Financial protection for the future, nest egg, retirement savings

The federal government is changing the way retirement compensation arrangements are taxed, a measure likely to benefit employers that offer registered pension plans.

The change to retirement compensation arrangements (RCAs) was proposed in the 2023 federal budget.

Lea Koiv, president of Lea Koiv & Associates Inc. in Toronto, said the change, which would apply to retirement benefits after March 28 (budget day), is good news for the pension industry. “A number of employers will benefit,” Koiv wrote in an email.

RCAs are employer-sponsored arrangements that allow an employer to provide supplemental pension benefits to employees.

The Income Tax Act caps the annual pension accrual that a registered pension plan can provide — $3,506.67 for 2023. Koiv said that a wage of $175,334 would hit the limit for a plan with the maximum 2% rate of accrual.

Many employers provide pensions based on an employee’s total earnings, Koiv said, so RCAs are used to “top up” the employee’s registered pension plan if they earn more than $175,334.

Employers can pre-fund supplemental retirement benefits through contributions to a trust established under an RCA. The Income Tax Act imposes a refundable tax at a rate of 50% on contributions to an RCA trust, as well as on income and gains earned or realized by the trust, according to the federal budget.

“The tax is generally refunded as the retirement benefits are paid from the RCA trust to the employee,” the budget document states. For example, $100 in contributions to the RCA trust would result in remitting $50 of refundable tax to the CRA; if the RCA trust pays out $100 in benefits, it would trigger a $50 tax refund.

However, Koiv said many RCAs weren’t funded. Instead, the pensions were “secured” by a letter of credit (LOC) from a financial institution.

The annual fee or premium for the LOC is subject to the 50% refundable tax.

For example, if the annual fee for the LOC is $100,000, the employer must contribute $200,000 to the RCA trust: $100,000 paid to the financial institution to cover the fee and the other $100,000 remitted to the CRA for the refundable tax, the budget stated.

“The CRA had taken the position that the fees paid for the LOC represented a ‘contribution’ to the RCA,” Koiv said. “On a practical basis, the amount in the 50% refundable tax kept mounting, as the actual pensions were paid from company funds,” which does not trigger a 50% refund.

The budget proposes amending the Income Tax Act so that fees to secure or renew an LOC for an RCA that is supplemental to a registered pension plan will not be subject to the refundable tax. In the LOC example, the employer would only need to pay the $100,000 annual fee and not remit the $100,000 refundable tax to the CRA.

Employers will also be able to apply for a refund for previously remitted 50% refundable tax. However, Koiv pointed out that the refund will be tied to previously paid retirement benefits.

“It is unfortunate that a refund cannot be obtained for the full amount of the 50% refundable tax that had been paid in respect of the fees for the LOCs,” she said.

The measure is expected to cost the federal government $23 million in the 2023-24 tax year and $60 million in each of the four years that follow.