Over the next few years, we expect to see an increasing popularity of IPPs. Indeed, professionals operating through a company are likely to increasingly use this retirement vehicle plan than the RRSP.

The choice must be made no later than the year in which the member reaches the age of 71. The choice to be made will depend on the retiree’s personal situation and will have to be part of a general retirement planning strategy.

IPP Pension Payment

 A first choice is to receive a pension directly from the IPP. As mentioned above, this pension will be calculated based on the number of years of participation in the IPP at the rate of 2% per year of service.

Thus, if the IPP had been put in place at age 45 with no buyback of years of participation and the member retires at age 65 after 20 years of participation, the pension would be $70,133 in today’s dollars or 40% of the eligible salary: 20 years x 2% = 40% x 175 333 $ = 70 133 $

In fact, this pension will be higher since it will be based on the eligible salary indexed to retirement as shown in the table in the What is an IPP section? It should be noted that actuarial valuations are no longer required from the time a pension is paid by the IPP and therefore there are no actuarial valuation fees during retirement.

 Transfer from the IPP to an RRSP

 The second choice is to transfer the funds accumulated in the IPP to an RRSP and this is the choice that will probably be made most often.

It will usually be preferable not to make this transfer immediately at the beginning of retirement but to leave the IPP in place until age 71 in order to be able to make the transfer with minimum tax implications.

Indeed, tax limits apply on the transfer from an IPP to a RRSP. Since the amounts accumulated in the IPP exceed the amounts that could have been accumulated in an RRSP, a portion of the amount transferred from the IPP to the RRSP would be taxable in the pensioner’s income if the transfer is made immediately after retirement.

In the meantime, the funds required for family expenses may come from non-registered investments, TFSA withdrawals, RRSPs, or dividends paid by the company depending on the retirement planning strategy chosen.

The RRSP must be transferred to a RRIF by December 31 of the year the member turns 71. The first mandatory RRIF withdrawals begin the following year at age 72. However, if the company is sold or liquidated before, the IPP must be transferred to the RRSP at that time.

Purchase of a life annuity

 A third option available to the IPP member is to use all or part of the funds accumulated in the IPP to purchase a life annuity from a financial institution.

This choice allows to transfer the risk of portfolio management to the financial institution who pays the life annuity. It also ensures income security throughout retirement since the pension is payable until death. The conditions of the pension should correspond as much as possible to the pension provided for in the text of the IPP plan.

Which choice to make?

 As mentioned earlier, several strategies can be considered, and the choice made for the IPP will have to be part of a comprehensive retirement planning strategy. In this regard, several decisions need to be made to optimize revenues and throughout this period. Some of the main ones:

• At what age should be claimed the old age security (OAS) pension and the Régie des Rentes du Québec (RRQ) pension.
• In what order to disburse investments (non-registered, corporate, TFSA, RRSP, IPP.
• Income splitting with spouse.

Early retirement before age 65

The IPP member may decide to retire before age 65. In this case, if the member chooses to receive the IPP pension, the company may contribute and deduct an additional amount on that occasion.

Regular contributions to the IPP are calculated in anticipation of a pension payable starting at age 65. In the case where the member takes a pre-retirement at age 60 for example, the IPP therefore begins the pension income 5 years earlier than expected. The company must therefore contribute an additional amount in order for the IPP to be able to pay these 5 additional pension years.

The following table shows the additional amount required based on the pre-retirement age and the number of years of participation.

It should be noted that RRSP contributions cease the year following retirement and that it is not possible to contribute additional amounts in the event of pre-retirement, except for the last annual contribution following the year of retirement.

Retirement after age 65

If the member decides to delay retirement after age 65, the company may continue to contribute to the IPP as long as the member continues to receive salary.

Maximum annual contributions gradually decrease from $50,000 at age 65 to approximately $43,000 at limit age of 71, as shown in the table on the first page.

Death

Death before retirement

In the event of death before retirement, the funds accumulated in the IPP can generally be transferred without tax implications to the spouse’s RRSP and are not locked in.

If there is no spouse It is possible to designate other beneficiaries, for example children. In this case, IPP funds will be taxable on beneficiaries’ tax returns. It should be noted that funds accumulated in an RRSP are generally taxed on the deceased’s tax returns.

In the text of the IPP the spouse is generally defined as the person who:

• is married to the participant or
• has been living with the participant in a marital relationship for at least 3 years or less than 1 year if a child is born from their union or adopted.

It should be noted that it is possible to change the spouse definition in certain circumstances, which could better meet the objectives of the member with respect to his estate.

In all cases, however, the married spouse is entitled to an amount equal to half the value of the IPP under the Quebec Civil Code Partition of Family Patrimony dispositions.

Death after retirement

In the event that the professional dies after retirement, the consequences will depend on the choice initially made by the member at the time of retirement.

If the member elected to receive a pension from the IPP at retirement, the surviving spouse will receive a pension of 66 2/3% of the pension received by the participant before his death. For example, if the member was receiving an annual pension of $70,133 and that he dies the seventh year after his retirement, the surviving spouse will receive a pension of $46,750 or 66 2/3% of $70,133.

If the member’s death occurs during the first 5 years following the beginning of the pension payment, the spouse will receive a 100% pension until the 5th year following the beginning of the pension and 66 2/3% thereafter.

Upon the death of the spouse, the remaining funds in the IPP will be paid to the spouse’s estate and taxable in the income of the estate or heirs.

If the member did not have a spouse or had designated other beneficiaries, the pension may continue to be paid by the IPP to beneficiaries until the 15th year following the member’s death. The balance of the IPP funds is then paid to the beneficiaries in the 15th year following the beginning of the pension and is taxable in their income.

It should be noted that for tax reasons, it could be advantageous to liquidate the professional’s company within one year after the death when there is no spouse. The IPP will then have to be dissolved and the sums returned to the heirs.

It would therefore not be possible to continue to pay the pension to beneficiaries until the 15th year following the beginning of the pension.

An alternative is to use the IPP funds to purchase an annuity payable until the 15th year after the member’s annuity begins. The remaining balance of the funds, after the purchase of the annuity, will be returned to the beneficiaries at the time of purchase of the annuity in the year of death

For example, if the participant’s pension is $70,133 and he or she dies 3 years after retirement while $1,000,000 remains in the IPP, a pension of $70,133 payable for 12 years may be purchased from the IPP funds at a cost of around $720,000.

The remaining $280,000 will be paid to recipients and added to their income. Recipients may also choose to receive all the funds immediately.

If at the time of retirement, the member had chosen to purchase an annuity, from a life insurance company for example, the conditions of the annuity should correspond as much as possible to the annuity provided for in the text of the plan, as mentioned above.

Growing popularity

Individual pension plans have been around since the early 80’s. So why the recent interest?

Until 2018, given the different tax rates, it was generally preferable for companies to pay a remuneration to their shareholders in the form of dividends rather than salary.

Starting in 2018 and following changes to tax rates, it has generally become more advantageous to pay the basic remuneration in the form of a salary rather than dividends, which is now the case for most incorporated professionals.

Since this change, incorporated professionals have the option of contributing to the RRSP. The maximum annual RRSP contribution in 2023 is $30,780, or 18% of a salary of $171,000 in 2022.

Another option now available is the possibility of setting up an Individual Pension Plan (IPP).

The main advantage of the IPP compared to the RRSP as shown in the illustration below is that the contribution increases with age while the RRSP contribution is the same regardless of age. The maximum contribution to the IPP becomes higher than that of the RRSP at the age of 35 and reaches approximately $50,000 at the age of 65.

The salary required to maximize RRSP or IPP contributions is the same at $175,333 in 2023, for example. Since the pensionable salary increases with inflation, the maximum contributions of both plans tend to increase in a similar way over the years and the difference in favor of the IPP tends to be maintained.

It is possible to contribute to either the RRSP or the IPP, but not both at the same time (except for an annual contribution of $600 to the RRSP when an IPP is set up). A choice must therefore be made between the two regimes.

It should be noted that professionals carrying out their business personally without being incorporated unfortunately cannot set up an IPP.

What is an IPP?

In actuaries’ terms, an IPP is a defined benefit pension plan. This is the same type of plan as the one in which, for example, civil servants participate.

The IPP makes it possible to accumulate amounts required to pay starting at age 65 a pension of 2% of the salary per year of participation during the career.

The maximum salary for the purposes of calculating the pension is the same as the one used for calculating the maximum RRSP contribution, i.e., $175,333 in 2023.

For example, for a year of participation in 2023, the maximum pension payable at age 65 would be $3,507 or 2% of $175,333 and the contribution required in 2023 to provide for the payment of this pension will depend on the participant’s age as shown in the table on the first page, (for example, $30,780 for a participant for a participant aged 35 years old).

The following table illustrates the total amount of the pension payable starting at age 65 depending on the age at which the IPP was set up and the number of years of participation in the IPP as shown in the table on the first page, assuming that the participant will receive the salary maximizing the pension throughout his career.

For example, if the IPP is set up at age 40, the pension payable at age 65 after 25 years of participation would be $87,675 in today’s dollars:

25 years x 2% = 50% x $175,333= $87,675

If we consider an annual increase of 2.5% of the eligible salary, the pension would instead be $162,525, or nearly double. The IPP therefore offers protection against inflation by making it possible to make additional contributions based on the indexation of future salaries.

Cash flows

RRSP contributions are made personally by the professional out of the salary received and are deducted from his personal income.

Contributions to the IPP are made directly by the company, which deducts them as an expense for the pension plan.

Thus, for the same salary paid, the cash available for family expenses will be higher in the case of the IPP because the contribution is not made from the salary received but directly by the company.

At equal salary, the professional therefore has an additional amount of about $15,000, i.e., the after-tax value of the RRSP contribution that would have been made personally ($30,780 x 50%). 

Setting up the plan

When setting up the IPP, the following documents are prepared for the purpose of accreditation by the Canada Revenue Agency (CRA):

• Initial actuarial valuation.
• Description of the pension plan.
• Tax forms.

In addition, a trust agreement is drafted to eventually be deposited with the financial institution where the account will be opened.

There must be at least three trustees who are generally:

• The professional.
• His or her spouse.
• A person who is not a potential heir of the professional (e.g., a friend, a colleague).

When the IPP is set up, it is possible to recognize the years of participation for the salaries paid by the company in previous years.

Let’s take an example where the company would have started paying salaries in 2018 and the IPP is set up in 2023. The 5 previous years, i.e., 2018 to 2022, can be recognized for the purposes of calculating the pension payable starting at age 65. The amount of this pension would be $17,535 (5 years x 2% = 10% x $175,333).

In order for the IPP to have the necessary funds to pay this pension, the contributions of $146,500 initially made to the RRSP from 2018 to 2022 are transferred without tax consequences from the participant RRSP to the IPP.

The company will generally also be able to contribute and deduct an additional amount representing the excess of the higher annual contribution to the IPP that could have been made during these years compared to that of the RRSP.

The following table illustrates different scenarios depending on the participant’s age when the IPP is set up in 2023.

For example, if the participant is 40 years old when the IPP is set up, an amount of $146,500 would be transferred from the RRSP to the IPP without tax consequences and the company would contribute and deduct an additional amount of $15,060 to recognize the years 2018 to 2022 for a pension of $17,537($3507 x 5 years) payable from age 65.

The company may also make an initial current contribution for 2023 to the IPP of $32,730 for a participant aged 40 years old in the example.

In addition, the participant will be able to make a final RRSP contribution in 2023 of around $22,700 ($600 in subsequent years).

However, past years cannot fully be recognized if the market value of the RRSP is less than the required amount of approximately $146,500 for the transfer.

It should be noted that contributions made in the past to a spousal RRSP cannot be used to be transferred to the IPP to recognize past years of services.

Accumulation period

 Additional contributions

 The following table illustrates the amount of additional contributions to retirement savings that can be made to the IPP compared to the RRSP according to age of the participant at the time the IPP is set up and assuming an annual increase rate of eligible salary by 2.5%.

For example, if the IPP is set up at age 40, contributions to the IPP up to age 65 amount to $1,534,000 compared to $1,109,000 for the RRSP, i.e., $425,000 more.

 Tax savings

 The following table illustrates the tax savings realized by the company on higher contributions to the IPP until the participant reaches age 65. In the previous example, the additional contributions of $425,000 results in a tax saving of $87,000 assuming a company tax rate of 20.5%, or $425,000 x 20.5%.

Accumulated amounts

The table at the bottom of the page illustrates the amounts accumulated at age 65 according to the age at which the IPP was set up and the following assumptions:

• Rate of salary increase : 5%
• Rate of return on investments : 0%
• Average tax rate on investment income in the company : 40%
• Actuary fees every 3 years : $1, 000

Retirement savings

 The scenario which the IPP is set up at age 40 allows to contribute $425,000 more than the RRSP scenario and thus accumulate $2,880,000 in retirement savings compared to $2,089,000 in the RRSP scenario, i.e., $791,000 more at age 65.

Company

In the RRSP scenario, the company gradually invests the sum of $425,000 freed up by lower RRSP contributions for an accumulated value of $677,000 at age 65.

In the IPP scenario, the company instead invests the tax savings on the additional contributions of $425,000 or $87,000 ($425,000 x 20.5%) for an accumulated value of $128,000 at age 65.

Total Accumulation (retirement savings and company)

 In total, the accumulated value in the IPP scenario will be $242,000 higher at age 65, mainly due to tax savings on additional contributions to the IPP as well as the accumulation of income on these sheltered contributions.

Valuation every three years

Assumptions for the purpose of calculating the required IPP contributions are set out in the Income tax Act. As a result, the IPP contribution amounts according to age as shown on the illustration on the first page are the same for everyone.

Among the main assumptions, the salary increase rate for the purpose of calculating the pension payable at age 65 is 5.5% annually and the expected rate of return on investments in the IPP is 7.5%.

In fact, for the last 30 years, the indexation of eligible salary for the purposes of calculating the pension has not been 5.5%, but rather around 3% which is 2.5% less. Thus, if the trend continues, the required return on investments would be around 5% rather than 7.5% or 2.5% less.

Every three years, the actuary must assess whether the funds accumulated in the IPP are sufficient to pay the pension at age 65 based on, among other things, the actual salary increase and the actual performance of the IPP over the preceding 3 years.

If the actuary notes for example that the indexation of eligible salaries was 3% and that the investments generated less than 5%, the company can then contribute and deduct an additional amount to the extent that there was no surplus at the time of the previous evaluation.

For example, if the value of the IPP is $300,000 and the return was only 4% rather than 5% as required in the previous situation, the company will be able to fill the 1% shortfall by making an additional contribution of $9,000 ($300,000 x 1% x 3 years).

On the other hand, if the return was higher than expected, the IPP is allowed to accumulate a surplus of funds of 25%. If the investments exceed this margin, the company will have to stop contributing until the surplus of 25% is eliminated.

Deductible management fees

Portfolio management fees (usually 1 to 2% of the value of investments) paid by a RRSP are not deductible from personal taxes.

Portfolio management fees of IPP investments paid by the company are considered an expense of the company and are deductible annually from its taxes at the rate of 12.2%, 20.5% or 26.5%.

The following table shows the potential savings of the company on an annual investment management fee of 1% in the IPP scenario, compared to the RRSP scenario.

The following table shows the amount of accumulated tax savings and management fees at age 65 if reinvested at the rate of return of 5% and considering an average corporate tax rate of 40%.

It should be noted that the fees paid in the RRSP scenario, although not deductible annually, would result in a tax saving at retirement because taxable withdrawals from the RRSP or RIFF would be lower.

Tax optimization of investment allocation

Unlike professional income, which is generally taxed at the rate of 20.5% for incorporated professionals (26.5% for income over $500,000), investment income (interest, dividends and capital gains) is taxed in the company at basically the same rate as an individual as shown in the table below.

On the other hand, once paid by the company to the shareholder certain revenues are subject to an over-taxation in comparaison to personal tax rates (ex: 5% in the case of interest income and 10% in the case of foreign income such as dividends received on US shares).

Therefore, it is advantageous that investments that generate interest income or foreign income be made in a retirement savings vehicule so that they are taxed only at the personal level at the time of retirement withdrawals and not during the accumulation period.

In the scenario where the IPP is implemented at the age of 40, this could represent tax savings vehicule in the range of $18,000 to $35,000 on fixed or foreign income.

Passive investment income (Interest, dividends, taxable capital gains)

Another advantage of channeling a larger portion of future savings into retirement savings rather than keeping it in the company is that it potentially reduces the negative impact of investment income on professional income tax rates.

Recall that as part of the Morneau reform, a new rule was introduced in 2019 to limit the saving capacity of companies.

Under this new rule, when annual investment income (interest, dividends and taxable capital gains) exceeds $50,000, the tax rate on professional income will gradually increase from 20.5% to 26.5%.

By allowing more of the future savings to be invested in retirement savings rather than in the company, the IPP can help reduce the impact of this new measure.

In Quebec, however, the impact is generally less penalizing for incorporated professionals. Indeed, when the company pays a 26.5% rate instead of 20.5% on professional income, the professional pays a lower personal tax of an equivalent amount on dividends received from the company.

Retirement at age 65

At retirement, a participant has several options:

Payment of a pension by the IPP;

Transfer from the IPP to an RRSP;

Purchase of an annuity from a financial institution

The calculations are made on the assumption that the participant is male with a spouse who is 3 years younger.

For example, the company could contribute and deduct an amount of $185,000 if the professional retires at age 60 after 15 years of participation and begins to receive the IPP pension.

In Summary

Setting up an IPP allows to invest and deduct a larger portion of the company’s future savings in retirement savings during the accumulation period.

The main benefits are:

• Contribute and deduct additional amounts during an actuarial valuation (every 3 years) following a period of high inflation and/or low returns.
• Deduct portfolio management fees;
• Allow better tax allocation of investments by providing tax shelter for investments that are overtaxed when earned and paid by the company (5% on interest income and 10% on foreign income);
• Potentially reduce the negative impact of investment income over $50,000 on the company’s tax rate.
• At retirement several choices are available:
  • Transfer from IPP to RRSP
  • Payment of a pension directly from the IPP
  • Additional contributions for early retirement before age 65

• Upon death, the IPP can be transferred to the spouse’s RRSP.

The following table summarizes the various scenarios illustrated in the bulletin. The objective is to present an order of magnitude of the expected results according to certain typical situations. It is important to note that several assumptions have been made (e.g., rate of return, inflation rate, tax rate) for projection purposes and some have been simplified.

The results could therefore vary if these assumptions were modified.