If you own a business and are impacted by the tax rules for passive investment or splitting income, you’ll want to ensure they have effective planning in place. An Individual Pension Plan (IPP) should be on of the options you consider. Your spouse and children could participate if they are employed and paid by the corporation as they would be considered connected individuals (a person is connected if they own or are a spouse, child, parent, or sibling of someone who owns 10% or more of the shares of the company)
An IPP helps lower the passive investment income a business needs to recognize for tax purposes, protecting access to favourable tax rates under the small business deduction. The benefits of the small business deduction start getting clawed back when passive income in a business exceeds $50,000 and is fully eliminated when it exceeds $150,000. Income earned by an IPP is excluded from the passive income calculation while all expenses associate with the operation of the IPP are tax-deductible to the corporation.
IPPs provide potential tax savings under pension splitting rules (starting as early as age 55), creditor protection, predictable retirement income and accelerated retirement savings (starting at age 39). IPP funding is age sensitive, reaching about 29% of pensionable earnings by age 64, versus 18% for RRSPs. This creates opportunity for increased growth of tax deferred savings.
Where a spouse or child receive a salary working for the corporation, the spouse or child can be added to an IPP. Employment income from the company sponsoring the Individual Pension Plan is a key to participating in an IPP because it’s required to calculate the pension accrual. Dividends don’t qualify for pensionable earnings. Salary can go as far back as 1991 and can extend up to year-end when a plan member reaches age 71.
An actuary must set up and explain the plan to ensure it complies with federal and provincial rules (where applicable). Contributions to an IPP include three components:
- Past service based upon age, T4 earnings, and the number of years employed by the plan sponsor.
- Partial settlement of past service with actuarial calculation of RRSP transfer with balance spread over 1-15 years
- Current service commitment each year based upon T4 earnings
To setup and administer a plan in Ontario it generally costs between $1,700 and $2,500 per year depending upon the service provider selected. All administration, borrowing costs (if any) and investment management fees related to the operation of an IPP are tax-deductible to the corporation.
The following client example uses a medical corporation to demonstrate IPP funding.
Medical Professional Firm Example
(Adapted from May 2019 Advisors Edge Article by Michelle Schriver)
Consider Dr. Paul Evans and his spouse Sarah, ages 50 and 47 (not real people). They’ve decided to implement an IPP in response to CRA’s passive and split income tax rules to fund their retirement.
They both have income beginning in 2005 from the medical corporation where they work. Paul’s earnings history allows him to accrue the maximum pension possible from 2005 onward calculated using indexed average wages. The accrued pension liability for Paul’s 14 years of earned income as January 1, 2019, would have been $464,440.
Sarah’s earnings are less, at $30,000 annually as an office manager, with accrued liability of $102,818. Total accrued liability for both Paul and Sarah is set out on Table 1 and totals $567,257.
Paul has maximized his RRSP since 2005, resulting in a qualifying transfer of $364,821 from the RRSP to fund the IPP, leaving a remaining funding liability of $99,619. Because that remaining liability isn’t in the plan on Jan. 1, the CRA allows an interest adjustment on the amount. Assuming mid-year funding, the adjustment is $17,416. If the IPP were implemented in the latter part of 2019, the adjustment would be larger.
As shown in Table 1, the corporation’s maximum IPP contributions for 2019 are $151,454 for Paul and $53,924 for Sarah. The minimum contribution for 2019 would be $44,904 and $11,042. This includes the current service, which is the annual contribution that must be funded in the year, as well as a “going concern special payment,” which is funding for past service. This payment can occur over 15 years.
Table 1: Medical corporation’s potential IPP contribution for 2019
|Maximum IPP contribution for 2019||Incorporated doctor (Paul)||Spouse (Sarah)||Total|
|Accrued liability Jan. 1, 2019||$464,440||$102,818||$567,257|
|Less: transfer from RRSP||($364,821)||($59,200)||($424,021)|
|Unfunded liability Jan. 1, 2019||$99,619||$43,618||$143,237|
|2019 current service funding||$34,418||$6,451||$40,869|
|Minimum IPP contribution for 2019|
|Going concern special payment (funding of 2005-2018 liability over 15 years)||$10,486||$4,591||$15,078|
Source: Individual Pension Plans—A Technical Guide with updated figures for 2019
Table 2 summarized the amount of funds set aside in the IPP after the initial transfer If the corporation chooses maximum funding in year one. A total of $516,274 will have been transferred to the IPP to fund Paul’s pension, as shown in Table 2. If the IPP is kept in place until age 65 Paul and Sarah, they will have a projected pension of approximately $88,000 and $19,000 (in current dollars). The pension payout can continue to grow until age 71 when pension payments must start.
Current service contribution for Paul is about 23% of wages; for Sarah about 22% (versus 18% of earned income for an RRSP). Those percentages will go up as they reach age 64.
Table 2: IPP total assets
|IPP contribution||Doctor (Paul)||Spouse (Sarah)||Doctor + spouse|
|Corporation’s maximum contribution for 2019||$151,454||$53,924||$205,378|
Source: Individual Pension Plans—A Technical with updated figures for 2019
Other considerations for business owners
IPPs work best if the corporation or holding company continues to maintain the IPP and pension payout. If the corporation is sold and a holding company is not on place before the sale, the plan would be wound up and transferred to a life annuity, RRSP or locked in registered account if the connected person holding the IPP is over the age of 71 (subject to maximum transfer value rules).