Are there better ways to invest for your future and at the same time reduce your current tax bill? In North America where we have supersized everything, is there a supersized pension as well? What about an Individual Pension Plan (IPP) or a Retirement Compensation Arrangement (RCA)? Both allow your corporation to make tax-deductible contributions towards your retirement; these contributions are not taxable to you until after you retire. Do you want to know what the differences between these plans are and more importantly, which plan is better for you?
We have summarized some of the various plans below. However, please note that this list is not exhaustive. It is important that you discuss the setup, implementation and maintenance with a IPP/RCA specialist.
IPP
An IPP is a structure that allows corporation e.g. professional corporations (PC) to make tax-deductible contributions on behalf of their key employees (including the dentist) to fund their retirement. Income earned inside an IPP is tax-free. Hence, a dentist must have a PC before an IPP can be established.
What are the advantages of an IPP?
Non-taxable to you: Your PC gets a full deduction on the contribution and you are not taxed until after you retire. Hence, your PC is paying for your retirement.
Creditor-proof: If you are sued or go bankrupt, assets within the IPP will be protected.
Higher deduction limit: Depending on your age, the IPP contribution limits are typically much higher than RRSP limits. Annual limits are a function of several variables including your age, length of service to your company and past salary. IPPs are a defined benefit plan. Simply stated, if the investments in your IPP perform poorly, your PC can make additional tax-deductible contributions to compensate for the poor returns. This is not permitted for an RRSP.
Fees are deductible: The annual IPP maintenance fees paid by the PC are deductible; this is impossible with an RRSP.
What are the disadvantages of an IPP?
There are costs associated with setting up an IPP as well as maintaining it. Also, an actuarial valuation is required every three years to calculate the tax-deductible contribution limits. The following are other factors that need to be considered.
Locked-in: Unlike an RRSP, an IPP does not permit early withdrawal i.e. you can only draw out funds once you retire.
No splitting: There is no equivalent to a spousal RRSP with regards to an IPP unless your spouse also works for the company and therefore qualifies for an IPP. However, with many dentists, the spouse plays an integral role as in the practice as the office manager etc.
Are you a candidate for an IPP?
IPP’s are best suited for individuals who:
* Are 40 years and older, (the older one is, the greater the tax-deductible contribution limits), and
* Earn a minimum employment income of $100,000 per year after expenses.
You will likely ask what happens to your IPP when you are ready to sell your business. You may either maintain the IPP or to close it; in any case, it stays with you and not with the purchaser.
RCA
Similar to an IPP, an RCA is another structure that allows PCs to make “supersized” tax deductible contributions on behalf of their key employees (including the dentist) to fund their retirement. One major difference between an IPP and RCA is that an RCA typically provides for larger, tax deductible contributions to be paid by the PC on the dentist’s behalf.
Unlike a pension or an RRSP where contributions are completely held in a single account, the RCA is divided into two (2) separate sub-accounts in which the assets are held. Each contribution is divided equally between the RCA’s “investment account” and another RCA account, called the “Refundable Tax Account” (RTA), which is held by the government.
The assets in the investment account can be invested in any investment (similar to an RRSP). However, taxes can be reduced if the RCA holder invests in tax efficient investments, such as those that appreciate but do not pay much (if any) dividends or interest. If the investments held inside the RCA generate any income or realized capital gains, 50% of such amount must be paid to the RTA. The assets in the Refundable Tax Account are held by CRA and do not accrue interest. The RTA is refundable on a basis of $1 for every $2 of benefits paid out during the year.
Some of the factors used in the calculation of tax-deductible contributions are age, an average of the employee’s best three years’ T4 earnings and the normal retirement date of the employee. An actuary will provide the amount of tax deductible contributions which can be made by the PC. In most cases, the older one is, the greater the tax-deductible contributions which can be made by the PC on the employee’s (dentist) behalf.
What are the advantages of an RCA?
Tax deferral: Through an RCA, substantial taxes may be deferred to a time of the individual’s choosing. This deferral of tax could result in huge tax savings depending on the country where one chooses to retire as the amount withdrawn may be taxed at a more favorable tax rate.
Tax jurisdiction: The issue of the tax jurisdiction is a bonus feature of the RCA. If a Canadian Citizen retires taking up residence in a different country, the assets can be withdrawn under the tax treaty in place between Canada and the country of retirement. For example, if the RCA holder takes up residence in Florida, (s)he will pay 15% taxes on any withdrawal from the RCA. Without the RCA, this income could be taxed at a rate as high as 46.41%.
Creditor-proof: Also, assets inside an RCA are creditor-proofed and RCA contributions escape the 1.95% Ontario Employer Health Tax and probate fees. Most of all, it is a legal and tax efficient way for dentists and possibly their spouses to save for their retirement and avoid many of the constraints and disadvantages imposed by RRSP’s.
What are the disadvantages of an RCA?
Set up and maintenance: There is a one-time set up cost and annual maintenance costs. The benefits upon retirement far outweigh the cost of setting up an RCA if one retires in a country which has a tax treaty with Canada, such as the U.S.
Are you a candidate for an RCA?
RCA’s are best suited for individuals who:
– Are 40 years and older, (the older one is, the greater the tax deductible contribution limits),
– Earn a minimum employment income of $150,000 per year after expenses. The more one earns, the more suitable an RCA is for him/her.
– Have little personal non-tax-deductible debt,
– Are planning to retire outside of Canada or to possibly a lower tax province.
Please note that a Professional Corporation (PC) or a corporation is also a prerequisite for an RCA. Hence, a dentist must have a PC or a corporation before an RCA can be established.
Please refer to the chart on previous page which summarizes what plan works best for you. It is worth your while to take the time to research and discuss the various options with your professional advisor before choosing your plan.
David Chong Yen is a chartered accountant. He advises healthcare professionals and owner-managers. He can be reached at: dcy@dcy.ca or www.dcy.ca
