Unlike most Cana-dians who use RRSPs to save for their retirement, business owners have the advantage of setting up individual pension plans, which can prove to be a superior retirement option for people in that situation.

IPPs allow “business owners systematically to use money from their corporations to generate a pension benefit for themselves,” says David Ablett, director of tax and retirement planning with Winnipeg-based Investors Group Inc. This strategy runs counter to “using the proceeds of the sale of a business to fund retirement” — a common practice among business owners.

An IPP is exactly what the name implies — a registered pension plan for a single person. Usually, IPPs are set up for small-business owners, incorporated professionals or senior executives. Spouses may be included in an IPP if they are employed by the same firm.

IPPs are defined-benefit plans registered with the Canada Revenue Agency and subject to federal income taxes and provincial pension benefits regulations. An IPP can be set up only by an incorporated business, which acts as the plan sponsor and makes annual contributions to the IPP on behalf of the business owner. Says Ablett: “[IPPs] work best for individuals who are over 45 years old, with T4 income in excess of $100,000.” In fact, he adds, “The annual contribution level increases as age increases.”

For instance, Ablett says, the maximum contribution an individual can make to an RRSP in 2009 is $21,000. But a business can contribute as much as $25,200 to an IPP on behalf of a 45-year-old individual, and $30,500 for someone who’s 55 years old. “The contribution limits of an IPP are regulated by the Income Tax Act,” he notes.

Incidentally, the maximum IPP contribution is established by an actuarial valuation that is done when the plan is set up and every three years thereafter. Consequently, maximum contribution levels are not the same for different plans and will vary with age, earnings and length of service.

“Since contribution levels for an IPP can be substantially higher than for RRSPs, the total value of assets in an IPP will be much greater, thereby offering business owners a superior retirement income,” says Prem Malik, a chartered accountant and financial advisor with Queensbury Strategies Inc. in Toronto.

More important, given that an IPP is a DB plan designed to provide a predictable income for life, the sponsoring company is required to fund the necessary level of contributions, adds Malik, which reduces its profits and its income taxes.

“At the end of the day, both the business and the business owner come out ahead,” he says. “For the business owner, earnings in the plan accumulate tax-free and taxes are only payable when funds are withdrawn during retirement, while the business pays fewer taxes.”

Essentially, an IPP is a tool for taking cash out of a business in an efficient, tax-effective manner.

“Unlike an RRSP, ‘top-up’ contributions can be made to an IPP to cover investment losses,” says Patricia Lovett-Reid, senior vice president with TD Waterhouse Canada Inc. in Toronto. “The protection that IPPs offer in a down market is a big benefit not provided by RRSPs — there is no downside.”

An IPP can also be “topped up” if its net return on investment is, on average, less than 7.5% a year over a three-year period, a rate prescribed by the CRA. This actuarially determined rate is used to ensure the payment of benefits specified by the IPP.

The important thing to consider is that a firm must make the necessary contributions, Lovett-Reid says: “It can borrow money to make contributions, in which case the interest is deductible for tax purposes.”

Ablett suggests a company that establishes an IPP should have “taxable income in excess of $500,000 annually” in order to maximize the benefits of its deductions. This is because the tax rate on taxable income below $500,000 is 16%, and 32% above $500,000.

IPPs also allow a firm to make a one-time contribution for the business owner’s past service, to as far back as 1991, which is when IPPs were first established. Generally, this amount is based on the difference between RRSP and IPP contribution levels for the past years.

“This is another way for the business owner to take money out of the business,” Malik says, “which benefits from a tax deduction, while the value of plan assets increases to the benefit of the business owner.”

@page_break@Once a business owner is ready to retire, which can be as early as age 55, the IPP’s assets can be used to pay a pension directly, purchase an annuity from a life insurance company or be transferred to a life income fund, locked-in retirement income fund or RRIF, depending on the relevant provincial pension legislation.

Plan assets remaining upon the death of an IPP holder can be transferred to a surviving spouse or estate. If a business owner chooses to retire early, a lump-sum contribution can be made by the business to fund pension payments.

Any surplus in an IPP — that is, funds in excess of what is required to pay the defined benefits outwhen the business owner retires — belongs to the business owner and is paid as a fully-taxable lump sum.

Setting up and maintaining an IPP is a complex and costly process involving actuarial valuations, preparation and filing of plan documentation, engagement of trustees and managing investments, as well as ongoing administration and regulatory reporting. All fees are paid by the company and are tax-deductible.

“The typical cost of setting up an IPP ranges from $2,000 to $5,000, while the cost of plan administration ranges from $800 to $1,500 annually,” says Ablett, “and actuarial valuations, which must be done every three years, cost between $1,500 and $2,500. Some firms that actively promote IPPs charge an annual fee of about $1,000.”

IPPs have other advantages. “The corporation has 120 days after its yearend to make an IPP contribution, compared with 60 days for RRSPs,” says Lovett-Reid.

However, IPPs do have some limitations. IPP assets subject to provincial lock-in rules cannot be withdrawn until retirement. And the firm must make mandatory contributions. “You cannot skip contributions in any given year as you can do with RRSPs,” Malik says. IE