Navigating the Passive Income Rules: IPPs for RetirementChristopher Briggs, RRC®, Wealth Advisor
With changes to passive income rules now in effect for small business, owners may be looking for ways to invest income earned in their corporation. Contributing funds to an Individual Pension Plan (IPP) may help to increase retirement savings on a tax-deferred basis outside of the corporation.
What is an IPP?
An IPP is a defined-benefit pension plan that is registered with the Canada Revenue Agency (CRA). While the IPP has been around since 1991, there has been renewed interest in the plan as business owners look to direct money away from their corporation’s accounts.
An IPP behaves similarly to a Registered Retirement Savings Plan (RRSP) in that contributions are made to the plan and can grow on a tax-deferred basis for retirement. Eligible contributions are determined based on a maximum funding valuation prepared by an actuary. Eligible contributions are necessary for the plan to have sufficient assets to pay for benefits under the provisions of the plan. As such, contribution limits typically increase with years of service. For individuals over the age of 40, the IPP contribution limit may end up being greater than that of an RRSP, which has the potential to increase retirement savings.
Advantages of an IPP
In addition to potentially higher contribution limits, the IPP may guarantee a certain level of retirement income for the account holder, since it acts as a defined benefit pension plan. This is because the annual returns of the IPP are prescribed at a specific rate. The current rate of return is 7.5 percent, as determined under the Income Tax Act.
This is unlike the RRSP which depends on market performance. If annual returns generated by investments held in the IPP do not meet this level, additional tax-deductible funding can be made by the corporation to ensure that the benefits will be paid. This is mandatory in some provinces. In good years—when performance exceeds the prescribed rate—the corporation can take a contribution holiday.
In certain provinces, funds held within the IPP may be protected from creditors. As well, payments from the IPP may be eligible pension amounts for income-splitting with a spouse in the recipient and spouse’s personal tax returns.
There are a variety of costs associated with the IPP, including set up and maintenance, as well as annual government filings and actuarial reports that are required every few years. However, unlike the costs associated with managing an RRSP, these costs, as well as the annual investment management fees, may be deductible to the corporation.
Seek Professional Advice
An IPP may provide an opportunity for incorporated business owners to improve retirement savings, while also helping the corporation to navigate the recent changes in passive income rules. However, this is not a simple tax-planning exercise. Should you have an interest, please get in touch to discuss how an IPP may benefit your particular situation.