If you’re like many entrepreneurs, you’ve neglected your retirement savings too long and your RRSP contribution limit is pathetic to boot. Fear not, because an individual pension plan can do a lot to solve your problems.
IPPs are a special type of pension plan conceived by the Canada Revenue Agency in 1991 with business owners in mind. Funded by your company, IPPs dodge two tax bullets at once: contributions are a tax-free to you and a tax-deductible expense for your company. Investments held in the plan grow and compound tax-free; tax is payable only on the amounts you withdraw in retirement. When the golden years come, you can take up to $70,000 a year out of the plan — twice the limit of RRSPs. IPPs are even creditor proof. Wow.
How much can your company contribute? Annual limits are a function of several variables, including your age, length of service to your company and past salary. But let’s say you’re 55 and have paid yourself an annual salary of $100,000 since 1991. If your firm had set up an IPP for you last year, it could have made a first-time contribution equal to the sum of your annual RRSP contribution limits dating back to 1991, namely, $114,743. This year, $24,122 could go into your IPP, with annual contribution limits rising by 7.5% per year till you’re 65. By then, you’d have accumulated a pension valued at $632,384, at a compound annual growth rate of 7.5%. IPPs leave RRSPs in the dust.
Because IPPs are a class of defined-benefit plan, the CRA requires them to grow by 7.5% a year (a number set arbitrarily by the taxman). If your plan depreciates, your company is obligated to make up the difference. If your plan grows by more than 7.5%, the contribution limit drops in the next year. In fact, it can drop as low as zero for several years. Think of it this way: the growth of your plan is expected to follow a predetermined curve.
The catch: Yes, your company is on the hook when growth stalls. But David Williams of Williams Wealth Management Inc. in Toronto, one of Canada’s few IPP specialists, says it’s not as bad as it sounds. “The wonderful thing about IPPs,” he explains, “is that the company can borrow the funds and the interest payments are tax-deductible.” Another catch: only key executives aged 50 or more who earn annual salaries (i.e., T4 income) of more than $86,111 automatically qualify for an IPP. Also, the money in an IPP is inaccessible till you turn 55, which is difficult for some cash-starved entrepreneurs to accept. (Note: should some calamity such as critical illness or disability strike, you can collapse your plan without penalty.) Finally, only active corporations (e.g., no holding companies, no sole proprietors) can institute IPPs.
Turbo tip: You can increase the initial contribution limit by applying all of your unused RRSP contribution room dating back to the incorporation of your firm. You can also carry over any missed contributions and forgone investment income since your plan’s inception. Before long, the zeroes in your retirement account start looking a lot better.
© 2004 Caroline Cakebread