To RCA or not RCA … that is the question

Romeo is the owner-manager of a very successful private Canadian corporation. A colleague told him that he way want to consider a Retirement Compensation Arrangement (RCA) funded with life insurance to help meet his retirement income needs. Romeo has contacted his insurance advisor to give him more information. His advisor tells him that there are many different

insurance-based planning strategies, the RCA just one of them. Other strategies to consider include the Insured Retirement Program (IRP), the Corporate Insured Retirement Program (CIRP) and policy withdrawals.

Each of the strategies presents different issues. Not only does Romeo need to consider the level of retirement income benefit he’ll get, but also the cost to implement and maintain each strategy, the complexity and the flexibility of each strategy to deal with change. Once he’s done this, he can make an informed decision.

Let’s look at Romeo’s situation. His corporation will have annual pre-tax cash of $100,000 for the next 10 years to fund the strategy. We’ll use InnoVision to support each strategy with the following assumptions: 1) 6% rate of return 2) IA option 3) cash value maximizer solution. For each strategy, Romeo will receive retirement income benefits from age 65 to life expectancy (21 years). For IRP and CIRP, we’ve assumed a 7% bank loan rate. Other assumptions include a 45% personal tax rate, 31% personal dividend tax rate and a 33% corporate tax rate.

With the RCA strategy, Rome’s corporation will contribute $100,000 to the RCA for 10 years. Of that, $50,000 will fund the InnoVision policy and $50,000 will go to the Canada Revenue Agency (CRA) to pay the refundable tax owing. The $100,000 contribution to the RCA is a deductible expense to the corporation. The retirement income benefits will be funded from a combination of policy withdrawals and refunds of refundable tax. Any retirement income benefits that Romeo receives from the RCA are fully taxable as part of his income.

With the IRP and policy withdrawal strategies, the corporation will pay Romeo a bonus of

$100,000 for 10 years. Romeo will pay tax on the bonus and use the after tax amount to fund the InnoVision policy. The bonus payment will be a deductible expense to the corporation.

With the CIRP strategy, Romeo’s corporation will purchase an InnoVision policy. Insurance premiums are not a deductible expense to the corporation. The corporation will borrow from the policy and use the borrowed funds to pay Romeo a taxable dividend. The corporation will realize tax savings by claiming a deduction for the loan interest expense.

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Based on the facts provided here is a summary of benefits under each strategy:

Note: This summary closely reflects the current tax environment in Ontario. In Ontario and certain other provinces, corporate tax rates in the future are expected to be lower than 33%. In other provinces like Alberta, corporate tax rates are already below the 33% tax rate. In addition to lower corporate tax rates, future eligible dividend tax rates for certain provinces will be less than the 31% personal dividend tax rate used. Lower tax rate assumptions should widen the income gap between the CIRP (non-RCA) and RCA strategies.

Comparing income benefits is important when considering the different strategies. But it is also important to understand there are other issues to consider. An RCA can be onerous to establish. Typical RCA situations require legal agreements and an actuarial report. Costs for these requirements can be significant. With an RCA, there are annual fees to consider and CRA filing requirements that must be met. An RCA does not offer the same level of flexibility as non-RCA solutions. For example an RCA’s retirement income benefits must be paid and to do so requires a change in employment status. These restrictions do not apply to non-RCA solutions. Retirement income planning can be an important part of any owner-manager’s financial plan. If an RCA is being considered, it’s prudent to also consider non-RCA strategies.

May 11, 2009