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By Spencer Tilley, CFP, RFP, CFA
Special to the Financial Independence Hub
There is a common theme among high net worth and high-income earners: “How can I save on tax?,” and “What are the most tax efficient ways to save for retirement?”
No question that focusing on tax savings is the most crucial component to some of the most successful individuals in the world.
In Canada, RRSPs, TFSAs and pension plans are commonly utilized retirement vehicles, but what happens when you max out your available room? Unfortunately, as a salaried employee, your additional options for tax-efficient retirement savings are limited, or non-existent.
Retirement Compensation Arrangements (RCAs) are one strategy that not many know but may be available to you as a high-income earner.
What is an RCA?
RCAs are a tool for a high-income earner to save additional funds on a tax-deferred basis, over and above the RRSP/pension limits, for their retirement. It is funded by an employer for the employee’s long-term benefit. It was created to help supplement and overcome the income gap in retirement that occurs because of the relatively low annual prescribed RRSP/pension limits.
Basically, RRSP room has not kept pace with wage growth and there is essentially a cap on the amount that can be saved tax-deferred for retirement. RCAs help make up the difference between what can be saved for retirement and what is needed in retirement, on a tax-deferred basis.
Here’s what you need to know:
Today, top personal tax rates are over 50% in 7 out of 10 provinces, with the other 3 provinces clipping north of 47.5%. With these high personal tax rates combined with the recent changes in the Federal Government Small Business Tax regime, RCAs, along with the Individual Pension Plan (covered here), are making a comeback as a strong player in the retirement game for highly compensated executives and can provide a huge tax benefit for those who may qualify to use it.
How it works:
The employer contributes 100% of the amount, of which 50% is sent to the CRA, held in a non-interest bearing, refundable tax account and 50% is deposited to your RCA Investment account, held with a custodian where it can be invested on a tax-deferred basis. Withdrawals are taxed as regular income. Giving the CRA 50% of your money today may seem like a bad deal, but let’s examine the benefits a little closer:
The Benefits
Employee benefits (assuming top marginal tax rate):
- In 7 out of 10 provinces, you would otherwise be paying the CRA 51.3%-53.53%, upfront and permanently. You are already ahead of the game in these provinces
- In the other 3 provinces, you would pay 47.5%-49.8% to the CRA, so at most a 2.5% disadvantage. But …
- The real advantage lies in your ability to withdraw the funds over time and at your discretion, rather than receive them personally all at once, thus (hopefully) reducing your income in any given year enough to drop you into a lower tax bracket and ultimately pay less tax
- Contribution limits are not based on RRSP room and can exceed pension contribution limits by significant amounts
- 50% is contributed to the RCA investment account and invested for your retirement.
- When you withdraw funds in retirement, 50% of your withdrawal is added back to the RCA investment account via a refund from the CRA refundable tax account (the 50% that went to the CRA at the beginning)
- Funds are the employee’s in the end, whether the company is around or not
Employer benefits:
- 100% of the employer contributions are tax-deductible for the business
- Key employee retention
The Downside/Risks
- An actuary needs to be hired to implement and keep track of everything incurring an annual cost for administration” approximately $1,000/year
- 50% of the contribution is sent to the CRA in the form of a refundable tax
- Money in the CRA account is held in a non-interest bearing account
- Investment risk is taken on by you and not your employer (unless the RCA is funding for a defined benefit supplemental pension guaranteed by your employer)
- Employment income needs to be high over the last 15 years to qualify
- This is only for those who have maximized their pension benefits and cannot achieve 70% of their current income as retirement income with existing retirement plans
- A company cannot ‘bonus down’ to keep income lower than the small business limit
Who this is best suited for:
High-income earners: groups of managers or executives, successful business owners, or other highly compensated individuals where income is tied to special employment incentives, such as a professional athlete.
Let’s review a simplified example:
Assume you have earned a $1,000,000 incentive paid above your usual salary of $314,928/year in Alberta, which you have received for the last 10-15 years. If you were to pre-plan with your employer and utilize an RCA, the benefit could be upwards of approximately $200,000 using the RCA strategy vs straight T4 income: that’s like an extra $10,000/year for 20 years of your retirement!
Some technical details:
If this $1,000,000 incentive were paid as T4 income, in Alberta you would pay $480,000 (48%) tax and you would keep $520,000 (52%).
Moving forward, annually, you would pay tax on interest, dividends and capital gains earned on this money (assuming it all flows into your personal non-registered account) at your personal tax rate for that year.
If the $1,000,000 was paid through an RCA, $500,000 would be sent to a CRA refundable tax account and $500,000 to your tax-deferred retirement plan account. Annually, 50% of any income received in the RCA account would be sent to the CRA refundable tax account. In retirement, whatever you withdraw for your personal income is taxed at your personal rate and 50% of the withdrawal is replenished by the CRA refundable tax account. The net result is a lower tax burden.
*The calculations for this simplified example have been prepared to assume that the RCA investment account has a rate of return of 6.5% per annum, assumed administration costs and assumed future tax rates. These calculations have been validated by Westcoast Actuaries Inc. Please note that the results of these calculations are sensitive to assumptions on how your retirement assets (both non-registered and RCA) are invested, your pre- and post-retirement personal income tax profiles, etc.*
To create an RCA
- You need to have a knowledgeable Portfolio Manager to guide you through the process, set up the account, and manage the funds properly
- You need to employ an actuary like Westcoast Actuaries, which would take care of set-up and annual administration
- Ensure your employer is on board with the strategy: planning ahead is critical
It should be noted that this strategy does not include information about a potential strategy utilizing a life insurance policy. Insurance and estate risk mitigation strategies should always be discussed in conjunction with the plan to ensure sensibility.
So, do you qualify for this tax strategy?
Tax rules are constantly changing and the best way to find out if this could apply to you is to connect with the retirement experts at RT Mosaic today (www.rtmosaic.com) where we combine advanced financial planning with discretionary portfolio management.
Spencer Tilley is a co-founder and licensed Portfolio Manager with RT Mosaic. Spencer graduated from the University of Calgary with a Bachelor of Commerce degree and has obtained the Certified Financial Planner (CFP), Registered Financial Planner (R.F.P.) and Chartered Financial Analyst (CFA) designations. He gained his experience at an exclusive firm in Calgary before starting RT Mosaic in 2010. Spencer works closely with his clients throughout Canada and with his extensive knowledge, particularly in the areas of retirement analysis, tax minimization and corporate planning, helps clients optimize their financial affairs. Through his dedication and earned trust, Spencer’s goal is to give each of his clients’ true peace of mind. Spencer currently sits on the national board of the Institute for Advanced Financial Planners (IAFP).
Disclaimer: This article was created by Spencer Tilley in collaboration with Westcoast Actuaries Inc. This post should not be construed or interpreted to be investment advice or direct financial planning advice. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services. Related information is presented ‘as is’ and does not make any express or implied warranties, representations or endorsements whatsoever with regard to any products or service. It is solely your responsibility to evaluate the accuracy, completeness and usefulness of all opinions and information provided. This post does not warrant and makes no representations about the accuracy, reliability, completeness or timeliness of the content, be error-free or that defects in the information will be corrected. The law is constantly changing, and your situation should always be consulted with the proper professional. All links and images have been cited and are owned by those individuals under their individual sites.
