For business owners and senior executives, traditional retirement savings vehicles like Registered Retirement Savings Plans (RRSPs) and Registered Pension Plans (RPPs) may not provide enough income to sustain their lifestyle after retirement. A Retirement Compensation Arrangement (RCA) offers an alternative that allows for more substantial retirement savings while offering tax advantages and flexibility.
What is a Retirement Compensation Arrangement?
An RCA is a trust-based plan where an employer—sometimes along with an employee—makes contributions to a custodian who holds the funds in trust. The custodian distributes the funds later, typically upon retirement, loss of employment, or a significant change in work responsibilities. This structure allows business owners and professionals to supplement their existing pension benefits or other savings.
Unlike RRSPs and RPPs, RCAs do not have fixed contribution limits. Instead, contributions must be reasonable based on factors such as salary, years of service, and expected retirement income needs.
Advantages of an RCA
- Higher Contribution Potential: Unlike RRSPs and RPPs, RCAs allow for larger, customized contributions without arbitrary caps.
- Tax Deferral: Employer contributions are tax-deductible, and employees are only taxed when they receive benefits, potentially at a lower rate in retirement.
- Supplemental Retirement Income: RCAs can be used alongside RPPs or Individual Pension Plans (IPPs) to provide a more robust retirement plan.
- Severance Planning: Employers can use RCAs to fund severance payments, deferring employee tax liability.
- Estate Benefits: If structured properly, RCAs may help avoid probate fees upon the plan holder’s death.
- Creditor Protection: RCA funds may be protected from an employer’s creditors, adding an extra layer of financial security.
Considerations and Potential Drawbacks
While RCAs provide several advantages, they also come with some complexities:
- 50% Refundable Tax: Contributions and investment earnings within the RCA are subject to a 50% refundable tax, which is held by the Canada Revenue Agency (CRA) and refunded over time as funds are withdrawn.
- Ongoing Costs: RCAs require setup fees, administrative costs, and annual tax filings.
- Investment Restrictions: Unlike personal non-registered investments, RCA investment income is entirely subject to the 50% refundable tax.
- CRA Scrutiny on Reasonability: Contributions must align with industry norms and the employee’s role and compensation to be deemed acceptable.
When Does an RCA Make Sense?
An RCA may be a suitable strategy in the following scenarios:
- For High-Income Earners: Business owners and executives who have maxed out their RRSP and pension contributions can use an RCA to build additional retirement savings.
- Business Exit Planning: Entrepreneurs preparing to sell their business can use an RCA to reduce their company’s value and minimize capital gains tax.
- Retaining Key Employees: Employers can use RCAs as a tool to reward and retain top executives with a tax-efficient retirement plan.
- Tax-Efficient International Retirement: If retiring in a lower-tax jurisdiction, RCAs may provide a way to reduce personal tax exposure.
Making the Most of Your Retirement Strategy
For those with substantial income and retirement planning needs beyond the limits of RRSPs and RPPs, an RCA can be a valuable option. However, due to the tax and regulatory considerations, consulting with a financial professional is essential to determine if an RCA fits within your overall retirement and tax strategy.
Contact Finuity Wealth today to learn more about how an RCA can support your retirement goals.
