An Individual Pension Plan is a type of defined benefit pension plan that many successful entrepreneurs may want to consider for their retirement as an alternative to RRSPs. The reason that RRSPs can be a insufficient on their own is that the allowable contributions are limited to 18% of your income, up to a maximum of $23,820 in 2013 and $24,270 in 2014.
For many entrepreneurs, this is insufficient. Using an IPP can allow you to boost your tax-deferred retirement plan contributions, and help you save for a more secure retirement.
What is a Defined Benefit Pension Plan?
An IPP is a defined benefit pension plan. A defined benefit pension plan is paid out based on a formula related to age and years of service. This form of pension is quickly becoming extinct in many corporations that now favour a defined contribution benefit (like the RRSP) where the payout is dependent on how the underlying investments do.
If you own a company, and receive T4 income from that company, an IPP can give you the benefit of a define pension plan, where your payout is based on your years of service and your age.
Using an IPP
An IPP allows a business owner to set up a defined benefit pension plan for themselves. In this arrangement, your company pays the majority of the contribution to the plan. The amount that can be contributed depends on the income, years of service and age of the person. Years of service can go as far back as 1991, and for those that do, the first year contribution could be over $400,000!
Since this pension plan involves $100,000 or more in annual contributions, it’s obviously for well-off businesses that have some money to spare. The amount paid by the company is, however, reduced, as its contribution is a tax-deductible expense. Some of the rules for setting up an IPP include:
- The sponsor must be an incorporated and active company; no holding companies.
- You must, as the plan member, be considered an “employee” earning T4 or T4PS income from the corporation.
- Documents related to the pension plan provide a formula for the amount of benefit earned by the member.
- There must be strict guidelines for plan investments.
- Business contributions to the IPP must be certified by an actuary in order to by deductible from corporate income.
Remember that the money in an IPP grows tax-deferred. This means that when you receive distributions from the plan during retirement, you will have to pay taxes on the money, and pay according to your current situation.
Plan members must be residents of Canada when the plan is set up, and pay income taxes in Canada. While you can move outside of Canada later, and receive distributions even if you live outside Canada (you'll still have to pay Canadian taxes on them), when the plan is set up, you have to reside in Canada.
An IPP can be an excellent way for an entrepreneur or professional to “catch up” contributions. Many business people don't have a lot of spare cash in the early years of their business to contribute to an RRSP, so the IPP can be a good way for them to quickly fund their retirement plan now that they have found business success.
There are also other considerations with an IPP that need to be fully understood before you set up this plan. If you think an Individual Pension Plan might fit your own financial situation, be aware that this is a complex arrangement and you need to talk with a financial planner that is very experienced with benefit plans.