If you are an employee who shudders at the amount of income taxes withheld from each paycheque, the introduction of a federal tax bracket for the 2016 tax year for income in excess of $200,000 subject to a 33 percent tax rate has not been likely well received. Including provincial taxes, many high-income earners will now be subject to tax at a marginal rate that is close to or exceeds 50 percent (depending on province of residence). Combined with a reduction in this year’s Tax-Free Savings Account annual dollar limit and because the Registered Retirement Savings Plan has a maximum contribution limit (which is reached at approximately $140,000 of earned income), you may be left wondering where to turn to save for retirement.
If you are able to review and negotiate your compensation structure, one potential solution for retirement savings is to have your employer establish a Retirement Compensation Arrangement (RCA) as a part of your remuneration package.
What is an RCA?
An RCA is an employer-sponsored arrangement that can provide for larger contributions to retirement savings than may be achieved through traditional registered plans.
How Does an RCA Work?
Contributions are made by your employer to the RCA, with a portion remitted to the Canada Revenue Agency (CRA) as refundable taxes. The net amount is received by the RCA; as such, it is not included in your taxable income. This can then be invested accordingly. The employer can deduct 100 percent of the contributions from their taxable income.
In general, contributions to, and income earned by, the RCA are subject to a refundable tax of 50 percent, but in most provinces this is less than, or close to, the highest combined federal and provincial marginal tax rates. The refundable tax balance is held on an interest-free basis by the CRA and is refunded to the RCA when distributions are made to the employee.
As an example, assume that an employer contributed $10,000 towards an employee’s RCA. The employer would deposit $5,000 into the RCA account and remit $5,000 to the CRA as refundable taxes. If the RCA earned $400 of income, the RCA would retain $200 in its investment account and would remit $200 to the CRA in refundable taxes. When the RCA is wound up, $5,200 would be distributed to the employee and the CRA would pay the refundable tax balance of $5,200 to the RCA, an amount which would be distributed to the employee. As such, the employee ultimately receives $10,400 as taxable income.
What Happens at Retirement?
At retirement, distributions from the RCA are included in the employee’s taxable income in the year they are received. If you have a lower marginal tax rate in retirement relative to your marginal tax rate when contributions were made to the RCA, you will have effectively saved tax. RCA distributions are considered pension income, so they may also be eligible for spousal pension income-splitting. If an employee retires outside of Canada, RCA distributions are subject to tax at the non-resident withholding tax rate, which may be less than the marginal tax rate in retirement.
To determine if an RCA makes sense for your situation, we would be happy to organize a discussion alongside your tax advisors.