As a dentist you know that from time to time you may be presented with a challenging case of a difficult extraction. As a Wealth Advisor and Financial Planner, I can tell you we are also often presented with a case of a potentially difficult extraction but instead of it being a molar, our challenge is to how best extract funds in the most tax efficient manner from the Dental Professional Corporation (DPC) of a practicing dentist.
One of the methods which has become more popular, especially given the recent tax changes involving Canadian Controlled Private Corporations (CCPC), is the Individual Pension Plan or IPP.
An IPP is a defined benefit pension plan tailored to small business owners such as dentists. It allows for the DPC, as sponsor of the plan, to fund a defined benefit style pension for the dentist and even their spouse if they are also employed by the practice. Thus, extracting corporate funds and directing them to a source which will provide tax efficient retirement income.
The amount of annual funding is similar to an RRSP in that it is a percentage of T4 earnings to a maximum annual limit; however, for an IPP that limit is even higher than the RRSP contribution limit – and grows each year. In addition to the annual funding, the company can also contribute any past service earnings as well as a lump-sum terminal funding at retirement. All these contributions are tax deductible to the corporation. Like an RRSP, your investment choices are broad and any income or capital gains generated inside the plan are sheltered from taxes, but unlike an RRSP, all of the administration fees and investment management fees are tax deductible expenses to the corporation.
Because an IPP is a formal pension plan, it must be registered with the provincial government and must make annual filings and reporting. In addition, a triennial valuation must be performed by an actuary. The plan administrator will generally perform all these requirements and the cost for these is customarily included in the annual administration fee, which is tax deductible.
When the actuary conducts this triennial review one of the items reviewed is the rate of return achieved by the plan. IPP’s are legally mandated to achieve an annualized rate of return of 7.50%. If there is a shortfall, the company is required to contribute the difference to the plan. Again, this catch-up contribution will be a tax-deductible expense to the corporation. However, if the plan achieved a greater than 7.50% return, the DPC might have to take a contribution holiday if the amount is significant.
At retirement the plan can be set up to provide a regular stream of income by way of a pension or the commuted value of the pension can be transferred to a Locked-in Retirement Account or LIRA.
The difference in value over an RRSP at retirement can be significant. One projection we had calculated for a 55-year-old dentist and his 50-year-old spouse had them with over $1 million more in the IPP than if they just went the RRSP route at retirement.
This will not only allow them to extract more money from the company in a very tax efficient manner, but it will also provide them with a known pool of capital at retirement, which will provide them with a predictable income stream through retirement.
Upon death of the annuitant the remainder of the plan can be transferred to a surviving spouse or if there is no surviving spouse, the annuitant’s estate.
However, there are some drawbacks to an IPP. The most common drawback is that it limits contribution room to an RRSP. However, this limitation isn’t a major one for dentists since the bulk of retained earnings, is destined to provide for a retirement income in the future. Some of the other drawbacks are because regular contributions are required to be made, this can be problematic for businesses that don’t have regular income streams. Another small limitation is that funds within the IPP can’t be accessed before the age of 55, but for most dentists these constraints are not an issue.
At TriDelta Financial we recognize that the recent tax changes, IPP’s have become a very effective tool for extracting funds efficiently from your DPC and should be given serious consideration by every incorporated dentist over the age of 45.