As a dentist, you’re probably aware of the impact the Income Tax Act has on your life, considering tax is likely your biggest expense. With the average Canadian dentist paying personal tax rates of 43%–50%, taxes drag on dentists’ ability to grow their wealth over time. Understanding how to reduce this drag is crucial in achieving financial goals, whether you’re a serial entrepreneur or someone aiming for a work-optional lifestyle.
One of the most underutilized tax planning opportunities available to dentists lies within pension legislation. Business owners and incorporated professionals can use an Individual Pension Plan (IPP) to help grow their wealth on a tax-deferred basis.
So what is an Individual Pension Plan (IPP)?
IPPs are registered pension plans with the CRA that business owners/incorporated professionals can create for the benefit of themselves and their families. You’ve likely heard of employees of large public companies or the government who have access to sizable pensions. An IPP is no different. It is a defined benefit pension that promises to pay an income during retirement and is governed by the same rules as large pensions.
IPPs provide many benefits, but to be succinct, I will focus on those that help dentists accumulate wealth while also reducing corporate and personal taxes.
You could think of an IPP as a corporate RRSP on steroids. Your corporation contributes to your pension on your behalf. The advantage here is that pension legislation is more generous than RRSPs and allows for larger annual contributions. If you view the chart below, you’ll notice that the allowable contributions to a pension begin to outpace those of an RRSP. This advantage means significantly more funds will grow on a tax-deferred basis, which ultimately means a bigger pot to draw from in the future. In most situations, the difference is between $700,000–$1,000,000 of additional funds at the time of retirement.
|Age||RRSP Contribution||IPP Contribution||IPP Advantage|
Reduce Passive Income Inside Corp and Increase Funds Growing Tax-Deferred
In 2018, the Federal Government changed rules concerning passive investments within corporations. These changes made it less advantageous for incorporated individuals to use corporate dollars to create retirement portfolios for themselves and their families.
You’re probably aware that your dental corporation pays a lesser tax rate on your first $500,000 of active business income (12.2% in Ontario), known as the small business deduction. Any earnings after that are taxed at the higher corporate rate (26.5% in Ontario). Not only is it less advantageous now, but it is also punitive anytime passive investment income earned within a corporation exceeds $50,000.
With the 2018 changes, your access to these lower tax rates will reduce by five dollars for every dollar of passive income earned above the $50,000 threshold. At $150,000 worth of passive income, your small business deduction is eliminated, meaning your corporation will pay tax at the higher 26.5% on all your active business income.
In addition to the small business deduction problem, passive income is also aggressively taxed within a corporation. Passive income inside a corporation is taxed at the highest marginal tax rate of 50.2% (Ontario).
How pension legislation can help with both problems
An incorporated dentist can shift passive assets into an IPP. Investment returns within an IPP do not affect your access to the small business deduction. The investment returns are also tax-deferred (not taxed at 50.4%), and no taxes are paid until the income begins to be paid from the pension. When the income is eventually paid, it’s taxed at your personal tax rate rather than the highest marginal rate, 50.4%.
Large corporate tax deductions (past service, regular contributions, and terminal funding)
When setting up a pension, there is almost always “past service.” Past service refers to a period where the owner earned T4 income from the corporation but did not contribute to a pension. We commonly see past service contributions in the five to six-figure range. Upon plan setup, dentists can contribute for past service and immediately receive a sizeable corporate deduction, reducing corporate taxes payable.
As mentioned earlier, pension legislation is more generous and allows for significantly higher contributions after age 40. These contributions are tax-deductible expenses to the corp. Over the lifetime of the pension, incorporated individuals can expect six or seven figures worth of corporate deductions, providing even further tax savings.
One of the most valuable tax benefits lies in terminal funding. Terminal funding is the amount a corporation needs to contribute to a pension upon the pensioner’s retirement to provide the individual with full pension benefits.
Terminal funding amounts are also six and seven figures in size. This corporate tax deduction provides incorporated dentists with significant corporate tax savings and a full pension at an earlier retirement date.
Passive Investment Income: Income earned from investments unrelated to the business’s primary operations.
Active Business Income: Income earned from a business’s primary operations.
Small Business Deduction: The first $500,000 of active business is taxed at a small business rate
(9%-12% depending on your province).
Investment Management Fee Deductibility
Today, most investors who have funds invested, whether through an RRSP or some other account, are being charged an investment management fee (IMF). This fee will typically fall between 1%–2% per year based on the total funds invested.
A unique advantage an IPP has over an RRSP is that all investment management fees associated with IPPs are tax-deductible to the corporation. With RRSPs, investors cannot deduct investment management fees. Over a 20- or 30-year period, this amounts to significant tax savings that would have otherwise been unavailable using RRSPs.
Given the pandemic, it is safe to say the tax environment for incorporated professionals will continue to be challenging and likely even more punitive in the future. It has never been more important for dentists to ensure they take steps to protect their financial future for themselves and their families.
Anytime a serious discussion around IPPs or any other specialized tax advice is being had, it’s crucial to have the right professionals involved. We always recommend engaging your accountants, financial planners, and other tax professionals when evaluating any advanced planning solutions.
About the Author
Brandt Butt is a Portfolio Manager and Investment Advisor with the award-winning team Endeavour Wealth Management with iA Private Wealth. Brandt’s focus is working with incorporated dentists between the ages of 35-45 who are looking to set themselves up on the right financial path in hopes of reaching a point where they are choosing to work, instead of having to. He helps dentists accomplish this dream by collaborating with their accountants and lawyers helping them to implement advanced financial planning solutions specific to dentists.