What Is An Individual Pension Plan (IPP)?
An Individual Pension Plan is a defined benefit pension plan that many successful entrepreneurs may want to consider for their retirement as an alternative to RRSPs.
After all, while RRSPs make up an integral component of any retirement plan, they do come with limitations.
For starters, allowable contributions to an RRSP are limited to 18% of your annual income, up to a maximum of $26,230 in 2018.
As you can imagine, for so many self-employed individuals who don’t have access to a workplace pension plan, these limits on RRSP contributions could make it near impossible to fully fund their retirement.
Furthermore, RRSPs are a type of defined contribution plan. This means that while the employee has some control over the amount that they put into the RRSP during their working years, the income that they are able to generate during retirement is far from guaranteed.
Sustained poor market conditions, either during the accumulation phase of their investment or after retirement, can severely reduce the investment holdings from which they need to draw income.
With a defined contribution pension plan, such as an RRSP, the employee assumes all of the risks.
This is where an Individual Pension Plan can help.
Its purpose is not to replace the RRSP as a retirement vehicle, but rather to enhance a self-employed individual’s ability to create retirement income.
What Is An IPP?
An Individual Pension Plan (IPP) is a defined pension plan which is established by an incorporated company for the benefit of one individual.
The individual, usually the company’s owner, or an executive, usually initiates the request, as the IPP is to be established for their benefit.
As the owner of the company, providing that you are drawing a T-4 salary from the business, you can make contributions to your own IPP.
To draw a T-4 salary from your business, it must be incorporated. A sole proprietor is not able to set up an IPP.
Contributing to an IPP will help to boost your retirement savings while also reducing your company’s income tax burden.
Who Assumes the Risk of an IPP?
As I mentioned above, an IPP is a type of defined benefit pension. This means that the employer is assuming the investment risk, not the employee.
In other words, it’s the company’s responsibility to ensure the pension plan is sufficient to meet the income needs of the employee throughout their retirement, based on a set of predetermined conditions, which we’ll explore a bit later.
In fact, upon establishing an IPP, the company must ensure that an actuary has reviewed the pension plan, and certified that the contribution calculation of the plan meets legal requirements.
There are several rules by which an IPP is governed, but before we examine them further, let’s take a closer look at defined benefit pension plans.
What is a Defined Benefit Pension Plan?
A defined benefit pension is a plan which is paid out based on a formula related to age and years of service.
This means that an employee is able to determine precisely what their retirement income, or benefit, will be, based on the age at which they retire, as well as their number of years of employment with the company.
Unfortunately, this type of pension is quickly becoming extinct in many corporations that now favor a defined contribution plan (similar to an RRSP). With this type of plan, the payout at retirement is dependent on the performance of the underlying investment.
Why are Employers Moving Away from Defined Benefit Plans?
While employees love the retirement income security provided by a defined benefit plan, they’re far more expensive for employers to maintain.
That’s because, with a defined benefits plan, the employer must ensure that the plan remains adequately funded for the duration of an employee’s retirement, regardless of how well the markets perform.
This creates a long-term liability for the company and may require them to periodically bolster plan assets by injecting vast sums of cash directly from corporate earnings.
Such an enormous financial commitment can have an adverse impact on profits, in an environment where companies need any competitive edge they can get.
How can an IPP Help Entrepreneurs?
Individual Pension Plans (IPPs), make it possible for entrepreneurs to receive the many benefits of a defined plan that I’ve described above. But there are a number of criteria you must meet to qualify.
Let’s take a closer look.
IPP ADVANTAGES
• Annual contribution ceiling higher than an RRSP
Allows you to accumulate more savings than an RRSP, thus increasing your retirement income.
• Tax-deductible company contributions
Contributions to your plan are made by your company. Therefore regular or special contributions and the costs of
setting up and monitoring the plan are fully tax deductible.
• Tax-sheltered returns
Your investment returns are also tax sheltered, allowing you to boost your retirement savings. Since the plan is for you
alone, all funds belong to you.
• Elect to purchase past service (to increase contributions and retirement income)
You can make up for the years of service when you may not have contributed enough for your retirement. Electing
to purchase past service allows you to inject additional funds into your plan today. This provision, which is available
as soon as your IPP is instituted, greatly benefits those who wish to take early retirement or top up their pension plan.
• Annuity upgrade possible upon retirement
When it is time for you to retire, your company can substantially upgrade your plan with additional tax-deductible
contributions.
• 7.5% return
If the investments return is under 7.5%, the company may cover the shortfall. This special contribution is deductible
for the company and non-taxable to you.
IN SHORT
The IPP is suitable for:
• Company owners who pay themselves an adequate salary and who have long periods
of service working for the company
• Profitable companies that pay too much income tax
• Company owners who have not been making systematic RRSP contributions
The IPP may also be the right solution for:
• Making up for a significantly underperforming RRSP
• Making up for a temporarily underperforming RRSP
Using An IPP
As I mentioned previously if you own a company and receive T4 income from that company, an IPP can give you the benefit of a defined pension plan, where your payout is based on your years of service and your age.
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