How Professionals and Business Owners Can Supersize Their Retirement Savings

TAXATION

Professionals and business owners (“owners”) have a
unique planning opportunity available to them through
incorporation. The use of a corporation can be very
beneficial for an owner if they are in the habit of saving
within their corporation. Small businesses have access
to the Small Business Tax Deduction (SBTD), which is a
deferral of tax paid when assets are retained inside the
owner’s corporation. The ability to defer paying taxes
allows owners to compound their assets inside their
corporate structure at a higher rate than if the money
was withdrawn, personal income tax was paid and the
after-tax amount was invested personally in a nonregistered
account outside of the owner’s corporation.

Legislative landscape

Recent government tax changes (legislation passed in 2018 and will come in effect later in 2019) placed a limit on the amount of passive income (i.e., interest, dividends and some capital gains) that an owner could generate inside their corporation, which is $50,000 for 2019. An owner with passive income above this $50,000 limit would have their SBTD clawed back and eliminated when passive income exceeds $150,000. As a result of this tax change, owners should review their financial strategy to ensure that their SBTD is protected and the attractive tax deferral benefit is retained as part of the owner’s longer-term retirement savings plan.

More specifically, this recent change in legislation has revived an old planning strategy: The Individual Pension Plan (IPP). For an owner over the age of 40 and earning more than $147,222 annually, the IPP can be a very attractive planning tool for protecting their SBTD for the following reasons:

• higher annual tax-deductible registered account contributions
• opportunity for surplus tax-deductible contributions
• tax-deductible administration costs and election to purchase past service

Corporate tax deductions

IPP contributions are based on the owner’s age, while RRSP maximums are indexed to inflation. As a result, an owner over 40 will see greater contribution room to their retirement savings plan. For example, in 2019, at age 40, an owner could contribute $28,734 to their IPP or $26,500 to their RRSP. Comparatively, in 2019, at age 60, an owner could contribute $41,936 to their IPP or $26,500 to their RRSP.

Surplus corporate tax deductions

Additionally, the ability to contribute more corporate money to the IPP may be available to an owner if the rate of return in the IPP falls short of the government-prescribed 7.5% per year. Given the current interest rate outlook (Government of Canada 10-year bond at approximately 1.44%), achieving 7.5% over the foreseeable future for any investor, let alone a conservative investor, seems daunting. As a result, the corporation would be required to contribute more corporate money to the IPP to make up any return shortfall. Therefore, assets are being shifted from the corporate investable assets to the IPP and further reducing passive income capacity and risk to the business owner’s SBTD.

Servicing cost tax deductibility

Further encouraging the shifting of assets from passive income assets to registered assets is the fact that both investment management fees and actuarial charges are tax-deductible to an owner’s corporation. Actuarial and annual reporting charges are unique to IPPs, as a licensed actuary must complete a funded status valuation of the plan every three years at a minimum, while regulatory filings and bookkeeping activities may also be required. However, this actuarial charge is more than offset by the fact that investment management fees are tax-deductible to the corporation compared to an RRSP scenario where these fees cannot be personally or corporately deducted. As a result, if we assume that the actuarial charges and investment management fees offset one another, the assets still shift from the corporate investable assets (where fees are paid) to the IPP (where fees are incurred).

Purchase of past service

Lastly, similar to an RRSP (which accumulates RRSP contribution room over time), an IPP allows for the
purchase of past service. An owner may have had years where they were not able to contribute enough for
retirement. In this scenario, the owner can make a lump sum contribution from their corporate investment
assets to their IPP to make up any deficiency. As a result, assets are shifted from corporate non-registered investable assets to the IPP, thereby reducing the balance of corporate investable assets that may produce passive income that would risk the owner’s SBTD.

IPP due diligence

This planning strategy can provide significant retirement and tax benefits to an owner with the ability to incorporate. However, establishing an IPP should be made after careful deliberation, as the following disadvantages may actually outweigh the benefits of the plan (as compared to an RRSP):

• complications in the setup and administration of the plan
• restrictions on what the IPP can invest in
• restrictions on IPP investments
• possible annual contribution requirements

Before committing to this long-term strategy, it is vital to work with an experienced financial professional with the knowledge and capacity to handle IPP planning for owners.