What Is an Individual Pension Plan (IPP)?

An Individual Pension Plan (IPP) in the United States is a specialized defined benefit retirement plan for incorporated business owners, high-income professionals, and self-employed individuals. These plans offer a structured approach to retirement savings, allowing participants to build substantial tax-deferred wealth beyond the limits of more common retirement vehicles. They are often referred to as Solo Defined Benefit Plans or Cash Balance Plans.

Understanding Individual Pension Plans

An Individual Pension Plan functions as a registered defined benefit (DB) retirement plan. These plans establish a predetermined retirement income, calculated through a formula considering factors like salary history, years of service, and age. This differs from defined contribution plans, where the retirement benefit depends on investment performance and contributions. The employer, typically the business owner’s corporation, assumes the investment risk and ensures future payouts.

These plans are particularly suited for incorporated business owners, professionals, and high-income employees with significant earnings, often in their mid-40s or older. Those with stable, high incomes who can consistently contribute substantial amounts find these plans advantageous. They allow for significantly more tax-deferred retirement savings than other common plans. The sponsoring company (sole proprietorship, LLC, or S-Corporation) establishes and funds the plan, with the owner or employee as the primary beneficiary.

A cash balance plan, a specific type of defined benefit plan, often serves this purpose. It’s a “hybrid” plan, combining features of both defined benefit and defined contribution plans. A hypothetical account is established for each participant, crediting them with a “pay credit” (e.g., a percentage of salary) and an “interest credit” (a guaranteed rate). The employer retains investment risk and is responsible for funding.

Key Features and Mechanics of IPPs

These defined benefit plans offer distinct characteristics. They have significantly higher tax-deductible contribution limits compared to other retirement savings vehicles. The maximum annual benefit can reach $275,000 for 2024. Contributions are calculated by an actuary based on the desired benefit, participant’s age, and expected investment returns, allowing for accelerated retirement savings.

These plans offer considerable tax efficiency. Contributions made by the sponsoring company are generally tax-deductible, reducing the business’s taxable income. Assets within the plan grow on a tax-deferred basis, meaning taxes are not paid on investment gains until funds are withdrawn in retirement. This deferral can lead to substantial wealth accumulation over time, particularly for individuals in higher tax brackets. Upon retirement, the pension income received is then subject to taxation.

Participants, particularly business owners, often control the plan’s investment strategy. This control must adhere to federal pension regulations, outlined in the Employee Retirement Income Security Act of 1974 (ERISA). Assets held within a qualified retirement plan, including defined benefit plans, generally receive strong creditor protection. ERISA-covered plans typically shield funds from general creditors, including those from lawsuits or bankruptcy, providing asset security.

These plans require actuarial valuation and funding. An enrolled actuary determines the required annual contributions to ensure the plan can meet its future pension obligations. Periodic assessments of funding status are involved, and the sponsoring company must make up any shortfalls.

Regulatory oversight and actuarial services contribute to the administrative complexity and higher costs associated with these plans. Annual filings, such as IRS Form 5500 with Schedule SB, are required and must be signed by an enrolled actuary. These administrative requirements ensure compliance with IRS and Department of Labor regulations.

IPP Compared to Other Retirement Plans

Individual Pension Plans (Solo Defined Benefit Plans or Cash Balance Plans) offer distinct advantages over other common retirement vehicles. They contrast with 401(k) plans, which are defined contribution plans. In a 401(k), the final benefit depends on contributions and investment performance, with the employee bearing investment risk. Defined benefit plans promise a specific income at retirement, shifting investment risk to the employer.

Contribution limits represent a significant differentiator. While 401(k)s have annual contribution limits (e.g., $23,000 for employee deferrals in 2024, plus employer contributions), defined benefit plans allow much higher contributions, sometimes exceeding $300,000 annually, particularly for older owners. This higher capacity for tax-deductible savings suits high-income individuals maximizing retirement funding.

Compared to other employer-sponsored defined contribution plans like Profit-Sharing Plans or Money Purchase Plans, Solo Defined Benefit Plans stand out due to their guaranteed benefit structure. While defined contribution plans rely on individual account balances, defined benefit plans offer a predictable income stream in retirement. This certainty is reassuring for those preferring a guaranteed payout over market-dependent returns.

Compared to a corporate investment account, an Individual Pension Plan offers substantial tax advantages and asset protection. Investments held directly within a corporation are subject to corporate income taxes on gains, and distributions to owners can incur personal income tax. In contrast, IPP assets grow tax-deferred within a trust, and contributions are tax-deductible. ERISA’s robust creditor protection for qualified plans shields IPP assets from business and personal creditors, unlike corporate investment accounts. It is also possible to combine a Solo Defined Benefit Plan with a 401(k) or other defined contribution plans, allowing for greater tax-deferred savings and flexibility.