Should you consider an individual pension plan?

August 28, 2019

With all the concern over the 2019 rules for passive investments in private corporations, individual pension plans (IPPs) are now getting more attention from incorporated physicians. Because the new passive investment rules can reduce access to the small business tax rate, incorporated physicians are looking for other tax savings via their corporations. IPPs offer this, as well as a pension upon retirement.

An individual pension plan is a defined-benefit pension plan for one person. Typically with an IPP, only the employer contributes to the plan for the employee. If you own a medical practice corporation, your corporation — as the employer — would make contributions for you as the employee.

Should incorporated physicians reconsider an IPP for tax reasons?

Essentially, an IPP is a way to save taxes, because the corporation can make tax-deductible contributions and the employee can benefit from tax-deferred growth inside the plan. Both of these benefits help with the federal government’s new corporate rules on passive investment income: the tax deduction helps reduce the corporation’s active income, and the tax-deferred growth lowers corporate investment income.

That said, IPPs aren’t just a prevention tool. Physicians who are losing access to low corporate tax rates might find that the IPP’s ability to reduce current taxes has become even more powerful.

IPPs generally make the most sense for practising physicians facing loss of the low corporate tax rate, who are at least 40 years old, who have had a corporation for years and who have been using salary as their compensation model.

How does an IPP compare with an RRSP?

The biggest advantage an IPP has over an RRSP is where it has a greater contribution limit. Currently, an RRSP’s contribution limit is 18% of earned income, up to a maximum of $26,500 for 2019. (If you earn more than $147,222, you will hit that $26,500 ceiling.)

IPP contribution limits increase with age. After age 50, they are much higher than RRSP contribution limits, allowing you to save more for retirement in a shorter amount of time. This can be especially beneficial if you do not start saving for retirement until later in life.

What are the advantages and disadvantages of an IPP?

IPPs can be a valuable option for retirement and tax savings but they also have disadvantages.

Advantages

Tax-deductible contributions: The corporation’s taxes are reduced through IPP contributions. If your corporate tax rate is 12%, the current tax saving of $10,000 of additional contribution room is $1,200.

Other deductions: The corporation can also deduct interest on borrowed funds, actuarial and accounting fees, and all expenses including investment fees in an IPP.

Tax-deferred growth: Income in the pension plan can grow tax-deferred until withdrawal. IPP assets are safe from creditors because these assets are held in a separate entity from your corporation.

Top-up contributions: You can top up contributions if investment returns are not enough to fund promised benefits; this usually means more tax savings when the investment priority is secure retirement income.

Past service contributions: Those with a long history of using a corporation with salary as compensation can make a lump-sum contribution for past service or amortize it over up to 15 years.

Pension splitting: Distributions from an IPP can be set up so as to be eligible for pension splitting (partial income splitting).

Disadvantages

Costs: Set-up and ongoing administrative costs are high for IPPs. Ongoing costs are often more than $1,500 per year for actuarial and administrative support.

Deduction limitations: Investment fee deductibility is usually a temporary advantage and not certain to be of benefit, so do not focus solely on IPP fee deductibility.

Strict compliance: The pension administrator and actuary have to ensure an IPP is properly set up, registered and maintained, or it could be deregistered, resulting in serious tax consequences.

Reduced RRSP room: IPP contributions reduce RRSP room, and IPP returns in excess of 7.5% may reduce IPP contribution room. Remember too that the key to lower overall taxes is to make withdrawals when your tax rates are lower. It is possible for an IPP to get “too big.”

Withdrawal restrictions: IPP funds are locked in until retirement and cannot be used for any other purpose. Spousal RRSPs cannot be used to make a past service contribution.

No spousal RRSP contributions: An IPP member will find their ability to contribute to a spousal RRSP (full income splitting) is limited.

Want to learn more?

Meet with your MD Advisor* to figure out whether an IPP might make sense for you. Your MD Advisor can also put you in touch with a pension and actuarial consultant to:

  • determine the amount that could be contributed to an IPP for past service;
  • provide a quote for set-up and ongoing costs; and
  • provide financial modelling of potential benefits versus costs.

The strategies available to incorporated physicians can be complex. Your MD Advisor can help you understand the potential consequences of the changes for private corporations and navigate the different options most suitable to your situation.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.

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