Retirement Compensation Agreements
A Retirement Compensation Arrangement (RCA) as defined in the Income Tax Act is an arrangement which is outside the registered pension plan system and is intended to top up retirement benefits over and above those benefits received from registered plans. It allows the company to make tax deferred contributions on behalf of key executives and employees.
Unlike registered pension plans, investment rules for RCAs are very flexible. Plan assets can be invested in stocks, bonds, mutual funds or pooled funds, T-bills, GICs, interest in a life insurance policy, etc. Funds can even be loaned back to the Company at reasonable interest rates.
Generally, an RCA is defined as a plan or arrangement under which an employer/employee makes contributions to another person, referred to as a custodian, to fund benefits payable to an employee on, after or in view of retirement of that employee. The RCA and the custodian will pay 50% of the contributions as a refundable tax to Revenue Canada. The remaining 50% of the contributions are invested by the RCA to fund the retirement benefits.
Three things are necessary to establish an RCA: a corporate sponsor, an employment relationship with the corporate sponsor, and an actuarial certificate to establish reasonableness of the contributions. With an RCA, a trust will receive funds from an employer and make payments after the employee's retirement or termination.
An RCA is a lesser used alternative to an IPP, since half of the investment will yield no interest. The IPP is a defined benefit pension plan that is regulated through the province. It has rules for maximum contributions. However, the RCA has no legislation restricting contributions, but is expensive to set up. The ideal candidate for an RCA is a Canadian resident who intends on leaving Canada for retirement. An RCA will be used during the sale of a business, for expatriates, and for replacing a shareholder bonus.
- Significantly higher contribution limits than registered plans.
- Immediate deduction to employer and not taxable to employee until paid.
- Flexible investment options.
- Allows deduction at current high tax rates and deferral of recognition of income by employee to future years at potentially lower tax rates.
- High benefit security as funds are held by custodian in trust.
- Flexible settlement options allowing member control over timing of income recognition.
- Does not affect RRSP or RPP (Registered Pension Plan) contribution limits.
- Refundable tax account is non-interest bearing therefore investment yield for RCA is only half of that of a registered plan if funds are invested in interest bearing securities.
- Limited access to funds while employed.
As Revenue Canada has set limits on contributions that employers and employees can make to Registered Pension Plans, these limits mean that executives earning in excess of these limits will suffer a reduction in lifestyle when they retire if their registered pension plan funds are their only source of retirement income. Due to current annual limits on contributions, RCAs are best suited for individuals who earn more than $150,000 annually as payments from an RCA allows for the catch-up of lost RRSP contribution room.
For individuals who may be considering becoming a non-resident of Canada, the plan could be wound down and a withholding tax paid which may range between 15-25%, based on where they go.
It is recommended that before an RCA plan is established, the advice of an accountant and/or lawyer be obtained so the technical points are appropriately addressed and documentation completed.