RCAs and IPPs – Revisiting Tax-Advantaged Retirement Savings

For professionals, prior to 2018, typical tax planning was to incorporate, set up a family trust, save inside the company and split income with family members to manage your annual tax costs. The reason it was such a popular tax planning solution? It worked well. With low tax risk, and being relatively easy to administer, it was an effective tool for long term financial security.

Then July 18, 2017 happened, and the tax planning environment changed dramatically for Canadian small business owners, especially professionals. The federal government implemented new limitations on earning investment income inside of corporations and significant restrictions on the ability to manage tax costs through income splitting turned more than 20 years of tax planning on its ear and a new landscape emerged.

It’s time to turn the page and embrace the new reality. The new rules are a part of the tax environment for the foreseeable future. What we need to do is to look at the tools we still have and determine how we make the best use of those to build a resilient plan which manages tax costs over your career and into your retirement.

For high-income earners, RRSPs just aren’t enough

In 1957, the Canadian government introduced the Registered Retirement Savings Plan (RRSP), on the premise that an annual tax-deductible contribution of 10 percent to a maximum of $2,500 of a business owner's T4 income would provide an adequate pension. 

Over the years, as with many types of tax benefits, the RRSP system has failed to keep up with inflation. In 2019, you needed to earn approximately $147,250 to maximize an RRSP. For comparison, the $25,000 of earnings required to maximize your RRSP in 1957 is approximately $228,500 in 2019 dollars. For high-income earners, today’s RRSP provide just under two thirds of the tax planning benefit they did when the program was originally introduced.

What is an RCA?

An RCA is a plan where a company can put funds into trust to be paid to employees when they retire. Larger companies may use an RCA to top up retirement benefits beyond those provided for by pension or other retirement benefits. For high income earners, RCAs can help bridge the gap between the benefits RRSP provide and what they expect they will need in retirement.

Five Key Advantages of RCAs

• Plan features are flexible, making it easy to adapt to the specific needs of each participant’s objectives.
• Contributions made to the RCA are not subject to payroll taxes and are tax-deductible.
• Once a person retires, the access to funds is flexible. In particular, participants do not have to wait until age 65, they may take out lump sums, or income over time, whichever suits them best. Given that plan assets are separate from the company’s, they can create an element of asset protection.
• Like an RRSP, payments from an RCA are taxed personally when withdrawn in retirement.

Two Key Disadvantages of an RCA

• Only half of the contributions to an RCA can be invested. Plan contributions and investment income are subject to a 50 percent refundable tax. This tax is refunded to the RCA at the same rate as retirement benefits are paid out to individuals.
• Neither the employer nor employee can directly control the investment assets while held in trust. Although often in consultation with the beneficiaries or the company, a custodian/trustee is responsible for the management of the trust assets while held by the RCA.

What is an IPP?

An IPP is a defined benefit pension plan for one member. IPPs specifically benefit owners of incorporated companies who do not participate in an employer pension plan and who have annual earnings in excess of $120,000. Individuals should be at least 50 years of age to derive the maximum benefits from the plan. The contribution advantage of using an IPP vs. an RRSP increases with age. Subject to certain limitations, a defined benefit plan will provide for an annual pension equal to a percentage of your highest earnings over a given period.

Five Key Advantages of IPPs

• All contributions to an IPP can be invested.
• Contributions are tax deductible, allowing for efficient flow through of corporate savings / profit to business owner, bypassing new passive income rules and taxation.
• IPPs fall under pension legislation, so you can split income in retirement with spouse or significant other.
• Contribution limits are higher than in RRSPs and you can top up your contributions if the IPP does not achieve a 7.5 percent annual growth rate.
• Assets are secured from creditors.

Two Key Disadvantages of an IPP

• The pension cannot be drawn upon (with limited exception) until the individual turns 65. Furthermore, existing RRSPs may need to be transferred into the locked plan to fund past service.
• Plans are provincially regulated. In some provinces, contributions may be mandatory regardless of the financial circumstances of the individual or the company. In addition, provinces regulate the type and diversification of investment which may not necessarily align with the investment objectives of the individual.

Which is better: an RCA or IPP?

Consider the hypothetical example of Dr. Smith. She’s 50, incorporated her practice 10 years ago and wishes to retire in seven years. She’s coming into the highest income earning years of her career and wants to focus the next seven years on her retirement savings which have not been a priority up until now. 

An RCA is flexible and an effective means of moving the taxation of income into the future, where taxable personal income is expected to be lower. The ability to use marginal tax rates in the future can provide a substantial tax advantage.

By effectively doubling the invested capital over an RCA, an IPP results in the highest amount of invested assets in the shortest amount of time, growing to provide long term financial security.

Which is best for Dr. Smith? The answer depends on her priorities. If her biggest concern is the short-term cashflow gap between 57 and 65 and having funds available until her other retirement assets come to maturity, an RCA is an excellent tool to consider. Although there are fewer assets working in the investment pool, where the tax advantage is going to be realized in the near term during a period of low taxable income, an RCA can provide considerable tax benefits.

However, if Dr. Smith’s biggest concern is funding her lifestyle after age 65, then an IPP could provide substantial benefits. Maximizing the current tax deductions, maximizing the investment pool and deferring income taxation until after 65 are some of the ways to benefit from an IPP. The IPP could boost Dr. Smith’s retirement savings to help her meet her long-term financial goals.

Finding out more

Professionals are high-income earning individuals with complicated tax situations and retirement planning and have many more consideration than other individuals. Discussing your long-term plans with an MNP advisor, in conjunction with your financial and legal advisors on a regular basis, leads to having a clear strategy and peace of mind. By having a well-informed team, we can identify opportunities like RCAs and IPPs or other estate and tax planning options that can help you realize your long-term financial goals. 

Robert Dean, CPA, CA, CFP, TEP, is a Business Advisor within MNP’s Tax Services team. For more information, contact Robert at 902.835.7333 or [email protected]