Retirement Compensation Arrangements
by Peter Merrick FMA, CFP, FCSI
Over the past three decades businesses operating in Canada have found it difficult to provide a worthwhile retirement plan for their top people. A Retirement Compensation Arrangement (RCA) is the Income Tax Actâ€™s retirement planning solution for affluent professionals, business owners and corporate executives.
An RCA enables you to supplement your pensions and registered retirement savings plans, while increasing your financial and retirement security.
In 1957, the Canadian government introduced the Registered Retirement Savings Plan (RRSP), on the premise that an annual tax-deductible contribution of 18 per cent of a business ownerâ€™s or executiveâ€™s total T4 income would provide an adequate pension.
In 1976, the federal government set Registered Pension Plan limits at $60,000. This was considered enough to provide for a 70 per cent pension for an individual earning a T4 income of $84,000 – a handsome executive- level salary at the time. If pensions and RRSPs had kept pace with inflation, todayâ€™s maximum pension limit incomes would be $193,000 (70 per cent) per annum for individuals earning $277,000 per year).
Although the 2003 federal budget increased both RRSP and pension contribution limits, individuals who earn more than $100,000 continue to experience retirement/pension discrimination.
To end RRSP/pension discrimination against high-income earners, the federal government in 1986 introduced the RCA in s. 248 (1) of the Income Tax Act.
An RCA is frequently overlooked in planning executive compensation. In the CCRAâ€™s 2003 Retirement Compensation Guild, an RCA is described as â€œ a plan under which contributions are made by an employer or former employer to a custodian in connection with benefits that are to be, or may be received or enjoyed by any person on, after or in contemplation of any substantial change in the services rendered by the taxpayer, the retirement of the taxpayer or loss of office or employment of the taxpayer.â€
Advantages of an RCA
There are several benefits to creating an RCA:
1. Contributions are 100 per cent tax-deductible by the employer, and are a non-taxable benefit in the hands of the employee. Taxes do not apply until the money is withdrawn during retirement.
2. RCAs are exempt from payroll and healthcare taxes.
3. RCAs are exempt from provincial pension regulators.
4. Assets in an RCA investment account compound taxfree.
5. An RCA plan can provide â€œgolden handcuffsâ€ as a reward for continued service.
6. An RCA allows the buyback of previous RRSP contribution room prior to 1991.
7. An RCA provides a pension/ retirement benefit for executives who are not permitted to make RRSP or pension contributions due to non-resident status.
8. Assets held in an RCA are creditor-proof and are separate from the sponsoring companyâ€™s assets, and are therefore protected from the sponsorâ€™s creditors.
9. Assets in an RCA are excluded from the holderâ€™s estate and are not subject to probate fees when a beneficiary is named.
10. Owners of RCAs can arrange to borrow up to 90 per cent of the amount of the RCA contribution and loan it back to their operating company.
11. Owners/key employees can retire offshore to a lower-taxrate jurisdiction where they can pay as low as 15 per cent tax on the proceeds from their RCA.
12. RCAs can be set up to defer tax on severance packages.
13. Small- and medium-sized business owners and partners can use an RCA as part of their exiting and succession planning.
How do RCAs work?
Money is invested in an RCA through a trustee and is divided equally between two accounts: the RCA Investment Account and the Refundable Tax Account. The Refundable Tax Account is administered by CCRA. All funds in the Refundable Tax Account are refundable to the recipient of the RCA once money is withdrawn from the RCA during retirement.
How much can be invested in an RCA?
Say an executive is 45 years old and has had a T4 income of $300,000 per year for 15 years. (Note: This income must have been received from an incorporated business.) Our executive has maximized his or her RRSP/Individual Pension Plan, and expects to receive annual income increases of 4.5 per cent per year until retirement at age 65. This person can expect to accrue pensionable income of $484,963, (70 per cent of the last three yearsâ€™ average). The estimated immediate contributions that can be made for this individualâ€™s RCA as a tax-deductible expense for the company and a non-taxable benefit for this individual is $2,653,000. The taxdeductible contribution for 2004 would be $186,000. (Contribution amounts in the RCA increase by approximately 3.5 per cent annually, to match inflation.
1. Use funds that have accumulated in your companyâ€™s retained earnings.
2. Use outstanding bonuses owed to your key people by making the contribution for them.
3. Fund the RCA over time.
4. Obtain financing from your financial institution.
5. Take out an eligible taxexempt life insurance plan.
Should you have an RCA?
RCAs benefit top executives and key employees by ending RRSP and pension-maximum discrimination. RCAs provide a disciplined and orderly way for employers to help key people fund their retirement in a taxeffective way. RCAs do not affect RRSP or individual pension plan contribution limits and there are no caps on how much can be contributed into them. Nor do they have any caps on the payouts to planholders. Assets are held in trust and are protected from creditors of both the company and the individual. RCAs are best for owners, executives, and key personnel of a company with corporate profits of more than $200,000. Ideal RCA candidates are between the ages of 45 and 65 and have gross annual incomes over $100,000. If your company is planning to make or has made contractual promises to offer supplemental pensions or savings plans to attract or keep key people, an RCA that utilizes maximum tax benefits for your company and tax deferral for your key people is an option worth investigating.
Peter Merrick, FMA, CFP, FCSI, Instructor at George Brown and Seneca Colleges, President of Merrick Wealth Management, a boutique financial planning, employee and executive benefit consulting firm, Toronto, ON (416) 854- 1776 – You can reach Peter at email@example.com or visit his web site at merrickwealth.com