Retirement planning is a critical aspect of financial stability for employees and employers alike. One such option available in Canada is the Retirement Compensation Arrangement (RCA). Here, we will explore what an RCA is, how it works, the types of plans available, and the benefits and considerations for both employees and employers.
What is an RCA?
An RCA is a plan or arrangement under which an employer (most likely) or former employer makes contributions to a custodian. The custodian holds these funds in trust with the intent to distribute them to the employee or former employee upon the employee’s retirement, loss of office, loss of employment, or a substantial change in their services.
How Does it Work?
Employers make annual tax-deductible contributions to an RCA, subject to a refundable 50% withholding tax. These payments are not taxed when contributed but are taxed when distributed to the employee. When distributions are made from the RCA, the taxes paid are refunded by the Canada Revenue Agency (CRA) at the same 50% rate. This means employees pay personal tax on distributions from the RCA in the year they receive them, potentially at a lower tax rate.
Types of RCA Plans
RCAs can be structured as either a Defined Benefit Plan (DBP) or a Defined Contribution Plan (DCP):
- Defined Benefit Plan (DBP): This plan provides a predetermined annual pension amount upon retirement. It requires periodic actuarial assessments to ensure it is adequately funded.
- Defined Contribution Plan (DCP): This plan provides benefits based on the contributions made and the investment returns on those contributions. The risk of investment losses falls on the employees.
Benefits of RCAs
For Employees:
- Future Pension Benefits: Employees enjoy future pension benefits and the security of knowing that RCA assets are protected from employer creditors.
- Tax Efficiency: The 50% refundable withholding tax rate is often lower than the top personal tax brackets (53.53% in Ontario), allowing more efficient investment growth within the RCA.
- RRSP Contribution Room: An employer’s contributions to the RCA do not reduce the employee’s RRSP contribution room.
- Lower Future Taxation: By receiving RCA payouts in years with lower income, employees can benefit from lower marginal tax rates.
For Employers:
- Tax Deductibility: Contributions to an RCA provide an immediate tax deduction to the employer.
- Flexible Payment Options: RCAs can be used to provide severance payments, with the full contribution amount being immediately deductible.
- Golden Handcuffs: RCAs can help retain key employees by requiring certain employment tenure before pension contributions vest.
- Probate Fees: RCA proceeds are not subject to probate fees if a beneficiary is designated.
- Payroll and Healthcare Taxes: RCA contributions do not require withholding payroll and healthcare taxes.
- Credit Protection: RCAs offer a level of protection from the employer’s creditors.
Considerations and Disadvantages
- 50% Refundable Tax: Contributions and income within the RCA are subject to a 50% refundable tax, reducing the immediate investment amount.
- Non-Interest-Bearing: The refundable tax remitted to the CRA does not earn interest.
- Setup and Management Fees: Initial setup fees and ongoing management and administration fees can be significant.
- Sufficient Contributions: Employers must ensure contributions are reasonable to avoid re-characterization of the plan by the CRA.
How Much Should Be Contributed to an RCA
Careful planning is essential to ensure that contributions to an RCA are reasonable and meet CRA requirements. For a Defined Contribution Plan, contributions around the 18% used for RRSP deduction room are a good starting point. For a Defined Benefit Plan, contributions should be sufficient to fund the calculated future pension obligations. This gives more leeway in establishing a contribution amount.
Recent Scrutiny by CRA
Recently, the CRA has started examining RCAs more closely. Currently, three former Toronto Blue Jays are engaged in court battles with the government over millions of dollars after the CRA disputed their use of RCAs as a tax-deferral strategy. As a result, these former Blue Jays players received reassessments rejecting some of the RCA deductions they initially claimed on their Canadian income tax returns. In one case, the government rejected a $16 million amount claimed in deductions through contributions made to an RCA. It could take several years before a final decision is determined in any of these cases. A decision in the Tax Court of Canada, either way, will probably face an appeal, so it could be years before the matter is resolved.
Retirement Compensation Arrangements (RCAs) offer employers a flexible and tax-efficient way to provide retirement benefits to their employees. However, they require careful planning and consideration of the specific circumstances of both the employer and the employee. Professional advice is recommended to navigate the complexities of setting up and managing an RCA effectively. For more detailed information and personalized advice on RCAs, consult with a financial advisor or tax professional.