The ABCs of RCAs

Tax Minimization Strategy for High Income Individuals

Focusing on tax savings is the most crucial component to some of the world’s wealthiest people. The common refrains among high net worth and high-income earners are “How can I save on tax?”, and “What are the most tax efficient ways to save for retirement?” There’s no question that focusing on tax savings is the most crucial component to some of the most successful individuals in the world. But unfortunately, if you are a salaried employee the options for tax-efficient retirement savings are limited, or non-existent.

In Canada, RRSPs, TFSAs and pension plans are commonly utilized retirement vehicles, but what happens when you max out your available room?

However, Retirement Compensation Arrangements (RCAs) are a lesser known vehicle for lowering taxes and increasing retirement savings as a high-income earner.

What is an RCA?

RCAs are a tool for high-income earners to save additional retirement funds on a tax-deferred basis, over and above the RRSP/pension limits. They were created to help overcome the income gap in retirement that occurs because of the relatively low annual prescribed RRSP/pension limits. RCAs are funded by employers for the long-term benefit of employees.

RRSPs have 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 in what is needed in retirement, on a tax-deferred basis.

Here’s what you need to know:

Today, the top personal tax rates are over 50% in eight out of 10 provinces, with the other two provinces clipping north of 47.5%. These burdensome rates, combined with the recent changes in the Federal Government Small Business Tax regime, are fuelling a retirement planning comeback for RCAs, along with the Individual Pension Plan. They can provide a huge tax benefit for highly compensated executives who are eligible to use them.

How it works:

The employer contributes 100% of the amount, of which 50% is sent to the CRA and held in a non-interest bearing, refundable tax account. The other 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, until you take a closer look at the benefits.

The Benefits

Employee benefits (assuming top marginal tax rate):

• In eight out of 10 provinces, you would otherwise be paying the CRA 50%-54.8%, upfront and permanently. You are already ahead of the game in these provinces
• In the other two provinces, you would pay 47.5% or48% 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. That hopefully reduces your income in any given year enough to drop you into a lower tax bracket so you 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 still in business 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 such as professional athletes where income is tied to special employment incentives. 

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 roughly equivalent to receiving an extra $10,000/year for 20 years of your retirement.

Some technical details:

If this $1,000,000 incentive was paid as T4 income, in Alberta you would pay $480,000 (48%) in 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

1. You need to have a knowledgeable Portfolio Manager to guide you through the process, set up the account, and properly manage the funds.
2. You need to employ an actuary like Westcoast Actuaries Inc. to take care of the set-up and annual administration.
3. You need to ensure that your employer is on board with the strategy – and 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 they make sense.

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 today with the retirement experts at Cardinal Point, where we combine advanced financial planning with discretionary portfolio management. 

Disclaimer: 

This article was created by Spencer Tilley in collaboration with Westcoast Actuaries Inc. 

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