RCA case studies

Estate Planning is an ongoing process, and adjustments must be made from time to time or when significant life changes arise. Luckily, the planning relative to the Retirement Compensation Arrangement (RCA) can be adjusted as circumstances change to meet your clients’ estate-planning needs.

Whether it’s a sale of a business, pre-nuptial or divorce issues, family equalization issues, a golden handcuff of a key employee or better creditor proofing, the RCA is a vital component of estate planning an advisor must consider for his or her high-earning business-owner, key-employee and executive clients.

The following case studies help shed some light on how an RCA can resolve such issues and achieve overall financial and estate planning goals.

CHARITABLE GIVING

Your client has a well-balanced retirement plan consisting of non-registered investments, a small amount of RRSPs, an IPP and an RCA. He is also currently in the middle of negotiating the sale of his business, and so will also make use of the capital gains exemption limit.

He has more than enough to live off of, as do his spouse and children. But he’s interested in leaving a legacy for a charity he strongly believes in.

Part of your client’s RCA investment account includes a life insurance policy that maintains the tax-exempt status of the RCA investment account, which has been over-funded. The premiums paid for the insurance policy within the RCA have also been 100% tax-deductible to the corporation.

In this case, you could advise your client to adjust his plan document and beneficiary designation in the RCA trust so when the life insurance proceeds are paid tax-free into the RCA trust upon his death, the trust will pay the proceeds to his favoured registered charity.

It’s a win-win-win strategy for your client, his company and the charity.

GOLDEN HANDCUFFS

Your client is getting close to retirement, and is ready to start drawing from her RCA.

While she would like her son to take over her business, he’s not quite ready yet; but with a little more guidance and maturity, he’ll do just fine.

Your client’s long-time friend and employee has been with the company since inception. While this executive could certainly help guide your client’s son as he learns the business, she, too, is looking to slow down.

But if she retires too soon, it’ll complicate your client’s plans. She needs to provide the executive with an incentive to stay, but in this case, paying a larger salary or bonus isn’t the answer. And while your client wants to be fair, she needs to keep the shares of the company for her family.

Under guidelines established by the Canada Revenue Agency, an executive’s pension should amount to 2% times the years of service, up to 70% times final average earnings.

Advise your client to provide her friend with an RCA, which can be wrapped around the executive’s corporate RRSP/MPPP to provide a supplemental pension to CRA guidelines. Ensure that she includes a vesting clause, though, that gives incentive for the executive to stay until normal retirement. This will ensure your client’s son has time, under the executive’s wing, to gain enough experience to run the business.

An added bonus is that contributions are 100% deductible to the corporation, and aren’t taxable in the executive’s hand until distribution from the plan begins, post-retirement.

STRUCTURED INVESTMENTS

Your client is an outgoing owner of a car dealership getting very close to retirement, and is looking to diversify her RCA investments.

One strategy you could suggest is to arrange financing through a lender so the RCA trust borrows money to purchase the dealership’s showroom and the service building. The new owner of the dealership would then pay rent to the RCA trust, which eventually pays off the loan balance while providing a regular flow of income into the RCA trust. This will ensure the RCA is continuously funded so your client and her spouse are looked after.

BUSINESS SUCCESSION

Your clients run a family business, and their children are the preferred choice to eventually take over. But, though they can run the company, the children can’t afford to buy the business outright (or at least not at market price from their parents/sellers).

In this case, your clients could establish an RCA to provide them (the parents/sellers) with a supplemental retirement income, which can also be funded on a post-retirement basis. As a result, their children (the buyers) can proceed with the buyout of the business by funding the RCA with the pre-tax operating income from the company, which is far more efficient than the children borrowing funds from the bank on an after-tax basis to fund the buyout. And the sellers/RCA plan members are not taxed until distribution from the RCA begins, allowing for long-term tax deferral.

Alternatively, this arrangement can be used in conjunction with a cash purchase of your clients’ shares in the company. Assuming the sellers haven’t used up their $750,000 lifetime capital gains exemption (LCGE) limit, the buyers can secure the cash or loan up to the sellers’ LCGE, and the rest can be funded through the RCA. The shares of the company are held in escrow until the funding has been completed, so your clients retain control in the event their children can’t meet the funding obligation.

PRE-NUPTIALS

Your business-owner or key-employee client manages a very profitable business. He’s currently divorced, but has been dating someone for a few years now and the relationship will soon be considered common law in the province he resides in.

The relationship is going well, but you – along with his adult children and estate lawyers – are deeply concerned about his estate in the event that he passes away. The solution, however, can be as simple as a changed beneficiary designation in the RCA.

In this situation, your client’s significant other, after consultation with her own independent legal counsel, could become the sole beneficiary of the RCA, given their now common-law status, in exchange for signing off on your client’s estate in the event of his passing.

This way, his children are assured that family assets, including the cottage everyone grew up in, stays in the family, while your client is comforted by the fact that his new partner is financially secure in the event of his passing.

Conclusions

Your client’s RCA is one of few CRA-approved, long-term tax-deferral strategies that can address a pension shortfall and discrimination due to the legislative funding caps and limits on an RRSP or other RPPs, such as IPPs and MPPPs. So it’s a critical component to any financial or estate plan for a high-earning business owner, manager or key employee.

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Pierre Ghorbanian is the managing partner of Retirement Compensation Funding Inc. .

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Pierre Ghorbanian

Pierre Ghorbanian, MBA, CFP, TEP, is vice-president, advanced markets business development, with BMO Insurance.