Are your business owner clients looking to attract key employees?

Offering extra retirement savings plans can benefit both, but it pays to choose wisely.

Company owners who need to attract and retain high-level people may be asking you how they can supplement their employees’ retirement income beyond RRSPs and pensions. There are several ways to do this, each with specific consequences for both company and employee.

The Pay-As-You-Go Method is the simplest. It’s an unfunded, unsecured liability that mortgages the company’s future cash flow to pay each employee as he or she retires. While this method requires no up-front investment, taxes or administrative costs, it can be a risk to the company’s cash flow if several people retire at once. And since there is no guarantee that funds will be available at retirement, it’s not likely to make employees feel secure.

A Secular Trust provides a secure pool that’s funded by the employees’ after-tax contributions. While this method guarantees funds will be available, it involves annual trust filings and related administrative costs, and the accumulated funds are taxed annually.

A Retirement Compensation Arrangement provides a funded pool in which half the contributions are paid to a trust, and the other half into a non-interest bearing refundable tax account held by Canada Customs and Revenue Agency (CCRA). Each time the company pays a retiring employee from the pool, tax is refunded from the CCRA account. While the company benefits from tax-deferral in this account, it misses out on any interest the funds could have earned, making the tax advantage very limited. As well, it requires a trust agreement, has complex legal and filing requirements and creates high administrative costs.

For an in-depth case study on how an Executive Retirement Account can work for your clients, click here: Executive Retirement Account – Case Study

While all the above solutions provide employee retirement savings, the following two options also offer an added benefit — the availability of funds to attract new executives. That’s because they’re based on insurance in case of the premature death of the executive. For companies who need insurance on key employees anyway, these solutions combine both key person protection and employee retirement savings in a single convenient policy.

A Traditional or Reverse Insurance Sharing Arrangement provides a funded pool in a tax-exempt life insurance policy with multiple owners (the employees). This policy provides tax-deferred investment benefits for the employee and an insurance benefit to the company. However, multiple ownership creates complex legal requirements, and complex tax issues during the accumulation period and when the policy turns over to an employee.

The Executive Retirement Account (ERA) strategy offers the same benefits that is much simpler to understand and administer. It provides a funded pool in a tax-exempt life insurance policy with only one owner — a single employee. Like the Traditional or Reverse Insurance Sharing Arrangement, the ERA provides tax-deferred investment benefits for the employee and an insurance benefit to the company. But because each policy has only one owner, it’s less complicated and less costly to administer. Requiring only a legal agreement between company and employee, it dramatically simplifies tax issues, minimizes the company’s non-deductible debt, and may be protected from creditors of the business under certain conditions.

With the Executive Retirement Account strategy, the employee purchases a single universal life policy and names the company as irrevocable beneficiary of the face amount (death benefit). The employee makes annual premium deposits to build the retirement fund, and the company pays annual amounts to cover the cost of insurance. The funds accumulate within the policy on a tax-deferred basis.

On retirement, the employee can withdraw from these funds as taxable annual income, or use the policy as collateral for annual loans (possibly tax-free). If the employee dies, the beneficiaries receive the remaining cash value, and the company gets the face amount tax-free to attract a new executive.

For more information on how the Executive Retirement Account can benefit your clients, and the tax and legal implications you should both be aware of, please visit www.sunlife.ca/advisor.