When it’s time to save for retirement, most wage-earners turn to registered retirement savings plans (RRSP) and tax-free savings accounts (TFSA). For a business owner, however, the choice is more complicated.  

In fact, the composition of a business owner’s income, usually consisting of a salary plus dividends (which don’t create RRSP contribution room), can make it hard to maximize RRSP contributions. As well, entrepreneurs would often prefer to keep their assets in the business to make it easier to reinvest them in new projects. The result: their retirement savings are not always set up in a formal way, and given the recent changes in legislation this can leave them exposed to an increasing tax bill. 

And that’s where the individual pension plan (IPP) comes in. 

What is an individual pension plan? 

In simple terms, an IPP is “a pension fund for yourself.” It shares many features of the registered pension plans set up by large corporations for their employees, the difference being that it is designed specifically for the business owner (and key employees). In an IPP, all the contributions are made by the company, and while they are tax deductible for the company, they aren’t considered to be taxable income for the individual. An IPP is also a defined benefit plan: this means that the retirement income is predetermined and guaranteed for life. This income is based on actuarial return projections, just as for any registered pension plan. Finally, note that assets held in an IPP are protected from creditors, which may not be the case for an RRSP. 

The following table summarizes the main differences between an IPP and an RRSP. 

Advantages in terms of capital accumulation 

For an entrepreneur, the IPP offers advantages in two main ways. The first involves capital accumulation. 

In fact, the annual contribution limits for an IPP are higher than RRSP limits, and they are based on the individual’s age. For someone over sixty, for instance, the advantage could be in the area of $20,000. This means that an IPP may be useful as part of a catch-up strategy after years of under-contributing. Note that the exact contribution room is determined by a number of factors, including years of service and annual income. It is also possible to make catch-up contributions for years of service before the plan was opened. 

Another advantage is that, in an IPP, the investment risk is entirely assumed by the company, not by the individual. In the event that the markets underperform the actuarial projections, it is the company that will fund the plan with additional contributions, which will also be tax deductible. 

Tax advantages  

Because contribution limits are higher than for an RRSP, the maximum contribution to an IPP will also give rise to a higher income tax deduction. As well, the plan set-up and management fees are generally deductible. But the IPP’s most significant tax benefits might be found elsewhere.  

In fact, in recent years, two important legislative changes have had an impact on business owners who would like to keep their investments within their companies. 

The first is the treatment of business investment income, known as “passive income”. Above $50,000 of passive income per year, the company gradually loses its eligibility for the small business deduction, which provides a very advantageous tax rate for income below $500,000. As it turns out, amounts invested in an IPP are not included in the passive income calculation. And remember, on top of that, IPP contributions are tax deductible for the company. 

The second legislative change that disadvantages the business owner is the increase in the capital gains inclusion rate for taxable income, which has risen from 50% to 66.6%. All capital gains realized by a company are therefore subject to more tax than in the past. However, if the gains are realized inside an IPP, this measure will not apply to them, and they will only be included in taxable income when withdrawn. 

Who is it for? 

Given its complexity and cost, an IPP would generally be relevant for business owners, incorporated professionals, senior executives and key employees who are over 40, or even 50, years of age, with a relatively high annual salary (usually above $100,000). As well, since the invested funds are locked in until retirement, an entrepreneur should be at a career stage where this kind of constraint is acceptable. 

As well, be aware that there is a “flexible” variant: the executive pension plan (EPP), which can be considered earlier in one’s career. The EPP is a combined pension plan that includes a defined benefit component, a defined contribution component and an additional voluntary contribution component. The latter two are deployed first. At a later age, the assets can be transferred into the defined benefit component.  

Once again, the IPP is more advantageous than an RRSP, but also more complex and costly. To gain some insight into this tool and potentially set one up for yourself or your key employees, your advisor is always your best starting point.