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The Companion Advisor: Retirement Planning
Supplemental Employee Retirement Pension Plans (SERP)Supplemental pension plans for senior executives are becoming extremely popular. Those individuals in the higher income brackets are not able to make the full 18% contribution to their retirement funds because of the legislative ceiling imposed by the RRSP and pension limits. The SERP gives these individuals a method of topping-up their retirement savings.

Retirement compensation arrangements (RCA):

An RCA is a SERP that is regulated by Canada Customs and Revenue Agency (CRA). The employer enters into a Trust Agreement with a trust company to act in the capacity of trustee/custodian and a participation agreement with the employee.

Under these arrangements, the employer or former employer, and in some cases, the employee, periodically remit contributions to the trust company and to a CRA refundable tax account. Due to the resulting complexity of employee contributions, many trust companies will not encourage employee contributions in its RCAs. However, if you make a request for employee contributions to the trust firm, some have been known to review that policy on a case basis. If the employer has financial problems, the employee or former employee's benefit is secure. Upon retirement, the former employee is assured of receiving his/her full benefits.

Letter of credit

The funding of this type of RCA is accomplished through an irrevocable letter of credit issued in favour of the trust company, as trustee. A letter of credit is a guaranteed loan promise, issued by the employer's bank, for an amount equal to the accrued liability for the supplemental benefits. The bank charges a fee for the letter of credit that is in proportion to the employer's financial stability; letters of credit are usually renewed annually.

In order to avoid the inference that the assets securing the letter of credit are in fact the contribution, which would necessitate a submission of 50% of that asset value to the CRA refundable tax account, no actual assets can be set aside to secure the letter of credit. The employer's assets generally must secure the letter of credit.

The premium paid for the letter of credit, not the security behind it, is considered to be the contribution to the RCA. The employer must remit 2 times the premium cost to the trustee. The trustee uses one-half of the remittance to pay the premium to the bank and the remainder is forwarded to CRA to meet the refundable tax account requirements. If a triggering event occurs, the bank will forward the amount under the letter of credit to the trustee, and the employer will owe that amount to the bank.

Fully-Funded

The employer can deduct the full amount of contributions. One-half of the employer's contribution is invested and held as an asset in the RCA trust, while the other half is remitted to CRA and held in the refundable tax account. One-half the investment income earned in the RCA trust is also remitted to CRA. Funds held in the tax account do not earn investment income.

Benefits paid to the employee from the RCA trust are taxable. For each dollar paid to the former employee from the RCA trust, CRA will refund 50 cents to the RCA trust so that the RCA trust and the CRA refundable tax accounts contain an equal amount of money.

There are two other ways to establish supplemental pension plans. With these options no trust is established and after retirement no annuity is purchased. If the employer has financial problems, the employee or former employee is not a secured creditor.

1. Pay-as-you-go:

These arrangements provide little security to the employee other than a promise from the employer to provide benefits after retirement. The employer and the employee enter into a contractual arrangement spelling out the details of the post retirement benefits. There is no pre-funding of benefits prior to the employee's retirement and the liability of future benefit payments is not reflected on the company's books. Upon retirement payments are made to the retired employee on a pay-as-you-go-basis.

2. Unfunded:

The employer and the employee enter into a contractual arrangement spelling out the details of the post-retirement benefits. The value of the accrued benefit expected to be paid in the future is recorded on the books of the company. The recorded value of the benefit is adjusted annually to reflect the additional year's benefit accrual, benefit disbursements, ageing of the group, new entrants to the group, changes in the earnings and other factors. Upon retirement, the recorded value of the benefit is reduced as payments are made to the retired employee.

Letter of credit
Fully-Funded
Security to employee • Fully secured • Fully secured
Cost to employer • annually, 2 x the premium for the letter of credit cost of benefits paid to eligible recipients
• cost of contributions to the RCA trust and CRA refundable tax account
Liability to the employer • 2 x annual premium for the letter of credit
cost of benefits paid to eligible recipients
• current year's contribution obligation
Refundable tax requirement • amount equal to annual premium for the letter of credit • ½ of contribution amount plus ½ of investment earnings
Role of the employer • files application with CRA for RCA account number
• enters into a contract with a trustee
• enters into a contract with the employee
• arranges letter of credit with bank
• annually, remits 2 x letter of credit premium to trustee
• files annual information return with CRA
provides trustee with amount required to make payments to eligible recipient(s)
• files application with CRA for RCA account number
• enters into a contract with a trustee
• enters into a contract with the employee
• remits 50% tax on contributions to CRA
• remits remainder of contribution to trustee
• provides trustee with investment instructions
• files annual information return with CRA
Role of the trustee • hold and supervise renewal of letter of credit
call letter of credit if necessary
• obtain remittance number
• receive employee and employer contributions
• carry out investments
• remit 1/2 of the income to CRA
• complete annual tax filing
• verify correct remittance and refund of tax through CRA
• determine need for election to recover refundable tax
• withhold and remit income tax and make payments to eligible recipients(s)
• report to employer and employee
• issue tax slips to eligible recipient(s)



 
Pay-as-you-go
Unfunded
Security to employee • limited to the company's ability to pay at the time benefits are due
• limited to the company's ability to pay at the time benefits are due
Cost to employer • cost of benefits paid to eligible recipients • cost of benefits paid to eligible recipients
Liability to the employer • current obligation to pay benefits to eligible recipients • unsecured liability on the books of the company
current obligation to pay benefits to eligible recipients
Refundable tax requirement • none • none
Role of the employer • enters into a contract with the employee
• calculates and makes payments to eligible recipient(s)
• issues tax slips to report payments
• enters into a contract with the employee
• ensures unfunded liability recorded on the books
• calculates and make payments to eligible recipient(s)
• issues tax slips to report payments
Role of the trustee • none • none

For more information on compensation arrangements, Canada Revenue Agency produce a booklet entitled Retirement Compensation Arrangements Guide. It can be downloaded from their web site at http://www.cra-arc.gc.ca/E/pub/tg/t4041/README.html


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