A family-owned business often represents more than half the value of the owner’s estate. Consequently, if much of your net worth is tied up in the business, you may not be as well-diversified as those who have a more traditional retirement portfolio. Remember that unlike a salaried employee, it’s up to you to fund your own retirement. Do you have a strategy? Are you relying on being able to sell your business for a sum that will enable you to enjoy a financially secure retirement? If you haven’t given further thought to that “far-off” day, it may be time to consider some other options for building your retirement nest egg.
Prashant Patel, VP, High Net Worth Planning Services, RBC Wealth Management Services, says many owners overestimate the value of their business. “You have to prepare for the worst,” he says. “It may take longer to sell or to transfer the business to management or family, and being over-weighted in reliance on the business for future retirement income is equivalent to someone betting their entire retirement on one stock,” Patel says.
Holding some of your retirement savings outside of the business can reduce your risk. If you withdraw proﬁts, this may protect them from future business losses. By paying yourself a salary, in addition to or instead of taking dividends, you can create an opportunity to beneﬁt from generating Registered Retirement Savings Plan (RRSP) contribution room or Individual Pension Plan (IPP) pensionable service.
IPPs have been available for many years; however, for quite some time, they were not commonly used in practice due to high administration costs and low pension limits. Now, IPPs are offered at a much lower cost and the government has increased the limits for tax-sheltered pensions. Additionally, with recent tax changes related to the clawback of the Small Business Deduction for high passive investment income in a corporation, an IPP can help to minimize this clawback since income earned in an IPP grows tax-deferred. The combination of these factors has sparked renewed interest in IPPs.
The Individual Pension Plan is designed to reduce uncertainty about your future income by paying you a steady stream of income upon retirement.
An IPP is a registered pension plan, similar to those offered by large organizations to their employees. However, an IPP usually only has one individual member — either the business owner or a key employee. It can also be extended to your spouse, if he or she is employed by the same company.
Although there is no minimum age or income level to set up an IPP, typically those earning a T4 salary of more than about $148,000 in 2018 (updated annually based upon new limits on certain factors set by the government and used in the formula to calculate this limit) and age 40 or older tend to reap the most beneﬁt from this retirement saving option.
Your business or employer makes annual contributions to the IPP over time and receives a tax deduction. The corporation’s IPP contributions replace your contributions to an RRSP. Similar to an RRSP, contributions grow in the IPP on a tax-deferred basis. Since an IPP is designed to give you a deﬁned amount of income at retirement, the older you are, the more money the company can contribute to the plan on your behalf.
Contributions will also vary depending on your past earnings and length of service with the company. The plan is designed to reduce uncertainty about your future income by paying you a steady stream of income upon retirement.
In addition to annual contributions, your business can potentially make a large contribution when the plan is initially set up to cover your previous years of service prior to the IPP being established, going back as far as 1991. Additional tax-deductible contributions may also be made to the IPP to make up for investment returns in the plan that are less than the 7.5 percent expected actuarial interest rate with inflation adjustments (in some provinces this is a requirement).
RRSP assets are generally only protected from creditors in the case of personal bankruptcy. That means that for the vast majority of business owners and incorporated professionals, RRSP assets remain at risk. Because it is a trusteed arrangement and a pension, an IPP may afford substantial protection from creditors. It is essential that you speak to a qualiﬁed legal advisor regarding any asset protection options available to you.
As the IPP is a registered pension plan, the funds in the plan are locked in both during your working years and in retirement under provincial legislation (with exceptions in certain provinces). This means there is less ﬂexibility compared to an RRSP when it comes to withdrawals from the IPP.
You can receive income payments directly from an IPP, or transfer some of the IPP’s funds, within legislated limits, to a locked-in plan. Some provinces allow additional pension income flexibility by unlocking the funds in special circumstances.
IPPs come with higher administrative costs compared to an RRSP. There are set-up costs, annual administration fees and mandatory actuarial valuations. These costs, however, are tax-deductible to your business, reducing the effective cost.
Note: The information provided is a selection of potential options to consider. As part of overall planning, it is important to speak with your qualified tax and legal advisors to determine whether these, or other, strategies may be suitable and to ensure your personal circumstances and goals are appropriately accounted for.
There are many intricacies to IPPs, so it is imperative to understand all of the details. Ultimately, for the right person, IPPs can offer signiﬁcant advantages — creditor-protecting assets today and greater retirement income in the future.