Individual Pension Plans for Health Care Professionals
October 28, 2019
By Tammy Rea and Tracey Lundell, Financial Experts
Saving for retirement in a tax-efficient manner
Family Doctors are often small business owners, and do not always have the opportunity to benefit from employer pension plans and, instead, are responsible for accumulating their own retirement savings. A common strategy employed by incorporated health care professionals involves the accumulation of wealth by retaining funds within their corporation. However, there have been recent changes to the taxation of passive income (ie: investment income) earned inside private corporations which may potentially reduce accessibility to the small business tax rate. Therefore, these changes have limited the amount that can be accumulated in a corporation at preferential tax rates.
Incorporated health care professionals may wish to consider an Individual Pension Plan (IPP) — a retirement savings plan that can provide additional opportunities to minimize the overall tax liability. An IPP is similar to a typical employer-sponsored pension plan except that it is typically created for one key employee, not a group of employees.
There are two factors relevant in determining IPP contributions:
The age of the employee
The amount and method of compensation
Consequently, IPPs are most appealing when the combination of these factors allow for contributions that exceed the Registered Retirement Savings Plan (RRSP) contribution limit. When the professional is over the age of 40 and is limited by the annual maximum RRSP contribution limit, an IPP may be advantageous.
IPPs = Defined Benefit Plans
As defined benefit (DB) pension plans, IPPs are regulated under provincial legislation and registered with Canada Revenue Agency (CRA). The corporation is both the IPP sponsor and administrator, with a trustee who will manage the IPP’s assets. When appointing a trustee, consideration should be given to the firm’s understanding of pension legislation and the type of custodial arrangement that governs the IPP. To establish the proper funding level, an IPP must be assessed by an actuary every few years.
Accumulating Retirement Assets in an IPP versus your corporation
Private Corporation income arising from an investment portfolio is treated as passive investment income, however, under recent changes to the rules governing the taxation of passive investment income, the small business tax rate will be reduced for passive income between $50,000 and $150,000 in a given tax year. The federal small business limit of $500,000 will be reduced by $5 for every $1 of passive income over $50,000. Depending on the province, the provincial business limit may or may not follow the federal treatment.
The potential loss of access to the small business tax rate is likely to have an adverse impact on professionals with a large retained earnings balance inside their professional corporations. An IPP should be considered as a tool for retirement income accumulation that may help minimize the tax impact of the passive income rules on the corporation.
Considerations for IPPs
IPPs can offer several benefits that make it an attractive strategy to help accumulate retirement savings:
As a DB pension plan, the retirement income from the IPP will be predictable over time.
There is some flexibility in how an IPP is set up and may include other features such as an additional voluntary contribution account held under the IPP umbrella that is separate from the required IPP contributions or a defined contribution component.
Costs associated with setting up and maintaining an IPP may be higher than other registered plans. However, administrative costs including accounting, actuarial and investment management fees paid by the corporation to establish and maintain the plan, as well as contributions to the IPP are tax-deductible to the corporation.
IPP contributions are not taxable to the plan member at the time of contribution so there is the benefit of tax-deferral.
Depending on investment returns, contributions may need to be increased or decreased to fund the pension benefit. If the corporation needs to borrow to fund the IPP, the interest may be deductible. Certain provinces may allow flexibility in funding requirements. For professionals that retire before the age of 65, the plan could pay a bridge benefit.
Income splitting with your spouse or common-law partner is permitted when the IPP benefits are paid out.
Income splitting can begin at age 55 rather than age 65 — the minimum age requirement for income splitting with a Registered Retirement Income Fund (RRIF), for all provinces other than Quebec, in which the age is still 65.
Once the IPP plan holder has retired, the actuary can determine if there is sufficient contribution room to pay terminal funding. Terminal funding provides an opportunity to make additional contributions if there is contribution room based on various actuarial assumptions for the IPP plan holder.
IPPs are protected from creditors.
Comparing an IPP with an RRSP
The key benefit of IPPs is that they permit higher annual contributions than traditional Registered Retirement Savings Plans (RRSPs). This typically occurs as the plan holder ages to ensure the plan is fully funded and can potentially enable greater tax-deferred accumulation within an IPP. A plan holder may accumulate significantly more in an IPP than in an RRSP because contributions are based on increasing age and income.
Funds within an IPP are locked-in, which means they cannot be withdrawn until retirement. With an RRSP however, funds may be withdrawn at any time, and are subject to taxation. Contributions can be made for past years of service covered under an IPP based on the salary drawn from the corporation. It is also possible to roll over the health care professional’s RRSP funds to an IPP, tax-deferred, to take full advantage of past service contribution room. As with an employer-sponsored DB plan, IPP contributions will reduce the plan holder’s RRSP contribution room in the following calendar year.
Retirement and death
Upon retirement, the funds accumulated in an IPP may be used to provide ongoing retirement benefits, used to purchase an annuity or transferred to a Life Income Fund (LIF) or locked-in RRSP. If the plan holder passes away before reaching retirement but has a surviving spouse, they will have the option of purchasing a deferred annuity with the IPP funds or commuting them to a locked-in plan. These options may vary by province. If there is no surviving spouse upon the death of the plan holder, the IPP proceeds are distributed to the plan holder’s estate or a named beneficiary and are subject to tax.
The optimal strategy for accumulating retirement savings will vary with each individual health care professional. Due to the inherent complexity involved in establishing and maintaining an IPP, consult with your financial advisor and other IPP specialists when considering if this retirement plan is right for you.
Tammy Rea and Tracey Lundell have worked in the financial industry together for over 25 years, with special focus on advising Health Care Professionals. Their experience providing lending, banking, wealth management and financial planning advice has been invaluable to many individuals as they focus on making their professional careers a success.