By Sean Wilson
Certified Financial Planner and Portfolio manager with Moraine Wealth Advisory in Calgary
Accumulating long-term wealth, especially for retirement, can pose challenges for incorporated professionals and business owners. Due to the absence of employer-sponsored pension plans, their primary choice for retirement savings is often an RRSP. However, a superior alternative exists for those aged 40 and above. For instance, if you’re 45 and anticipate earning at least $171,000 in 2023, creating an RRSP contribution room of $30,780, an Individual Pension Plan (IPP) would allow a contribution of $36,400—18% more, providing a $5,620 advantage. This advantage amplifies as the IPP contribution room expands with age. A 60-year-old earning the same amount could contribute $48,200, signifying a 57% increase over an RRSP.
The IPP, or Individual Pension Plan, presents incorporated professionals and business owners with the opportunity to shelter more income tax-efficiently than an RRSP, potentially generating a substantial six-figure annual retirement income. Moreover, IPPs offer various benefits including creditor protection, reduction in corporate taxes through tax-deductible contributions, and deductible investment management fees for the corporation.
A striking feature of IPPs is their capacity to steadily increase contribution room over time due to pension regulations governing funding obligations. This term, ‘obligation,’ can be misleading. IPP regulations stipulate that the pension and its investments must grow at an annual rate of 7.5%. Failure to meet this growth compels plan sponsors (typically the incorporated professional or business owner) to make up the difference with additional contributions. Surprisingly, these rules are advantageous, particularly for incorporated professionals and business owners who’ve recently established personal corporations or businesses and may lack available cash flow for IPP contributions initially. With each year that lacks a contribution, IPP contribution room escalates—far more notably than through an RRSP approach. This is due to the 7.5% annual liability that augments the available IPP contribution room. This liability accumulation permits plan members to eventually contribute significant corporate earnings to the IPP. This is especially beneficial for high-income professionals and business owners whose future earnings could surpass $500,000 annually.
Consider a specialist who starts an IPP at age 40. Instead of contributing in the initial years, she could use surplus cash flows to address immediate financial goals while allowing the IPP contribution room to expand. This expansion far exceeds what an RRSP could offer. Over a 30-year career, an IPP could yield over $900,000 in additional contribution room compared to an RRSP. Consequently, individuals earning between $275,000 and $500,000 annually could amass approximately $2 million more in retirement assets through an IPP, thanks to the mandated 7.5% growth rate. This advantage is especially pronounced in later career stages, aiding in reducing taxes on high corporate earnings.
Crucial to growth is the ability to accumulate the 7.5% liability in years of non-contribution, even during market downturns. For instance, if the portfolio declines by 2%, the annual IPP liability increases to 9.5%. Some IPP strategies involve investing in low-risk securities with returns under 7.5%, further enhancing contribution room.
IPPs also offer tax efficiency following recent Canada Revenue Agency (CRA) rule changes. Passive income exceeding $50,000 annually from investments in a corporation triggers a clawback of the small business deduction. With the likelihood of investable assets exceeding $1 million, IPPs offer an avenue to invest additional corporate earnings tax-efficiently, bypassing the clawback.
Estate planning advantages accompany IPPs, allowing flexibility in passing assets to beneficiaries. IPPs can roll over to spouses, providing guaranteed benefits until their passing. If you have adult children who will be taking over the family business, if the adult children also have an IPP set up the residual value of the parent’s pension can be transferred to the adult child tax free. Additionally, professionals nearing retirement can terminal fund their pension, optimizing tax efficiencies. Notably, IPP plan sponsors aren’t obligated to fully fund accrued liabilities due to being the sole plan members.
For these reasons and more, the IPPs capacity to accumulate annual liability stands as its most significant advantage for incorporated professionals and business owners. In essence, IPPs enable individuals to contribute substantially more income towards retirement compared to RRSPs.
To learn more about how an IPP can benefit you, feel free to contact Moraine Wealth Advisory for a complimentary consultation.