|
Retirement Compensation Arrangements
In the right circumstances a Retirement
Compensation Arrangement, or RCA,
could save you income taxes, provide
golden handcuffs, retirement funding
and/or help protect your assets.
RCAs are designed to provide
supplemental pension benefits for
senior executives and owner-managers,
and are also used to provide pension
benefits to an employee or an
employee group in situations where a
company does not have a registered
pension plan in place. The rules related
to the operation of an RCA are less
rigorous than the rules related to the
operation of a registered pension plan.
As such, RCAs are extremely flexible
and can provide an employer with a
wide range of alternatives related to
employee participation, funding
methods and timing of benefits.
Operationally, RCAs are relatively
straightforward. The terms of operation
for the RCA are set out in the RCA
trust agreement. The employer makes
tax-deductible contributions to the
trustee of the plan. The plan pays a
special refundable tax each year equal
to one-half of the contributions received
plus one-half of the income and capital
gains earned by the plan during the
year. This tax is refundable to the plan
on a basis of $1 for every $2 of benefits
paid out during the year. The employee
is taxed on benefits when they are paid
out of the plan.
An RCA contribution must be reasonable
in order to be deductible to the
corporation. This is the same test that all
corporate expenditures must pass. The
contribution limits are often actuarially
determined on the basis of providing the
employee with a reasonable pension
based on a percentage of the
employee’s average annual income
earned during his or her years of
employment. This can result in significant
catch-up contributions when you start
the plan, particularly if the company has
a history of paying large bonuses.
Various funding strategies are available
to the company. The funding method is
often selected based on the company’s
cash requirements and its objectives in
establishing the plan.
- Cash funding— The company makes
cash contributions to the RCA trust.
One-half is used to pay the special
refundable tax and the other half is
invested. The RCA can loan the
after-tax amount back to the company
at a reasonable interest rate and with
reasonable security. This can be a
win-win situation for both parties.
The company obtains financing at less
than bank rates and the RCA earns
interest at better than market rates.
In some cases, arrangements can be
made by the RCA to borrow against the
refundable taxes and loan the proceeds
to the company. In such cases the RCA
loan arrangement has significant cashflow
advantages over the traditional
bonus and loan arrangements entered
into by many owner–managers.
- Insurance funding— The company
funds a split-dollar life insurance policy
under which the company is the
beneficiary of the insurance policy and
the RCA is the beneficiary of the
investment component or tax-exempt
surplus. Special refundable taxes must
be remitted equal to the amount of the
annual premium attributed to the taxexempt
surplus. The benefit of this
arrangement is that the investment
income earned within the insurance
policy is tax exempt and not subject
to the 50 per cent refundable tax.
As such, the investment compounds
at pre-tax rates. The death benefit
received by the RCA will be subject
to tax unless it is paid out to RCA
beneficiaries in the year received.
Under this arrangement the RCA
funds benefit from policy loans and
death benefits received. The fact that
these investments are secure from
business risks is also attractive.
- Funding from future cash flow —
The company can undertake to fund
the RCA out of future cash flow as
the RCA’s benefit obligations come
due. This arrangement provides
limited current tax benefit to the
company and can leave the
employees at risk unless the company
provides the RCA with some form of
security. However, caution must be
used when setting the security. The
Canada Revenue Agency holds the
view that the company has made a
contribution if it provides the RCA
with a letter of credit under which the
bank encumbers specific corporate
assets. This will result in a refundable
tax liability equal to the amount of the
encumbrance. On the other hand, a
letter of credit secured by a floating
charge on assets will result in a
notional contribution equal to twice
the annual fee.
As noted earlier, RCAs can be a useful
component of a company’s retirement
package by providing flexibility and
cash-flow benefits. Depending on the
circumstances, other possible benefits
include:
- probate fee savings, since pension
benefits do not flow through the
estate
- tax savings if an employee ceases to
be a Canadian resident after
retirement
- flexibility in timing of contributions,
allowing contributions to track
profitability
- assistance in succession planning by
ensuring retiring shareholders have
sufficient retirement income
RCAs do have one key disadvantage — the refundable tax rate of 50 per cent
results in a prepayment of tax
because the top personal tax rate in
all provinces is less than 50 per cent.
This prepayment ranges from a high
of 11 per cent in Alberta to a low of
1.4 per cent in Newfoundland.
For most provinces the prepayment
is approximately 3.5 per cent.
Consequently, RCAs are more attractive
to Newfoundland residents and less
attractive to Alberta residents.
Is an RCA right for your company?
You should consider discussing the use
of an RCA with your professional
advisers if ...
you are a shareholder in a private
company with a history of income
above the $300,000 small business
deduction
- your company has the liquidity to pay
bonuses or RCA contributions
- your company wants access to
more capital
- your company wants to reward key
employees who have worked for
the company for a number of years
- you want to create a pension and
grow it by reinvesting it in your
business
|
