Tax expert explains why pension plan may be a way to navigate passive income if the RRSP is maxed out
An IPP could be a good option for business owners and incorporated professionals who have maxed out their RRSP contribution – but they have been warned that it’s not for everyone.
New passive income rules have provided some small businesses with another tax hurdle and IPPs offer a strategy to navigate this while providing a way to save for retirement.
John Waters, vice president and head of tax planning, BMO Wealth Management, said buying corporate life insurance is also an option as a way of taking that passive investment out of the company without creating a tax bill for the firm and shareholder.
An IPP, however, is a strategy that enables the business owner to put money into a tax sheltered plan while getting that tax deferral and having that retirement stream pay out down the road.
Waters said it suits someone who has a history of T4 employment earnings because it has to be consummate with the employment income that’s been received in the past.
He said: “It’s not for somebody who is just setting up their professional corporation today with no history of earnings, meaning you are not going to be able to put very much in in terms of past service contribution.
“It’s also not really for people that have had a company for many years. Again, if you are an incorporated professional but you haven’t remunerated through a T4 salary and you’ve been paying dividends as a means to getting funds personally through the company, you won’t have that history of T4 earnings that allow you to make those past-service contribution.”
Waters added that the client also has to be around the appropriate age, explaining that he would always suggest around 40 because at that stage the amount you can put into your IPP starts to exceed the annual amount you would put into your RRSP.
He said: “In effect, it’s one or the other. This is a replacement for the RRSP and at the age of 40, the limits start to exceed what you can put in for an RRSP in your IPP. As you get older, that spread gets more and more.”
The company must also have a relatively stable revenue income because of the annual requirement to top up the plan. A business that’s cyclical, and with cash flow “all over the place”, would be a problem in terms of funding the IPP.
Waters said: “It’s not for everyone. There’s a bit more complexity; there’s a cost to setting it up and you have to involve actuaries, so there is a fee required. Every third year you have to do an actuarial valuation, so there are added costs.”
He added: “[The IPP] has been out there for years and this is just another scenario where it might make sense to look at it because it could lessen the issue of investing through your business to fund your retirement and you could find yourself in a situation where your small business deduction is being clawed back.”