March/April 2003: by Darrell Nordstrom

The tax shelter businesses usually forget... individual pension plans

Introduction: If you are a successful small business owner that has been focused on the long-term growth of your business and your concerns have now become retiring from the business with an efficient succession plan, an IPP (Individual Pension Plan) may provide some answers.

Generally, these programs provide significant tax deductions for the corporation if the shareholder/employee's income has been in the $86,000 (plus) range and age is 45 or older.

Design: An IPP is an individual pension plan that can be established for the owner/employee(s) ''promising'' a pension benefit based on salary and years of service to the company. Once the pension amount is determined, the amount of deposits necessary to provide the level of promised benefit is established. The deposits will be made by the corporation to the pension plan on a tax-deductible basis and will be larger than RRSP limits each year.

Additionally, when starting the pension program it is possible to fund past service dating back to 1991. This demands a larger tax-deductible deposit in the first year of the program.

It is necessary to employ the services of an actuary to ensure the contributions are adequate and will provide the plan's defined benefits. The actuary will design the plan, provide past, current and future contribution limits, file all registration documents, and prepare regular reviews on your behalf. The initial tax deductible set up fee may be in the $2,500 range with annual subsequent costs being significantly less.

Deduction Limits: The attraction to retirement plans for many individuals is to reduce taxes immediately. Arguably, the most important feature is the ability to provide an acceptable retirement income through long-term tax deferral. Regardless, larger deductions provide both benefits.

For example, a 55-year-old owner/employee could set up a pension plan that provides the following tax-deductible contributions:

2003: $65,325 + $20,307 = $85,632
2004 = $21,830
2005 = $24,468
2006 = $25,228

The biggest tax advantage occurs the first year at $85,632 deduction due to the past service. Based on actuarial assumptions each successive year offers a substantially increased deduction limit when compared to RRSP limits.

Retirement Options: So far, the good news is that a larger amount of retirement funds are available because larger tax-deductible contributions have been deposited to the taxsheltered pension fund.

When retirement day arrives, the questions are focused on the income levels allowed from the program. Recent Saskatchewan pension legislation has been very positive because it allows great flexibility when withdrawing funds from the plan, almost identical to the rules for RRSPs.

The residual cash value of the plan can be transferred tax-free to the spouse of the member upon death, and transferred to other plan members (children/employees, for example) upon the death of both spouses with no immediate taxes payable.

Advantages: There are many advantages to an IPP.

1. The corporation gets a relatively large tax deduction ($85,632 the first year in the example) that helps reduce ''bonus down'' amounts that lower corporate profits to the small business deduction limit.

2. The money deposited to the pension plan transfers some of the value of the corporation to the individual and thereby reduces the value of the company, which makes it easier to transfer to the successor owner.

3. The shareholder/employee can save more for retirement and enjoy a better retirement income.

4. All funds in a pension plan are creditor protected.

5. In theory, any residual cash value of the pension plan can be transferred tax-free to spouses, to children that are employee/ members, and potentially grandchildren, thus postponing the tax bill from generation to generation.

Summary: For high-income shareholder/employees of small businesses the IPP is an attractive alternative for tax, retirement, and estate planning benefits. Ironically, these programs have remained relatively obscure, partly because of their complexity and partly because a limited number of situations have the necessary requirements. If you are in the select group that qualifies it may just be the ticket you need to provide the comfortable retirement you deserve.

. . .
About the author
Darrell Nordstrom, CLU, Ch.F.C., CFP, RFP, Senior Financial Advisor, Assante Financial Management Ltd. He can be reached at 1-877-837-3377 or 306-665-3377, or click to email Darrell Nordstrom.

Disclaimer
This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. This material is not intended to provide and should not be construed as providing individual financial, investment, tax, legal or accounting advice. You should consult your professional advisor(s) prior to acting on the basis of the information herein.

+ Back to main Archives page