GBL Actuaries & Consultants

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Considering that today so many executives will move multiple times in their career, severance payments can be opportunities for retirement planning and/or tax bracket management.

Executives could defer tax on their severance package with the use of an RCA. Given that many executives will receive in excess of what they require to live in the given year, saving, or sheltering some income can be advantageous.

When you use an RCA to receive the severance payment you allow the executive to withdraw the money as needed or not at all.  As there is no requirement to withdraw the income it can remain in the Plan and be available for future years when income is lower or nil.

Employment lawyers are starting to see the functionality of the RCA in these matters.

If a senior executive is terminated and paid out $400,000 as severance this amount is considered income in that year and subject to full taxation regardless of provincial residency.  To avoid the tax burden at once an RCA will allow the payment to be drawn out in smaller amounts over several years or a couple as needed.

In this case, an actuarial calculation will determine if the company may contribute $400,000 as a one-time contribution to an RCA. The RCA documents may be prepared to remove any company roll after initial contribution, or a letter of understanding may be prepared by all relevant parties setting out that the RCA is to be funded with a single contribution and the sponsoring company will have no legal tie or future responsibility to the RCA or plan member after funding. The RCA is then funded and as the plan member has been terminated, which would constitute a substantial and material change in the nature of employment, they would be legally entitled to commence withdrawals, again according to their requirements and not according to a legislated schedule as with a pension or RIF. 

If that individual found employment soon after termination from the previous firm they may not need to access the RCA for many years, and this may constitute a new important source of retirement income in the future.  If the plan member needs income, they may commence such income, but in amounts of their choosing. 

Therefore, the lump sum severance payment which would have resulted in top bracket taxation on the majority of the payment will be replaced with smaller payments that, because of tax bracket management, will attract substantially lower taxation. Applying Ontario rates, a $400,000 severance payment (excluding other income) would result in taxation of $168,055. Compared to withdrawing the money from an RCA over four years at $100,000 per year, would result in tax of $29,374 annually, or $117,496 in total, a considerable savings in tax by any measure.