Like many baby boomers, you’re careering toward retirement when you realize that your RRSPs — or lack thereof — simply won’t comfortably carry you through the “golden years.” Take heart. There’s still time to bolster your savings with a retirement compensation arrangement (RCA).
Relatively unheard of five years ago, RCAs are becoming increasingly popular for entrepreneurs approaching retirement. No wonder: an RCA is essentially an unregulated, unregistered pension plan set up by a firm for an employee or its owner. Unlike RRSPs, RCAs carry no restrictions on the types of investments you can make or the amount you can invest — which is a great relief when RRSP contributions are capped at $14,500 a year. But it’s more than an RRSP catch-up, says Jerry Gedir, president of financial consulting firm Continuity Resources Group Inc. in Saskatoon. “An RCA can establish a far larger, more proportional retirement fund for someone who has a history of significant employment earnings.” But there are other benefits, too. RCAs provide tax savings, the funds are largely creditor-proof and you can use them to boost your firm’s borrowing power. What’s the catch? RCAs can be expensive and complex to set up. Plus, complying with RCA-specific tax rules means losing some of the advantages of compound interest. Still, with the right plan and a savvy advisor, the benefits can be well worth it for you and your firm.
Here’s how an RCA works. A firm — usually at the behest of its owner — decides it will contribute to the pension of the owner or a key employee. It sets up a trust for that person, appoints a trustee and then starts paying into the trust, typically by bonusing down its net income. However, only half of the RCA funds actually go into the trust; the other half goes into a refundable tax account held by the Canada Customs and Revenue Agency (CCRA). As time passes, 50% of the trust’s annual appreciation must also be transferred to the CCRA account. Why? To equalize the values of the two accounts, which begins to pay out in equal amounts upon the beneficiary’s retirement. While there are no restrictions on the type of investments the trust can make, says Gedir, most entrepreneurs choose a universal-life insurance contract, which is tax-exempt and immune to decline. Still, the CCRA doesn’t give you carte blanche when it comes to contributions. Your plan must be “reasonable” relative to your years of service and earnings history, says Gedir. That typically means a fund that provides annual retirement income equal to 70% to 90% of your pre-retirement earnings.
The tax benefits start immediately. For the individual, paying tax on RCA income is deferred until retirement — when the individual is likely to be in a lower personal tax bracket. For the firm, contributions are a tax-deductible expense. But unlike contributions to registered pension plans, RCA contributions don’t have to be annual or even regular. “Contributions could go in when years are good,” says Gedir, “and you could take a contribution holiday when it’s a lean year.”
If you are the firm’s sole proprietor, your RCA can also pump cash into your company. “You can take the assets in the RCA, go to a bank, pledge those assets as security and get a loan,” says Gedir. Because the loan is secured, you can typically borrow up to 90% of the value of your contributions. In turn, the RCA trust can loan those funds back to the company to use until you retire.
Another RCA benefit: because the RCA funds are in an irrevocable trust and not yet in the hands of the owner / manager, says Tina Di Vito, VP and national manager at BMO Nesbitt Burns in Toronto, they may be immune from creditors in the event your company is sued or goes bankrupt. (Unless, of course, you have used them as collateral for a loan.)
RCAs have their drawbacks. The CCRA accounts pay no interest. Also, an RCA can be tricky to set up. “If you don’t do it right — for example, if you overcontribute — you could run into problems with the tax authorities,” says Gedir. Another mistake: cutting back on salary to invest in an RCA. That may be classified as a salary deferral arrangement, which could trigger punitive tax consequences. The key is finding an adviser who is familiar with RCAs.
Moreover, set-up costs are in the $30,000 ballpark, plus you’ll pay $1,500 for annual compliance work. Still, if you’re running out of time to feather your nest egg, the cost may be worth it, says Gedir: “RRSP limits are really peanuts compared to what you can do with an RCA.”
© 2003 Susanne Baillie
