Gabriel Lalonde
November 23, 2020

Why You Should Consider Replacing Your RRSP with an Individual Pension Plan

Retirement planning is an important part of your financial plan. Canadian business owners should pay close attention to their financial future because most of us want to retire someday – eventually. Unfortunately, business owners don’t have the luxury of an employer-sponsored retirement savings plan such as a defined benefit or defined contribution pension plan. Therefore, you have to explore alternative savings options such as a self-funded Registered Retirement Savings Plan (RRSP) or an Individual Pension Plan (IPP).

What is an RRSP?

A RRSP is one of the most common retirement savings options for Canadians. A RRSP allows us to make contributions into a tax-advantageous account. We’re allowed to contribute up to 18% of our personal earned income as long as we stay in the maximum annual limit. If we don’t maximize the annual contribution limit in a RRSP, the leftover, unused amount is carried over to the following year – indefinitely.

When we make contributions into a RRSP, the amount is deducted from our taxable income and could lower our tax bracket and reduce the overall amount of tax we’re required to pay. At the same time, all investment income (interest, dividends and capital gains) earned within the account grows tax-free until the time of withdrawal.

What is an IPP?

An Individual Pension Plan is a retirement savings account that can be an alternative to a personal RRSP for business owners and high-earning executives. An IPP Is created and funded by a company for an individual and can be a good financial planning strategy for Canadian business owners who are closer to retirement.

Similar to an RRSP, IPPs are subject to tax rules. You’re eligible to contribute into an IPP if you have employment income and receive a T4. Therefore, if you’re a business owner, you need to pay yourself a salary if you want to create an IPP. Unfortunately, income from being self-employed, partnerships and dividends doesn’t count as eligible employment income for an IPP.

What’s the benefit of an IPP vs. RRSP

There are benefits for both the business owner and the company when setting up an Individual Pension Plan. The first benefit is all contributions any into the IPP are tax-deductible for the company. The money will only be taxable for the beneficiary once the plan begins generating pension income.

A second major benefit of setting up an Individual Pension Plan is they are creditor-proof and can’t be included in any bankruptcies, debt settlements or legal proceedings.

A third benefit of an IPP is it provides a guaranteed pension income amount at the time of retirement. It’s similar to a defined benefit pension plan, but instead of being offered by an employer for an employee through a group pension plan, it’s set up by a business owner for a individual (often themselves). The downside is if there’s a shortfall in the guaranteed income payout, the business owner is responsible to make up the shortfall and ensure the full payout amount.

Although this is not unique to an IPP, business owners can take advantage of pension-splitting with your spouse. This allows you to put a portion of your contributions (up to 50%) into an account for your spouse. The tax advantage comes at the time of withdrawal. Instead of one spouse making withdrawals and declaring all the taxable income during retirement, the contributions and income can be split to keep the tax brackets lower for both family members.

Which one is right for you?

One notable difference between a Registered Retirement Savings Plan and an Individual Pension Plan is the eligible annual contribution amount. The RRSP contribution limit is based on your income whereas the IPP annual contribution limit is based on your age.

As you get older, your IPP contribution room increases. The amount you’re allowed to put into an IPP increases, not per your income, but with your age. The current 2020 maximum RRSP contribution limit is $27, 230. According to MoneySense, the maximum IPP contribution room is $38,005 at 60 and $41, 282 at 65.

If you’re over 40 years old and have an income of at least $100,000 per year, an Individual Pension Plan could be the right financial strategy for your retirement savings. Why? Because higher contribution limits mean you can create a larger nest egg and save more for your retirement.

An Individual Pension Plan can be a great financial strategy to help plan your next step – your life after work. Talking with a financial advisor can help evaluate all your retirement options and see which one works best for you, your family and your business. Contact us to discuss retirement strategies and see how retirement savings fit into your financial plans.

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