By: Steven J. Albiani, B.Comm (Hons.), CFP
As discussed in the second article on the benefits of incorporation for business owners and their families, individual pension plans (IPP) can offer many benefits when planning for financial independence. Traditionally, most individuals make their contributions to Registered Retirement Savings Plans (RRSP) in order to save for the future but equally important to reduce their current taxes owing and defer that payment until down the road. As incorporated business owners, an alternative to this is to hold those retirement assets in your corporation and to receive a larger tax deduction on the first layer of tax inside the business. Outlined below are the additional benefits to using an IPP as opposed to an RRSP.
During working years
Capitalization of Past Years of Service
Past Years of Service (PYS) represents the time that the business owner has been working for the corporation prior to the IPP being implemented. Canada Revenue Agency (CRA) allows PYS after 1991 to be accounted for in the calculation of what is owed to the plan on behalf of the owner. Often times, this amount is substantial ($100,000+) and represents a large corporate deduction against taxes owing for the current period.
Larger Annual Deposit Limits
Moving forward CRA has increased the annual deposit limits on RRSP contributions. Currently in 2007, individuals saving money in their plans can deposit up to $19,000. In the situation where an IPP is used, an actuarial calculation is done to determine this annual deposit amount. When an owner meets certain criteria, this amount can represent an amount $3,000-5000 higher than the annual RRSP limit every year moving forward. The increase deposit limit along with the increased tax deduction provides larger retirement benefit and business value into the future.
Tax Deductibility of Investment Costs
In any type of investment whether it a non-registered account, RRSP, or IPP there are costs to be incurred. These costs can come in the form of plan set up, maintenance, investment management fees, etc. In contract to RRSP accounts where none of these costs are deductible to the individual, an IPP has the corporation pay these costs on behalf of the owner as well as receive a full deduction for all amount paid. This is possible due to the fact that an IPP is considered a defined contribution plan in the eyes of CRA. When calculating this cost savings on an annual compound basis, these amounts can represent and significant value in the future.
Maximum Creditor Protection
A potential issue individual's face is liability in the event they were ever sued or faced personal bankruptcy. When this occurs and there is a successful claim by a creditor, any funds held as an RRSP can be ceased in order to pay the claim. In contrast, funds held within an IPP do not attract the potential of being ceased and are fully creditor proofed should such a situation occur. One major exception to the rule is if the owner holds segregated funds within the RRSP account which stand alone as creditor protected securities.
At Financial Independence
Terminal Funding
It is possible to modify the IPP provisions at retirement to maximize the benefits with indexation of the annuity, early retirement without reduction and bridging benefit. These changes result in an extra contribution, which is also tax-deductible for the company and tax deferred until the owner withdrawals the funds in the future.
In case of the Sale of the Company
If the shareholders' equity inside the corporation is very high, it may be difficult to sell the business. Transferring amounts to an IPP reduces shareholders' equity and thus makes the business more saleable to potential purchasers.
Assets Owned by the Employee
Upon retirement and in case of plan and employment termination, the surplus can belong to the participant and it is not taxable as long as it is not withdrawn. Upon retirement, the surplus can provide additional income to the participant.
Freedom of Choice of Withdrawals
The IPP provides the participant with three different options upon retirement:
- Discontinue the IPP and use the funds to purchase a life annuity
- Maintain the IPP to self-annuitize (i.e. payments made from the plan)
- Roll the funds into a locked-in life income fund (LIF) or a non locked-in registered retirement income fund (RRIF), depending on the applicable legislation.
A Snapshot of Registered Retirement Savings Plans vs. Individual Pension Plans
