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 Act’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 RRSP, on the premise that an annual tax-deductible contribution of 18% of a business owner’s or executives 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% 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, today’s maximum pension limit incomes would be $193,000 (70%) 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.
The Canadian Income Tax Act’s retirement solution for high income earners!
To end RRSP/Pension discrimination against high-income earners, the federal government in 1986 introduced in subsection 248 (1) of the Income Tax Act the Retirement Compensation Arrangement (RCA).
A Retirement Compensation Arrangement (RCA) is frequently overlooked in planning executive compensation. In the CCRA’s 2003 Retirement Compensation Guild, an RCA is described as “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.”
What are the advantages and benefits of an RCA?
There are several benefits to creating an RCA:
1. Contributions are 100% 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 Taxes do not apply until the money is withdrawn during retirement.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. Second, RCAs are exempt from payroll and healthcare taxes.
3. RCAs are exempt from provincial pension regulators.
4. Assets in an RCA investment account compound tax-free.
5. An RCA plan can provide “golden handcuffs” as a reward for continued service.
6. An RCA allows the buy-back 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 company’s assets, and are therefore protected from the sponsor’s creditors.
9. Assets in an RCA are excluded from the holder’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 percent 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 tax rate jurisdiction where they can pay as low as 15 percent tax on the proceeds from their RCA.
12. RCAs can be set-up to tax defer 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 into 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 into an RCA?
Imagine a dentist who 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 dentist has maximized his or her RRSP/Individual Pension Plan, and expects to receive annual income increases of 4.5 percent per year until retirement at age 65. This person can expect to accrue a pensionable income of $484,963, (70 percent of the last three years’ average). The estimated immediate contributions that can be made for this individual’s RCA as a tax deductible expense for the incorporated practice and a non-taxable benefit for this individual is $2,653,000. Their tax-deductible contribution for 2004 would be $186,000. [Contribution amounts in the RCA increase by approximately 3.5 percent annually, to match inflation].
How can your company finance contributions?
1. Use funds that have accumulated in your company’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 tax-exempt 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 tax effective 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 personal 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 dental practice 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 J. Merrick, FMA, CFP, FCSI is President of Merrick Wealth Management Inc. in Toronto, Canada’s IPP and RCA implementation specialist for corporations and professionals.