After years of plowing earnings back into their companies, many entrepreneurs find themselves sailing toward retirement with too little tucked away in RRSPs and other retirement-planning vehicles.
If that scenario sounds familiar, take heart — setting up an individual pension plan (IPP) or retirement compensation arrangement (RCA) could be the answer. These specialized retirement vehicles, which are set up through your company, accelerate savings, allowing entrepreneurs to catch up on reprobate retirement plans. Choosing which one is right for you depends on your age, circumstances, how much money you want to retire on and when you want access to it.
An IPP is a type of registered defined-benefit pension plan that offers more tax relief and greater payouts than RRSPs. Because of the cost and contribution restrictions associated with IPPs, they work best if you’re in your mid-40s or older with an annual T4 income greater than $120,000. (Prior to age 40, most people’s needs can be served by an RRSP.) Contributions are tax-free for you, tax-deductible for your company and largely creditor-proof. And, contribution limits are generally far greater than that of RRSPs; the precise amount depends on your age, and can be used to fund years of past service back to 1991. “They’re like RRSPs on steroids,” says Mike Himmelman, a certified financial planner with Halifax-based Citadel Securities Inc.
The catch? As a registered defined-benefit plan, your IPP must be evaluated every three years by an actuary to ensure contributions to it are sufficient to meet the IPP’s prescribed benefits, says Cynthia Kett, CA, CFP and principal at Toronto-based Stewart & KettFinancial Advisors Inc. Initial set-up costs about $5,000, and you’ll pay management fees of about 1%. Your firm must not only make annual contributions to the plan, but must also ensure it compounds at a rate prescribed by the Income Tax Act (currently 7.5%). If the investments within your plan perform poorly, your firm must cover the shortfall. If a surplus is generated, your firm must reduce its contributions accordingly. What’s more, you can’t touch the funds until you are of retirement age, which varies provincially. Finally, because IPPs are set up with defined benefit limits, they may not pay out enough to cover your desired retirement lifestyle.
That’s where RCAs come in. More flexible than IPPs, these savings vehicles are often designed to complement pension plans that have regulated contribution limits. RCAs are essentially retirement trust funds set up by the company for owners or key employees. Like an IPP, contributions are tax-deductible and offer creditor protection. RCAs can be set up at any time and there are no predetermined upper or lower limits on contributions. Just be sure the RCA doesn’t swell to levels disproportionate to your earnings history, or you run the risk of problems associated with having your RCA classified as a salary deferral arrangement.
One RCA drawback: Half the money you invest, plus 50% of your investment earnings, must go into a non-interest-bearing refundable tax account with the Canada Revenue Agency, which doesn’t appreciate. What’s more, establishing an RCA is relatively pricey; set-up fees run about $3,000, with annual compliance fees of about $1,500, as well as additional costs for triennial actuarial variations.
But for younger entrepreneurs, the drawbacks may be worth it. While you can collapse an RCA only if you retire, leave the company or change the services you provide (the money then is taxable), banks will allow your firm to borrow up to 90% of the value of your RCA..