Posted under: RCA
Building a strong team of employees is a challenging task for any employer and continually motivating and retaining your business leaders can be puzzling. While bonuses, shares and/or call options, group benefits and RRSP contributions are the typical go-to components of an executive compensation package, employee pension planning can be utilized by a company as a key differentiator, providing valuable incentives to employees. However, many employers have concerns about the high cost of registered pension plans (RPPs) and are actively searching for viable alternatives.
A Retirement Compensation Arrangement (RCA) is defined under Subsection 248(1) of the Income Tax Act (Canada) and allows a company to make tax-deductible contributions on behalf of key employees for the purpose of supplementing their retirement income. An RCA may be used to offer benefits that would have been provided for under an RPP if not for the restrictive limits. It can also be used to deliver a separate pension promise altogether.
The RCA Structure
The application for an RCA is filed with the RCA Unit of the Canada Revenue Agency (CRA). Each year the company may elect to make contributions on behalf of the plan member, who may also be required to contribute. Half of all contributions are made to the RCA Trust investment account and the other half are remitted to the Refundable Tax Account (RTA). Half of net realized investment income is also remitted to the RTA on an annual basis. Similarly, the investment account can recover half of net losses to the extent refundable tax has been remitted on realized gains in prior years
The investment account is managed by the trustees of the RCA, as directed by the company or principal plan member. There are few investment rules or restrictions:
Upon retirement or a change of employment status, the plan member will draw from the assets of the RCA Trust. An amount equal to 50% of the distribution from the investment account will be refunded to the investment account from the RTA after the T3-RCA Tax Return has been completed at the calendar year end. Payments from the RCA are flexible and not subject to any minimums, maximums or mandatory withdrawals at age 71. Payments are taxable in the hands of the plan member and subject to a 30% withholding tax at the time they are received. A lower overall tax rate may apply if the plan member receives the benefit in a lower tax jurisdiction, or ideally a country with which there is a tax treaty that does not impose tax beyond the withholding taxes payable to CRA.
Here are some ways companies can leverage an RCA for executive compensation:
The RCA may be tailored to fit the needs of a competitive market environment. Unlike most RPPs, the RCA has no requirement for immediate vesting and can be designed to include a graduated vesting schedule. This provision determines when the key employee acquires full ownership of the benefit. The forfeiture of any non-vested assets is an important consideration for the employee that may be searching for greener pastures.
Canada’s pension funding limits are much lower than those of our key trading partners, which creates an obstacle for many companies that operate globally. The RCA can be used to equalize the retirement income gap that exists amongst executive groups that may be comprised, for example, of Canadian, French and American employees. The RCA may be created on a stand-alone basis or sit on top of the pension plan that will often be established to fund the bulk of the future income requirements.
Supplementary Employee Retirement Plans (SERPs) are commonly found as part of compensation packages at many Canadian companies, regardless of size. The SERP is typically an unfunded liability which is paid out of cash flow upon the retirement of the employee, and is therefore somewhat flawed. Companies and shareholders alike seek to avoid growing liabilities on their balance sheets while employees who are members of SERPs would much rather see a funded program, insulated from creditors and ready to pay out an income stream at retirement. An RCA provides the only means of funding a SERP on a deductible basis in Canada. The trust structure of the arrangement provides full creditor protection and substantial flexibility with respect to withdrawals, as opposed to some SERPs that provide only for a lump sum payment upon retirement. Vesting schedules can again be included along with specialized provisions dealing with merger or change of control.
Many executives are faced with a sizable income inclusion as the result of a termination package or retiring allowance but, properly structured; the RCA is an effective tool in mitigating taxes. To avoid any accusations of a Salary Deferral Arrangement or Constructive Receipt, the employer must be the moving party to execute this strategy.
An actuarial calculation is used to determine if the company may contribute the full value of the severance as a one-time contribution to the RCA. The RCA documents may be drafted to eliminate contingent or continuing liability to the company after funding, or such conditions may be established by ancillary documentation. Once the appropriate language has been incorporated the plan will be filed with CRA and funded by the severing employer.
The terminated employee may access the funds in the RCA immediately after severance, or at his/her discretion. This may create the opportunity for significant tax deferral and reduction possibilities for that individual. A lump sum severance payment which would have resulted in top bracket taxation on the majority of the payment may be replaced with smaller payments that in turn may attract substantially lower taxation. Applying 2015 Ontario rates, a $400,000 severance payment (excluding other income) would result in taxation of $170,905. Withdrawing the money from an RCA over four years at $100,000 per year would result in tax of $26,126 annually, and $66,401 in savings.