A business owner with a Defined Benefit (“DB”) plan has several advantages over one with a traditional RRSP. A powerful tax planning tool that is only available through DB plans is known as “Past Service Buyback”. This is loosely defined as follows:
“The buyback of past years of service for a [Plan] member is calculated from the date of incorporation of the company sponsoring the [Plan] for years during which the member was not a member of a pension plan.” 1
In practical terms, Past Service Buyback allows a Plan Member to catch up on missed DB contributions from prior years. These contributions are tax-deductible, which presents an interesting opportunity for a tax-savvy business owner.
A business owner can set up a Defined Benefit plan, using either an Individual Pension Plan (“IPP”) or Personal Pension Plan (“PPP”) structure. An actuary can then calculate the amount, if any, of Past Service Buyback she has available. Working with her accountant, she can then decide if she wants to use some or all of that contribution room in the current year.
Here is a situation where this strategy may be beneficial to a business owner.
Offset Active Business Income above $500,000
The first $500,000 of active business income in a CCPC benefits from a lower tax rate, currently 15% in Ontario.2 Active business income above this amount is taxed at a much higher rate of 26.5% in Ontario.2
Tax accountants use several strategies to reduce total active business income down below the $500,000 level. As astute business owner can use Past Service Buyback as one strategy to get below this threshold. Let’s say that the company has $600,000 of active business income, and the business owner has $100,000 of Past Service Buyback contribution room. The company could make a $100,000 contribution to her Defined Benefit plan, reducing its income to the desired $500,000 mark.
Using a Personal Pension Plan (“PPP”)
A business owner with a Personal Pension Plan would have even more flexibility to accumulate Past Service Buyback and trigger it in the year that would have the greatest tax benefit. That’s a more advanced topic that requires an in-person conversation.
The strategies above are presented in a very simplified manner and should not be executed without guidance from a Professional Accountant.
I can assist you in determining the value of implementing the PPP as part of your overall investment and tax plan. Contact me for a free consultation to see if a PPP makes sense for you.
Personal Pension Plans (PPPs) require Plan Administration, Trustee and Actuarial services not provided by Richardson GMP Limited to be successfully implemented. We strongly suggest that clients obtain independent tax and legal advice prior to implementing a Personal Pension Plan strategy. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.