Posted under: Business Owners, IPP
Over the past several decades, different professional associations have moved to allow their members to incorporate. Incorporation can allow for many tax advantages, however the rules governing these corporations differ. For example, incorporated physicians and dentists are allowed to have family members as shareholders. This can allow for family members to be named shareholders and, even if the benefits of doing so are more limited than before with the 2018 tax on split income (TOSI) rules, dividends can be shared amongst those shareholders allowing for income splitting opportunities as permitted in the Income Tax Act.
One of the key planning strategies for incorporated professionals is to retain business income in their corporation, after paying the corporate tax, with the goal of taking dividend income versus salary. Professional corporations, which generally qualify as small businesses and have access to the Small Business Deduction, are subject to two levels of taxation on their business income. This is where the planning can be significantly different depending on the corporation’s access to the Small Business Deduction.
The Small Business Deduction (SBD)applies to active business income below $500,000, after expenses are paid, where the corporate tax rate is significantly lower. For example, in Ontario, the combined federal and provincial tax rate is 12.2% for business income below $500,000 and 26.5% for business income above $500,000.
For partners in partnerships, if professional corporations are established, this $500,000 threshold has to be split amongst the partners. So for a member of a national accounting or law firm, the SBD becomes negligible and, as a result, the total tax payable by adopting a dividend strategy can be higher than the tax payable by adopting a salary strategy. For example, in Ontario, the top marginal tax rate on salary income is 53.53%. In contrast, for a dividend strategy where the professional corporation does not have access to the SBD and eligible dividends are paid to the professional, the combined top marginal tax rate is 56%. As a result, for these professionals that earn high incomes, often times taking higher salaries becomes a necessity.
With these considerations in mind, the need for meaningful deductions becomes more pronounced and the planning for retirement differs greatly from other professionals. So how do incorporated professionals save for retirement in a meaningful manner? The Individual Pension Plan (IPP) should be at the core of said planning.
WHAT IS AN IPP?
Individual Pension Plans (IPPs), have been in existence for decades. An IPP is an alternative to RRSPs where business owners, incorporated professionals, and their family members who are employees, can participate in a self-directed defined benefit pension plan akin to what public sector employees receive. An IPP allows for significantly higher funding than RRSPs where the company funds the plan using pre-tax corporate dollars, as opposed to the RSP that is funded with after corporate tax personal dollars.
There are many advantages to utilizing IPP as an alternative to traditional registered plans. These advantages include large deductions to the business as a result of the increased tax-deductible contribution room (up to 65% more than an RRSP), creditor protection, deductibility of investment and administrative fees, and the option to top up the plan if the investments fail to return a benchmark return (net of fees). This opens up a host of deductible expenses at the higher corporate rate. Let us look at an example:
Jane Doe is a partner in ABC Law LLP. ABC Law has over 50 partners and thus their SBD per partner within their PC is only $10,000. Jane is 55 years old and incorporated back in 2014 with annual corporate income of $550,000, she has taken salary of $350,000 per year and has maximized her RSP room with a market value of $650,000. She pays a 1.5% investment fee within her RSP account. Jane is married and only needs $250,000 in salary for lifestyle. During her recent investment review with her financial advisor, an IPP is suggested as a possible alternative for saving for retirement. Let us look at her situation.
As Jane has been incorporated for 10 years, the IPP allows for a past service contribution of $121,100 which also requires a transfer of $301,000 from her RSPs as a qualifying transfer. She also has a 2024 current service contribution of $42,000. In year one Jane has combined funding room of $163,000. Combining the $163,000, the $301,000 in RSPs, accumulating a 7.5%, results in a market value of $491,500 in year one. The investment fees generated at 1.5% is $7,365.
Making the $163,000 contribution in year 1, plus the deductibility of $7,365 in fees will reduce the income Jane draws from the PC saving her $91,196 in personal taxes short term, within a creditor proofed retirement plan. Over 10 years she is able to accumulate $1,695,000 in assets versus $1,170,000 had she stayed the course and invested in RSPs, assuming her RSPs grow at the same 7.5% interest rate. In light of these unique tax rates governing these types of professional corporations, IPPs should be a core tool. The math speaks for itself.
Founded in 1995, GBL is a leading provider of retirement, health, and cross-border solutions for business owners across Canada. With offices in Calgary and Toronto, we have served 6,000+ clients, have 3,000+ Financial/Investment Advisors in our network, actively manage 2,000+ IPPs and RCAs, and have created 1,000+ HBPs and 3,000+ FMVs. We’re known for our industry leading client service and administration, as well as our top-notch actuarial group. Contact us today at [email protected] or 403.249.1820 and follow us to learn how we can help Build Your Future. www.gblinc.ca
