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.
This document has been prepared for use by the RBC Wealth Management member companies, RBC Dominion Securities Inc.*, RBC Phillips, Hager & North Investment Counsel Inc., RBC Global Asset Management Inc., Royal Trust Corporation of Canada and The Royal Trust Company (collectively, the “Companies”) and their affiliate, Royal Mutual Funds Inc. (RMFI). *Member – Canada Investor Protection Fund. Each of the Companies, RMFI and Royal Bank of Canada are separate corporate entities which are affiliates. “RBC advisor” refers to Private Bankers who are employees of Royal Bank of Canada and licenced representatives of RMFI, Investment Counsellors who are employees of RBC Phillips, Hager & North Investment Counsel Inc. and the private client division of RBC Global Asset Management Inc., Senior Trust Advisors and Trust Officers who are employees of The Royal Trust Company or Royal Trust Corporation of Canada, or Investment Advisors who are employees of RBC Dominion Securities Inc. In Quebec, financial planning services are provided by RMFI which is licenced as a financial services firm in that province. In the rest of Canada, financial planning services are available through RMFI, Royal Trust Corporation of Canada, The Royal Trust Company, or RBC Dominion Securities Inc. Estate and trust services are provided by Royal Trust Corporation of Canada and The Royal Trust Company. If specific products or services are not offered by one of the Companies, clients may request a referral to another RBC partner. The strategies, advice and technical content in this publication are provided for the general guidance and benefit of our clients, based on information believed to be accurate and complete, but neither the Companies, RMFI, nor Royal Bank of Canada, nor any of its affiliates nor any other person can guarantee accuracy or completeness. This publication is not intended as nor does it constitute tax or legal advice. Readers should consult a qualified legal, tax or other professional advisor when planning to implement a strategy. This will ensure that their individual circumstances have been considered properly and that action is taken on the latest available information. Interest rates, market conditions, tax rules, and other investment factors are subject to change. This information is not investment advice and should only be used in conjunction with a discussion with your RBC advisor. None of the Companies, RMFI, Royal Bank of Canada nor any of its affiliates nor any other person accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. In certain branch locations, one or more of the Companies may carry on business from premises shared with other Royal Bank of Canada affiliates. Notwithstanding this fact, each of the Companies is a separate business and personal information and confidential information relating to client accounts can only be disclosed to other RBC affiliates if required to service your needs, by law or with your consent. Under the RBC Code of Conduct, RBC Privacy Principles and RBC Conflict of Interest Policy confidential information may not be shared between RBC affiliates without a valid reason.
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