Retirement Planning for Small Business Owners
Ask a small business owner what their business plans are for the next two to five years and they will be able to articulate their projected growth in sales, and new markets they are hoping to expand into, etc. The response is often different if you ask about their retirement plans.
One of the best ways to start a retirement plan is to make regular RRSP contributions that allow your retirement savings to grow in a tax-sheltered environment.
Many small business owners choose to receive their remuneration in the form of dividends because of the lower tax rate on dividends, but we caution that you shouldn't forego a salary in favour of dividends just for the tax savings; instead, determine the optimal salary/dividend mix that will minimize both corporate and personal income tax, and maximize RRSP and CPP/QPP contributions.
An Individual Pension Plan (IPP) is an attractive alternative to an RRSP for owner-managers 40 years of age or older. An IPP is a defined benefit pension plan for owner-managers and their spouses. The corporation makes tax-deductible contributions to the IPP based on actuarial valuations and, in return, the member receives a guaranteed lifetime pension at retirement.
An IPP is not inexpensive to set up and maintain; however, it allows a small business owner to make larger contributions than through an RRSP and thus increase retirement assets. As well, the assets within the IPP are creditor proof. While it's not unusual to expect income from the future sale of a business, small business owners must consider the potential for fluctuations in value over time. What is considered a growth industry today might not be so in 20 years.
You've worked too hard to leave your financial future to chance. Make your retirement plan a top priority. Talk to us about developing your plan!
An Individual Pension Plan (IPP) is a pension plan established for a single individual who is interested in maximizing his or her tax-assisted retirement savings.
An IPP may allow a small business owner, owner-manager or senior executive to benefit from the retirement savings and tax deferral advantages of a registered pension plan. A typical IPP provides what is called a defined benefit; the amount of pension is determined at retirement by reference to a formula. This is different from an RRSP or a defined contribution pension plan, where only the account balance itself is available to provide benefits at retirement.
Pension plans registered under the Income Tax Act permit the deferral of taxation on employee compensation. Employer contributions are tax deductible, and are not subject to employee withholding taxes. Employee contributions are also tax deductible. Investment earnings on these contributions grow tax-free until they are used to pay benefits under the plan.
While flexible in terms of its settlement options, the basic purpose of an IPP is to provide a retirement pension to the plan participant. In the right circumstances, an IPP permits much larger tax deductible contributions than an RRSP. An IPP also usually offers the plan member a greater degree of creditor protection than an RRSP. With an IPP, a member will no longer be able to contribute to an RRSP in future years.
- An IPP is a registered defined benefit pension plan typically established for the benefit of a single participant. A defined benefit pension plan is designed to provide a lifetime pension starting at a certain age. The amount of the pension is determined by formula, and the contribution equals the cost of providing that pension (as calculated by an actuary).
- If the same or a related company employs the spouse, the spouse may be added to the IPP.
- Suitable candidates for an IPP are: small business owners, professionals (e.g. doctors, lawyers, dentists, and accountants) in provinces where they are allowed to incorporate, and executives with the support of their company’s management.
- To qualify, the IPP plan member must be an employee receiving T4 income, and be serious about planning for retirement. The company sponsor must have the financial resources to fund the IPP on an ongoing basis.
- Canada Revenue Agency requires a transfer from the plan member's RRSP to offset the contribution generated for past service (i.e. years 1991 to present). The Qualifying Transfer is determined by calculating the Pension Adjustment that would have been applied in each year of past service assuming that the individual had been in a defined benefit pension plan during those years. The total of the Pension Adjustments for those years less $8,000 and any unused RRSP contribution room equals the Qualifying Transfer.
- The former $8,000 RRSP over contribution is still available under an IPP and is deductible immediately.
- Contributions to an IPP are tax deductible to the employer.
- Expenses of the IPP (including actuarial consulting fees, interest on funds borrowed for contributions, and investment related fees) are tax deductible when paid directly by the company sponsor.
- Contributions made within 120 days of the end of the fiscal year are deductible within that fiscal year.
- The IPP assets may be invested by a trust company, under a Trusteed self-directed vehicle, or under a life insurance company contract.
- Generally, if an investment is allowed under an RRSP, it is acceptable for an IPP. There is a 10% investment concentration limit designed to ensure broad diversification of plan assets.
- Except in certain provinces, IPP assets are locked-in and may not be withdrawn in cash until retirement.
- Same Termination, Retirement and Death Benefits as other Defined Benefit Plans.
- For individuals over age 40, an IPP allows for higher tax deductible contributions than an RRSP
- Assets within an IPP can be protected from creditors
- In most cases, significant lump-sum past service contributions can be made when first establishing an IPP
- Higher tax deductible ongoing contributions …the older the member, the greater the contribution
- IPP contributions may be topped up if investment returns are insufficient
- Tax-deductible lump sum contributions at the time of actual retirement are possible in most circumstances
- Allows small business owners to defer taxes and plan for retirement.