rules that need to be complied with. So strict compliance is required.
Other disadvantages too, it doesn't, with an IPP, you're not able to make spousal contributions. So some individuals take advantage of spousal RRSPs. And that's really creating an RRSP asset for a spouse maybe that's not earning employment income and isn't creating any contribution room for RRSPs. So that's not available with the IPP.
- And again, there's a lot to-- a lot of information here. How do people know if an individual pension plan is actually right for them? Should they speak with someone to set it up?
- Yeah, absolutely. You can't really say that it's really meant for every business owner. It really depends on your particular circumstances. So I think you need to work with an advisor, first and foremost, to just review your situation and help you understand what the benefits are of the IPP, and then I think it's always helpful to do some sort of illustration to really show the benefits of the IPP. We need to make assumptions and try to predict the future, which is impossible. But that's helpful in understanding whether this is right for you or not.
- Pierre, thank you very much for joining us.
- Thanks for having me.