Intro
Jared: Welcome to the Tax Talk Podcast. On today's episode, I have Kit Richmond. Kit is here to discuss everything IPPs (Individual Pension Plans).
So, if you are a small business owner with a significant salary and are at least 40 years old, this is the episode you are going to want to watch.
Kit is going to unpack this topic in detail with me, and we will provide you with the information you need to make informed decisions to help you build that pension.
Overview of Episode
Jared: Kit Richmond is a Wealth Advisor and Portfolio Manager at the McDougall Wealth Management Group with National Bank Financial. Their team partners with entrepreneurs, professionals, business owners, and family farms in their goal to continue wealth creation, enable protection, and structure transition. The McDougall team offers a unique approach to wealth management with expertise and personal service to guide you and your family.
Kit, I just want to thank you for taking some time out of your busy schedule to hop on the podcast with me today.
Kit: Thanks a lot, Jared, really appreciate it.
Jared: Excellent. So, we are diving into a topic that seems to be coming up with my clients on a more regular basis, and that is individual pension plans. I figured Kit would be a good resource on this, and I'm looking forward to the insight that he can provide to you today.
What is an IPP?
Kit: So, let's start with the most basic question: What is an Individual Pension Plan, or an IPP?
An IPP, Individual Pension Plan, is essentially a defined benefit plan that is typically sponsored by a corporation. There are some advantages under the Income Tax Act in doing so. It's similar to an RRSP in certain senses but has specific advantages that might apply to some of the listeners of this podcast.
Setting up an IPP
Jared: So, in regards to that, is it something that someone, you know, if they've got a small business corporation, they could set up themselves? Do they need to speak to you, or is there another advisor that needs to be involved with this? How does that come about?
Kit: Good question. Generally, an IPP is set up with three different collaborating professionals and the business owner or professional service provider who is the client.
The first one is an accountant, which makes sense for most things, right? The second is an actuarial team because it is a pension plan regulated under the CRA, which requires certain disclosures every year and a triennial review every three years. The third is a Wealth Advisor or wealth advisory team, as you'll need to invest the funds within the pension plan.
Jared: So, similar to other investment opportunities that people might be looking into, it's important to get the right people on your team to ensure you're setting up a proper plan that benefits you. Getting these individuals on your team to get this pension plan in place is crucial if it's an option for you in your business.
Kit: Right, and I think the first step is to ask your accountant or wealth advisor, or one that you know offers this service, if an IPP is right for you. There are some costs involved, but the advantages generally outweigh the costs if it fits for you and your family. So, it's essential to ask your accountant or wealth advisor, who usually have contacts in the actuarial world to facilitate this.
Jared: Yeah, generally speaking, whenever I have clients come into my office, and I'm guessing it's the same for you, they ask if a particular plan or idea makes sense for them. The general discussion usually starts with "it depends," because we need to get into the details to determine if it is beneficial for you. Maybe the IPP is perfect for you, or perhaps it's not the best option, so having that discussion before jumping into something is crucial for getting the best bang for your buck in the long run.
Kit: Exactly, and that depends on family dynamics, whether you're an incorporated business or not, and several other factors. Age is actually a significant factor for IPPs because the advantages accumulate as you get older. We'll probably discuss who the ideal candidate is next, right?
Jared: For sure. Now that we've understood what an IPP is, who can open one?
The ideal IPP candidate
Jared: What is the ideal candidate for an IPP? Is there a certain type of business owner we're looking to gear this towards? Some clients have mentioned it as a potential retirement vehicle. Are there other options, and who should consider this plan?
Kit: The first thing we look for is age. It doesn't make sense mathematically to do an IPP versus RRSPs or maybe Hold Co investing until you're 40. The other important question is whether they have excess capacity to contribute to savings. If they can't make the normal registered savings or contributions to a Hold Co, it doesn't make any sense to do an IPP. You must be committed to making those excess savings. Having a corporation is crucial because the corporation needs to sponsor the IPP. In Alberta, contributions to the IPP are not mandatory; they are optional contributions by the corporation.
Jared: So, you need to reach a point in life where you are somewhat established and in an age bracket where the math makes sense. You should be able to commit to this for the long term, including generational planning.
Kit: Exactly. The conversation needs to be around whether the business setup is something you're going to want for the foreseeable future. For example, if you're a medical professional with a PC setup that you'll maintain for 10, 20, 25 years, it makes sense to sponsor the IPP through that. You need to consider whether this is a permanent setup.
Jared: Similar to considering a permanent life insurance policy, you want to plan not just for the next 5-10 years but beyond that. It's crucial to have the right team to play out different scenarios that might arise.
Kit: Absolutely, the conversation has to be around whether this is the setup you intend to have long-term in your work. One significant benefit is that you can name beneficiaries not directly involved in the corporation, like spouses.
Jared: It's good to discuss the annual salary needed to make this work. Is there a specific figure that makes the mathematics work for an IPP?
Kit: There's the salary component and the excess cash building up in the corporation. The IPP is determined on T4 income, just like normal pension contributions and RSP room, which maxes out in the low $30,000s. The IPP crosses over at age 40 and can be up to 30% of your income, particularly beneficial in six-figure incomes. This allows you to contribute $10,000-$20,000 more per year using corporate dollars, which is different from personal dollars.
Jared: If you're well-established and drawing a consistent salary, maxing out RRSPs, and based on discussions with your accountant and wealth advisor, an IPP could be a strategy to put away more for retirement and generational planning.
Kit: Yes, you can accelerate your savings using corporate dollars, which is beneficial. There's also creditor protection and other benefits. If you're interested, review your T4 income for the last 5-10 years. You can qualify some RRSPs to roll into the IPP, giving you more advantages.
Jared: If someone primarily paid themselves through dividends, does that mean the IPP option has passed for them?
Kit: There's still time, especially if you're accruing a lot of cash within the company and paying for personal expenses with T4 income. It's essential to use that income to your benefit. Situations change, and planning needs to be revisited to ensure it still meets your needs and goals. If necessary, there are options to get out of an IPP, like purchasing an annuity or pushing it into an RRSP and LIRA. It can also exist as its own entity, paying out a pension even after the corporation is gone.
Jared: Planning is always subject to change. Does the IPP offer options to get out if circumstances change?
Kit: Yes, you can purchase an annuity or roll it into an RRSP and LIRA. It's not final; you have options, and it can exist independently of the sponsoring corporation. It's good to have creditor protection, ensuring your asset is safe, especially if you've built up significant value over the years.
Jared: The ultimate purpose of the IPP is to provide cash flow for your lifestyle, ensuring you're okay no matter what happens to the business. So, how is the IPP funded?
Funding an IPP
Jared: How is the IPP funded? Are there specific methods, and does it involve both the individual and the corporation contributing?
Kit: It's primarily funded through the corporation with tax-deductible payments. Since it is a registered pension plan with the CRA, certain return metrics are reviewed every three years. If returns are moderate, you can top up your contributions. However, if returns are high, additional contributions may not be allowed.
Jared: So, it's funded with after-tax dollars from the corporation, which is beneficial.
Kit: Yes, it's advantageous as it uses lower tax rate corporate dollars. This helps build retirement pensions. Other options include continuing with salaries and contributing to RRSPs, but this depends on where you are financially during retirement.
Jared: If the IPP survives the corporation, is it protected from creditors and kept separate from corporate assets?
Kit: Absolutely, it's a distinct entity. You can invest in various securities just like RRSPs without the active vs. passive income rules in corporations. This keeps your retirement funds separate and secure.
Jared: So, the IPP acts as a separate retirement vehicle funded by the business but owned by you, protecting you from creditor claims and possibly aiding in tax planning for selling the business.
Kit: Correct. It allows income splitting and offers long-term benefits for you and your family. It’s a great way to secure your lifestyle and plan for the future.
Jared: Income splitting within the family is highly beneficial for tax purposes. Are there opportunities for the second generation to benefit from the IPP?
Kit: Yes, but generally, this discussion happens after the primary beneficiaries have been drawing from it for some time. It ensures that your retirement years are well-established before passing it on to the next generation.
Jared: And the growth within the IPP is tax-deferred, right?
Kit: Indeed, it's like an RRSP but with a different tax rate, as you know. This tax-deferred growth over 30-40 years can significantly impact your retirement funds.
Jared: If the corporation ceases, can the IPP continue independently?
Kit: Yes, the IPP can exist as its own entity, avoiding unnecessary costs of maintaining a corporation. Though annual filings are required, the benefits of higher contributions make it worthwhile. Over time, an IPP can double the assets compared to a traditional RRSP, significantly impacting your retirement lifestyle.
Jared: That’s fascinating. Now, if I open an IPP, are there any limitations on the investments I can put into it?
Kit: Any investments eligible for a TFSA or RRSP are also eligible for an IPP. The wealth management team will guide you through different philosophies and setups. The key benefit is that there are no tax consequences when changing your portfolio composition over time.
Investment limitations
Jared: Is there any limitation on the investments that I can put into it, or is it fairly open-ended similar to maybe a TFSA or RRSP in the type of underlying investments that are in there? Do I have a choice over that? Is that something I work with you and your team to determine? How does that transpire?
Kit: Anything that is in a TFSA or an RRSP eligible would also be eligible for an IPP. The wealth management team that you're dealing with will have different philosophies around what that looks like, so I can't speak to other setups, but I know what ours are, and they are similar to our non-registered accounts or other corporate accounts. The key is there are no tax consequences, which is quite helpful in terms of changing portfolio composition over time. There are no tax considerations when you're doing that, which gives us flexibility to manage that over the years.
Jared: Well, that makes sense. I think it's always important to understand because the general consensus out there is that a tax-free savings account is a savings account, but in fact, it can be all sorts of different investment types that you can put into that particular investment vehicle. Similarly speaking with the RRSP or the IPP, maybe when you're getting this set up in your early 40s, you can take on a bit more risk in your younger years. Then, as the IPP gets further down the road, you might translate those into less risky assets to ensure you're preserving some of that capital into those retirement years. Is that something people do?
Kit: Some people do that. I think a more fundamental question is asking what is risk. For us and our team, risk really is the possibility of destruction of capital, not the volatility of day-to-day. The tax-free savings account really should have been named the tax-free investment account because the power is in compounding over longer periods of time on an after-tax basis.
Jared: I agree because as we get closer to distribution, we want to have a certain amount that does not change based on market fluctuations. For example, Jared is set up for the next two or three years with the agreed amount, and there’s no situation where you have to resort to drastic measures because the IPP didn't perform well.
Kit: Absolutely. When you get to that point in life, you've worked hard, and it’s emotional to move on from the business you've poured decades into. When you're finally able to move on to the next adventure in life, you want to make sure those hard-earned dollars are secure. The first rule of Warren Buffett is to not lose any money, and the second rule is to remember the first.
Jared: Exactly. If you're constantly trying to time the market, you end up doing the opposite. You buy high, sell low, and eventually have no capital left. Real investing is about preserving capital.
Kit: Absolutely. An IPP is a great vehicle for accelerating savings and providing certainty for retirement. It's a tough emotional period when you stop practicing or sell the business, and having the financial piece of your life set up is powerful.
Jared: Yes, it gives you the option to dive into another passion, like volunteering or a new project, without worrying about finances. It’s rewarding to take the passion from one place to another without financial stress.
Kit: You might get involved in another business in an advisory role or help a startup, knowing your lifestyle needs are taken care of.
After Retirement
Jared: So what happens to my IPP in retirement? What are my options? Does it stay as an IPP through my retirement years? Do I have options to do other things with it? How does that play out?
Kit: The first option is to keep it as a pension, so it operates as a pension for you subject to CRA rules. You can take out a certain amount, and it can go to the spouse as the main beneficiary. The second is you can purchase an annuity, depending on rates and such. Some might prefer owning a portfolio and seeing it go up and down but overall up over a long time, rather than the certainty of an annuity. The third option is transferring to registered or locked-in plans, which you can work through.
Jared: That makes sense. Generally speaking, as long as you’re moving it within the registered side, there shouldn’t be any adverse tax impacts, right?
Kit: Correct, and it gives you flexibility to draw it down quicker if, for example, your health is a concern. There’s an unlocking you can do for locked-in plans, which might be more accelerated.
Jared: Does the unlocking work similarly to the LIRA, or is there an accelerated option?
Kit: With an LIRA, you can unlock 50% and put it into an RRSP, which has no withdrawal limitations, although you still pay tax. With a LIF, you have a maximum withdrawal limit to adhere to.
Jared: That’s more of a tax planning discussion with clients if there’s a health or other situation that accelerates it. If everything's fine, keep it in the IPP and move on.
Kit: Exactly. For example, health concerns can pop up unexpectedly, so it’s good to know your options and that you’re not stuck with the IPP forever.
Jared: If I pass away, does the IPP transfer at cost to my spouse?
Kit: Yes, there’s a rollover to the beneficiary. There's also the option for second-generation planning, which is more complicated but available.
Jared: Would you involve second-generation planning if the corporation was intended to keep going and transition to a child?
Kit: Yes, if the child buys the business from the parents, the parents keep their IPP separate and get paid over time. The child could start their own if they prefer.
Jared: The IPP stays tied to the original owner, so new owners can set up their own. This could be a strategy to move the business to kids, easing cash flow for the transition.
Kit: Absolutely. This gives flexibility and patience in selling the business, whether to kids or a third party, without the pressure to maximize immediately.
Jared: Flexibility helps with unexpected changes in the business environment. Would you prefer cash or a business that might not perform as well in the future?
Kit: That’s right. Sometimes, it’s better to have cash. In cases where multiple children inherit the business, it might be problematic if only one is interested.
Jared: The IPP can help avoid difficult family dynamics, ensuring financial security for the original owners while giving kids the option without pressure.
Kit: Exactly. It allows for smooth transitions and avoids forced sales due to health issues or other emergencies.
Jared: Preserving family relationships is crucial during transitions. Even if maximizing returns is important, maintaining harmony should be a priority.
Kit: Often, one spouse prioritizes family harmony. While transferring assets is important, sometimes relationships matter more.
Wrapping it all up
Jared: Wrapping it all up, do you have any final thoughts on IPPs that we didn't touch on and you think would be important for the audience to hear?
Kit: Just as a summary, IPPs are a tool that not a lot of people know about. Especially for professionals and business owners given the current tax structure and other economic factors, they are worth considering to confirm and protect your lifestyle for the future while being effective going forward.
Jared: I completely agree. I had some knowledge going into this, but this conversation has opened my eyes to new opportunities for certain clients, especially in the niche of business transitions. The transition piece was particularly enlightening and useful for many clients.
Kit: Absolutely. The key is to avoid getting stuck in a corner, whether with an IPP or another tool. Limiting your options can have long-term implications, both before and during retirement.
Jared: Exactly. Kit, thank you so much for joining me on the podcast. For anyone in the audience who wants to reach out to you, what's the best way?
Kit: You can find me online as a member of the McDougall Wealth Management Group with National Bank Financial in Red Deer. Alternatively, you can contact Jared, and he can forward my contact information. We have clients all over Alberta, so the location isn't a barrier. We really pride ourselves on building relationships with our clients and helping them achieve their goals.
Jared: Excellent. Thank you again, Kit. I really appreciate it. Once again, this is Jared Palon for the Tax Talk podcast. Thanks for listening, and we'll see you on the next episode. Take care!
