IPPs & RCAs with Fraser Lang | E004
Going beyond RRSPs when plnning for retirement.
Summary:
In the 4th episode of Financial Planning for Canadian Business Owners, Jason Pereira, award-winning financial planner, university lecturer, writer, and host of the podcast Fintech Impact, welcomes Fraser Lang, Senior Vice President of GBL, a financial planning firm focused on retirement planning. They discuss different retirement account strategies including IPPs, RSPs, and RCAs, including different combinations of the three and use cases for each.
Episode Highlights:
● 01:05: – GBL currently manages over 1,500 IPPs and about 500 RCAs.
● 01:50: – GBL sets up these accounts and manages them for what Jason considers a very reasonable price.
● 02:55: – An Individual Pension Plan is a self-directed, defined benefit pension plan.
● 03:20: – With a defined benefit plan, the amount of your income that is contributed to your pension plan is predetermined by a formula to increase as you get older.
● 06:58: – If your investments don’t make the promised return, you can get a tax return to make up the difference for your company.
● 07:40: – GBL is usually looking for connected members, or people who own 10% or more in shares of a company.
● 09:33: – Age 38 is the crossover point from an RSP to an IPP.
● 12:57: – One contribution number is the “past service” contribution, calculated for businesses that were founded in 1990 or earlier, of what their IPP and RSP contributions would have been based on their age at the time, and contributing a percentage of that now.
● 17:25: – Additional voluntary contributions are an option through a clause to be able to later deduct money from the account if needed.
● 21:48: – When you retire, you have several options for what happens to the account, including purchasing an add-on pension or a bridge benefit if you retire before age 65.
● 26:45: – The costs to setting up and maintaining an IPP varies depending on which Canadian province you’re in, but runs about $1,400-1,600 per year.
● 27:17: – In a fully funded IPP, you’re looking at about 40% more contributed over its life than you would maxing out an RSP.
● 28:00: – An RCA is one of the most misunderstood planning options, but put simply it is a supplemental retirement plan if your income far surpasses the limits of an IPP or RSP.
● 30:27: – With an RCA, some money is going into an investment account and some goes into a refundable tax account where you are prepaying tax on that money at a lower rate.
● 34:57: – You can defer withdrawal throughout your lifetime with an RCA.
● 39:07: – The setup and maintenance of an RCA has far fewer hurdles than a pension plan does.
3 Key Points
1. Certain pension plan setups allow you to delay and/or lessen the taxes taken.
2. The maintenance costs of these retirement plans are minimal compared to the benefit
you can receive from funding one of these accounts.
3. These retirement options allow for the transition of a business to beneficiaries.
Tweetable Quotes:
● “The IPP can be a nice diversification tool to get the money out of the corp and have it grow tax-deferred and fully credit approved.” –Fraser Lang
● “Where we see RCAs used a lot is with executives because unlike an IPP where if you’re not the owner of the business there can be some long-term liabilities, with a RCA, even if the room is higher than you need, you don’t ever need to fund that room.” –Fraser Lang
● “The number of use cases for this type of structure is fascinating. Everything from the business owner who’s trying to save for their retirement, the severance cases, the rewarding of executives...” –Jason Pereira
Resources Mentioned:
● Website – Jason Pereira’s
● Facebook – Jason Pereira’s
● LinkedIn – Jason Pereira’s
● Jason’s RCAs article
● GBL website–https://gblinc.ca/
● Email Fraser–fraser.lang@gblinc.ca
Full Transcript:
Speaker 1: Welcome to the Financial Planning for Canadian Business Owners podcast. You will hear about industry insights with award winning financial planner and entrepreneur, Jason Pereira. Through the interviews with different experts with their stories and advice, you will learn how you can navigate the challenges of being an entrepreneur, plan for success, and make the most of your business and life. And now, your host, Jason Pereira.
Jason Pereira: Hello and welcome to Financial Planning for Canadian Business Owners. I'm your host, Jason Pereira. Today's show, I have Fraser Lang, Senior Vice President for GBL. GBL is a well known Canadian actuarial company. It helps businesses implement different solutions that help with people's retirement. In particular, I brought Fraser in to talk about individual pension plans or IPPs, and retirement compensation agreements or RCAs, and how they can help people plan for retirement. With that, here's my interview with Fraser.
Jason Pereira: Hello, Fraser.
Fraser Lang: Hey, Jason. How are you doing?
Jason Pereira: Good. Thanks for coming in today.
Fraser Lang: You're welcome. No problem, any time.
Jason Pereira: So, Fraser Lang of GBL, tell us about GBL.
Fraser Lang: Sure. GBL was founded in 1995 by Gordon Lang, who is one of the principal experts in terms of pension plans within our country. We have over 1500 IPPs currently under management, about 500 RCAs that are currently under management. But, we've set up roughly about 3000 IPPs over the life of the company. We're a little different from other actuarial firms in the fact that we have financial planning specialists that are there every step of the way to navigate through clients business needs, their tax planning needs, and how that all fits within the structures that we establish for clients.
Fraser Lang: We bill the client directly for the work we do and we don't participate in any investment commissions that are derived from anything that is placed within the plans.
Jason Pereira: Effectively, I mean, I've used you guys for years, what you do is you set these things up and administer them at what I would call a very reasonable price, and take the burden, which let's face it, there's a very large filing burden on some of these strategies. You guys have streamlined that and you made it very easy for the client and for the advisor to work in collaboration with you.
Fraser Lang: Yeah, I think that that's one of the areas that people have a bit of a fear of IPPs, especially on the advisory side. Is this going to be a lot more work? Is this administratively cumbersome? As much as we can take the complexity out of it, that's what we do. What we've done as a firm is, in terms of fees, we're middle of the road, but we've reinvested on our service offerings. So, when you're looking at actuaries, it's not the same as shopping for produce where one price-
Jason Pereira: Not it's not.
Fraser Lang: Where everything is the same.
Jason Pereira: Service offerings are very different.
Fraser Lang: I've seen that in the past as well, where somebody may have found someone who was $100 a year cheaper, and in the end, they came back to us within a year or two just because they weren't satisfied with the service.
Jason Pereira: We'll circle back to pricing, but let's again... The target here is we're talking to business owners, so [inaudible 00:02:47] get away from that. We're going to start off with the IPP or individual pension plans. Tell us, Coles Notes, roughly what is an individual pension plan?
Fraser Lang: Sure. An individual pension plan is a self directed defined benefit pension plan, which might sound like a mouthful. But, essentially what... For those who are unfamiliar with defined benefit versus defined contribution, defined contribution is 18% of your earnings up to 152,000.
Jason Pereira: It's basically like an RSP, but it's wrapped up in a pension.
Fraser Lang: Exactly. The difference here with the defined benefit is similar to what government workers and teachers have where as you get older than age 38, the percentage of earnings that we use, or what I call the delta that we use to calculate room grows. So, if you had a 40 year old versus a 60 year old with the same income in the same year, the 60 year old's going to have the substantially higher contribution than that of the 40 year old, because they have a shorter period of time to fund for retirement.
Jason Pereira: Let's unpack that. We look at someone using a defined contribution plan. It's just like an RSP, money goes in, you're limited based on your RSP limit, whereas this one, anyone's who's ever seen one of these pension plans, there's a formula, number of years times a certain percentage of your income times... what am I missing? Times your salary or average salary. The contributions that can go into these can be substantially larger over time than a traditional RSP, correct?
Fraser Lang: That's correct.
Jason Pereira: Yeah. So basically, let's talk about why is that. Why is it that there is a difference between traditional pension plans, defined benefit pension plans, and RSPs and defined contributions plans?
Fraser Lang: Well, because a defined contribution plan is basically, you have your contributions based on your earnings. At the end of the day when you retire, you take a percentage of those assets, which is your payout that normally occurs. When you run out of assets, you run out assets there. Whereas with a defined benefit pension plan, what happens is there is the assumption there that, and we're using a two percent benefit formula, so it's two percent of one's earnings each year-
Jason Pereira: That's the most you can do, unless you're government, unless you're an MP or a judge apparently.
Fraser Lang: Yeah, exactly. We're limited in terms of that being the most robust pension calculation or benefit calculation we can provide. We add up all those years together, and in order to be able to guarantee a pension payout through a normal mortality or normal, let's say, age 85, you would need a larger pool of money to take care of that than you would with a defined contribution. Because the defined contribution, there is no promise to payout a specific dollar amount.
Jason Pereira: Yeah. Everybody's familiar with that with the RSPs, whatever comes out of it. So for example, someone earns 150,000 on average, two percent of that, they work at the company for 40 years, that's 80% of the 150, so now we're looking at, what is that? That's 120,000 that this plan is supposed to generate in income for the plan member for the rest of their lives.
Fraser Lang: Exactly, and on top of that, it is a pension that is index to inflation, so we do see the pension going up from one year to the next as well. It's not just a flat line payout. It's going to go up each year.
Jason Pereira: But, unlike a traditional defined benefit pension where you make contributions into it and then it's like, don't pay attention to the man behind the curtain. The money's being run for you by a pension authority, the pension provider here in this case, which is typically a business owner doing it for themselves, and we'll get into who else can do that shortly is basically able to self direct those assets. Their advisor can weigh in and guide them. They can self manage those, but essentially they're responsible for the return.
Fraser Lang: Exactly. I mean, if you're going to follow the defined benefit to the true letter of what it is, so if you're saying I want to have that specific defined benefit in retirement, there is an assumed seven and a half percent rate of return that the government established back in 1990. If your plan at the end of a three year rolling period fails to hit seven and a half percent in terms of the asset value, the company would have the opportunity to put in additional funds to backstop the pension.
Jason Pereira: So, when the pension doesn't perform as the government says it does, you get extra contribution room.
Fraser Lang: Exactly.
Jason Pereira: Which you do not get with an RSP. I mean, if you have a bad three year period and you average two percent per year, your RSP room is the same and unchanged, whereas with a pension, you not only basically have the normal contribution room you would've had, but now all the money that you didn't earn over those three years, the company can cut a cheque for that and make that contribution as well.
Fraser Lang: That's correct, and it's deductible to the company as an expense. It is the only type of plan out there for a business owner that has that mechanism that if my investments don't return a certain amount, I can actually get a tax deduction for making up the difference from my company.
Jason Pereira: Yeah. I mean, yeah at the end of the... That's incredibly valuable because especially a lot of the business owners I've spoken to in the past, many of them will turn around and say, "I take enough risk in my business. I want something more conservative on the investment side." What they want is the security of knowing they can be able to retire. If there business is lucky enough to get to a certain point, they know they're never going to have to worry about that. But, for many of them, it still very much is. So, let's go back to... So, who can set these things up, and what are we looking at in terms of a timeline, what the process is for setting one up?
Fraser Lang: We're normally looking at what we call connected members, which are people that own 10% or more shares in the company. The reason for that is there's a different set of rules that oversee a owner- manager versus an arms length employee. If you were to set this up for an arms length employee, the government would require that you have all the funding topped up to exactly where it should be because you're making a promise to your employee. If you're setting it up as a connected member, which is 99.95 of the plans that we establish, they look at it and say, "You're making a promise to yourself as the owner. If you don't fully fund that promise, we're not going to penalize you for it because it's not like you're cheating an employee."
Fraser Lang: So, really we're looking at the owner, spouse if they are receiving T4 from the business. They can be joint on the plan. And in the case where we might have a bonafide family business, where the kids are definitely going to continue the plan, they're active in the company, there's no viewpoint on selling or rolling up the company when mom and dad pass away, we can add them onto the plan when the reach the age where it makes sense mathematically, late 30s, and they can participate as well.
Jason Pereira: Couple things to unpack there. First off, typically business owners do this, and we could do this for employees, but I mean, I've talked people out of it before too because it doesn't... Here's the thing. It's one thing to want to be benevolent to your employees, it's something else to be on the hook for under performance in the markets to your employees. I have no problem cutting a cheque to my pension plan to make up for a couple bad years. I don't know if I want to, after setting up something that gives them all their pension contributions, also be on the hook for their performance, especially through retirement. That to me is a bit of an ask, and to most business owners when it's explained, it's also a bit of an ask. So, let's also talk about age. Basically, you said mid-30s. Prior to that, and I've seen this, before people are just generally better off with an RSP. Can you explain why that is?
Fraser Lang: Well, age 38 is the crossover point on an IPP contribution versus that of an RSP. If you're younger than 38, you have a couple things there. The majority of business owners in their early 30s or 20s, if they were so far ahead of the game that they started their company in their 20s, they often have other needs. Using your RSP not only you're not paying any carrying costs that you would to an actuarial firm, but you have the flexibility for things like the home buyers plan, lifelong learning plan, spousal RSPs perhaps if you're going to start a family and you might want to split some income with your spouse as well. I think there's a lot of flexibility, and I find that most businesses, it's not until they're really getting into their 40s and 50s where they have a lot of excess capital where they need that significant deduction.
Jason Pereira: Yeah. I mean, we've occasionally seen these things are marketed to people younger, but quite frankly short of being Zuckerberg and making that kind of money that early in life, we all have other priorities first before we get to... I've already maxed out my RSP, what else is there? Okay, so beyond that, let's talk about a couple other concerns here, a couple other things that come into play here. What's involved in setting one of these up?
Fraser Lang: There's a couple steps that we have to the process. We have a one page fact finder that we have clients complete, where they provide us with their past T4. It's very important that people realize that it is your T4 income from your company-
Jason Pereira: Not dividends.
Fraser Lang: Exactly. We sometimes see people using line 101 of the tax return.
Jason Pereira: No.
Fraser Lang: [crosstalk 00:10:54].
Jason Pereira: Yeah.
Fraser Lang: Yeah, that can capture a lot of other income, and that income is not going to be accepted by CRA. We look at their past income, how old they are, rough idea of what their RSP assets are because that has some impact on something called past service, and whether they have any unused RSP. From there, we come out with an illustration that shows a comparative analysis between an IPP versus that of an RSP, where they would be if they retired at one age versus the other. We normally review that with the client, their advisor, and we strongly encourage their accountant to be at the table so that everybody is on the same page.
Jason Pereira: Everybody signs off simultaneously, yep.
Fraser Lang: Then, from there, we have an application they complete, we draw up the legal documents, file them with the government. You're looking at about a month after we file them to get a registration number where you can set up the plan and start funding it. A few months later, depending on how quickly CRA is with processing the application, they will give you [inaudible 00:11:48] approval where they view all the past T4 to make sure it matches up with what they have on file. At that point, there is an RSP transfer that would happen from their existing RSPs into the plan, and there's something called Past Service that the company can fund at that point.
Jason Pereira: Okay, so let's talk about this. There is... That's a lot of work, but in fairness to my experience with you guys, I fill out basically two forms on behalf of the client, you guys take care of everything else we just discussed, and a big box comes back for me to sign. It sounds like a lot, but frankly to the end client and to the advisor, it really is not. You guys are carrying the ball on this. So, in terms of the contributions to start out, there's three types of contributions we're talking about off the bat, right? You just discussed one of them. There's the RSP transfer, so part of your RSP has to move into it. There is the basically current pension contribution, so that's the current contribution for the current year you're working, which over time grows to be, in my experience, significantly more than the RSP room. I think I just took in one client's $48,000 cheque when the RSP room is what, $25,000? I can't remember where it is right now. But, the point is that substantially more than they could have done otherwise. Then, there's the past service. Tell me about that past service piece. Why is it there and what kind of numbers we typically look at with that?
Fraser Lang: There's rules in place so that if you've had your corporation since 1990, we can go back and say, "Had I been in an IPP from the time I incorporated, here is the amount of money over what I could've put into my RSP." We look at their income and their age in each year, we say, "Here is what your IPP contribution would've been. Here's what your RSP contribution would have been." We take the difference of the two, we use that seven and a half percent rate of return and we accrue that, and we come up with a forward number and we say, "This is past service."
Fraser Lang: Now, with a pension plan, what happens is zeroing out all but $600 of your RSP room going forward. There's something called the pension adjustment that we provide-
Jason Pereira: So, you don't get both. You only get one.
Fraser Lang: Exactly, so in order to make the plan whole and to be able to do that past service contribution, the individual would transfer a certain amount from their RSPs, which is just equal to what their RSP room would've been for all those years plus that seven and a half percent. It's a tax neutral transfer into the plan, and it allows them to buy that addition deduction in past service.
Jason Pereira: Fair enough. To my experience, when I've done this, depending on age, I've seen these past service contributions be as little as $60,000 and as much as into the multiple hundreds of thousands. So, being able... For someone who thought that they were being diligent and maxing out their RSP every year and doing a good job of that, to turn around and tell them, "Oh by the way, if we set this up, not only do you get $15-20,000 more in room in this given year, but you can also cut a cheque for $300,000 into the plan. That's a tax shelter they never thought they were going to have access to.
Fraser Lang: Yeah, and the nice thing about that is that $300,000 in your example can be contributed lump sum or it can be spread out over time. They fund it by retirement, that's fine. There's no set schedule they need to-
Jason Pereira: But in fairness, when we're looking at a market for this, we're not looking at a business owner who doesn't have substantial cash flows. We're looking for businesses that you're leaving money behind in the corporation. You have a corporate surplus and you have good income that you can deduct against. Frankly, if you're in a highly volatile industry, I don't know that the IPP is made for you quite honestly because these are required contributions, right?
Fraser Lang: Definitely. I mean, in majority of the provinces, they don't necessarily enforce contributions if you miss on in a given year. However, if you're going to set up a plan and jump through all the hoops to get one down, why would you be setting up a plan if you didn't have the intention of funding it.
Jason Pereira: I unfortunately came across one that we took over and shut down that, I mean, the people were taking about $60,000 a year in income, and then rest of it was dividends. And I'm sitting there just shocked that the account and the advisor couldn't come together and realize that this was foolish because they were not maximizing the use of this thing. But, that's another note all together. So, you have the current service, you have the RSP gets rolled in, a part of it gets rolled in. You also have this additional pension contributions and the past service. Then, every three years, there's a review. We already mentioned this. If you underperformed every three years, you get to make additional contributions to basically make up that performance. If you over performed, nothing.
Fraser Lang: Yeah. You can hold up what we call a surplus. If you have more money in there than you're supposed to, you can hold up to a 25% surplus without reducing your contribution. To give you an idea, I've seen many markets cycle through the life of the plans. I've been with the firm since 2003, and I remember 2007 and 2008 where right at the end of that year because of the market being where it is, people may have been in a heavy deficit, threw a bunch of money in as a deduction to bring it up, and then when the next valuation came around, they're in a surplus because of the market.
Jason Pereira: Massive surplus.
Fraser Lang: Yeah.
Jason Pereira: But, then they get a holiday for making those contributions.
Fraser Lang: Exactly.
Jason Pereira: The goal here is about income. That surplus thing sounds interesting, but at the same time, let's not forget that this plan is targeting 7.5% per year. In order to be in a surplus position in the three year period, you basically have to essentially do close to nine percent per year for three years at least, especially in a low interest rate environment we're in. Unless you're taking a lot of outlandish risks, you're probably not going to get there.
Fraser Lang: That is correct. It's interesting the makeup of individuals. When I view this, I view it from the perspective of a financial planning side, and if you look at things like fixed income, where should I have my fixed income within your corp. You're getting taxed over 50% on a pretty low return to start with. In your RSP, it's getting eaten up by inflation because it's returning sometimes less than inflation. With your IPP, it might drag down the performance and in return-
Jason Pereira: [crosstalk 00:17:09].
Fraser Lang: Yeah.
Jason Pereira: Yeah, exactly. I know that's [inaudible 00:17:11] some people will say, "You know what, that's what I'm going to do. I'd rather make the contributions and keep my fixed income there and pay less tax on the capital gains elsewhere." So, there's also something else that comes as an option to these. Something called an additional voluntary contribution. You want to speak to what that is?
Fraser Lang: Yeah. I mean, additional voluntary contribution is a clause that the majority of actuaries would have within their IPPs. The reason behind it at the time is, when we mention this past service and this RSP transfer, there's normally a specific dollar transfer that happens from your existing RSPs. If you were to transfer more than that required amount and it was in error, and you wanted to be able to back out that additional amount you transferred in, you need to have a clause within the plan that allows you to do so, which is an additional voluntary contribution. Where we see it utilized in a lot of cases is I have past service where I have a $250,000 RSP transfer, I have $350,000 within my RSPs currently. I would rather have that extra $100,000 consolidated within the same account rather than just carrying a smaller amount around.
Jason Pereira: Yeah. You can have one account total for all of it.
Fraser Lang: Exactly, so what I'm going to do is I'm going to roll it into my IPP as an additional voluntary contribution and it doesn't make up part of the benefit necessarily, but it's all consolidated there, so with fees and expenses, you do have the ability to deduct those as expenses to the corp, and that can be a nice little [crosstalk 00:18:29]-
Jason Pereira: That was somewhere else I was going to go. So, fees and expenses can be deducted by the corporation, which is unlike an RSP. I will preface this by... I will put an asterisk behind that, and say that that depends in general, if that can be supported because some custodians, some dealerships, they will not permit that sort of thing, fees to be paid outside from a third party. If that's the case, well you know what the reality is, fees drag down the overall performance anyway so you've go to make it up on the deductions in the future. But nevertheless, it's something that is not made up for through RSPs, so another advantage there. If we're going to sum up the key benefits here, we're talking larger contribution rooms than RSPs, trying to essentially peg an income as opposed to question mark as to what's in and out of the RSP, the ability to deduct the fees, both on the core plan and the additional voluntary contributions, and the ability to make up for poor performance or just subscribe 7.5% performance over time. That pretty much sums it up, does it not?
Fraser Lang: Yeah. I mean, I'd throw creditor proofing on there as well.
Jason Pereira: Oh I forgot that one. Yes, so speak to that please.
Fraser Lang: With a pension plan, unless you know you're about to be sued and it's fraudulent conveyance, it's pretty much as airtight as you can get in terms of creditor proofing. RSPs, we hear about them being creditor proofed, but when you talk to a room full of lawyers, they tend to laugh and say it hasn't necessarily had the full test in court. I think if you are somebody with a business where you have some level of risk and keeping your money within your corp may attract risk of creditors, the IPP can be a nice diversification tool to get the money out of the corp and have it grow, tax-deferred and fully creditor proof.
Fraser Lang: The other point I would say is an advantage is, in light of the passive income rule changes that we saw last year-
Jason Pereira: Which we're going to have a guest speak about prior to you coming on.
Fraser Lang: So, you've already been in enlightened with regards to that, is what we're seeing in a lot of cases, incorporated doctors and professionals, where they retained a lot of money within their corporation, and now they have concerns about the income earned within that corporation clawing back some of their small business tax level. The interesting thing with the IPP is we've seen since the 2018 budget, especially with medicine professional corporations because they don't have ability to sell those down the road, is accountants actually saying to their clients, "Listen, we've done a great job in retaining within the corporation, but we have some unintended consequences now because of the 2018 budget with regards to passive income. I think you should look at an IPP as an option so we can get some money out of the corporation so we're not retaining too much in there." The IPP can be used very well on a corporate tax planning strategy.
Jason Pereira: Yeah, so that's very important. For anyone who wants to learn more about, go back and listen to the episode about it. And, just to enlighten you, unfortunately in this country, believe it or not, there is situations when you earn income within a corporation, it is entirely possible the total tax bill on that income is somewhere between 70 to 120 percent of that income. Frighten numbers, but the IPP helps limit that by taking money out of the corporation therefore reducing the amount of income generated within the corporation, therefore reducing the claw back of that benefit. Yeah. When I tell people what those tax rates are, their jaws just drop in shock. So, before we wind up on this, just on the IPP, I want to talk about two things. One, so someone gets to retirement age or they sold their business, whatever it is, what happens to these plans? What are the options for what we can do?
Fraser Lang: Well, you have three key options that are available to you on retirement. First of is, are you going to be keeping that company in question, in force throughout your lifetime? So, going back to medicine professional corporations. They don't sell their business. They tend to have a lot of their life insurance and other planning within their corporation that when they retire for all intents and purposes, it becomes a holding company. They're not going to sell that company over time. If you're not going to sell your company over time or collapse it, you can take the annual pension directly from the IPP. The advantage you have there is 100% of the assets are within the plan, you can income split the pension with your spouse, and it can be the opportunity for a very sizable top up to the plan the year that you start taking your pension.
Jason Pereira: Let's talk about the top up. What is that about?
Fraser Lang: It's called terminal funding, and what it allows you to do is depending on the age you're retiring, if it's before 65, you can actually purchase an add on pension, which is what we call a bridge benefit, which is just the equivalent of CPP paying out from the-
Jason Pereira: Yeah, so we've seen this. We see this with anyone who's got a defined benefit pension, if you're a teacher or if you're working for a company that has one, you retire before 65, they say, "Okay, well we're going to pay you this amount until 65, and then lower amount thereafter because CPP kicks in." Same basic benefit, right?
Fraser Lang: That, and we also are purchasing additional indexing, so I mentioned earlier in our conversation that these are indexed to inflation. The idea here is a dollar today and a dollar from five years from now will be different. The base pension is indexed at CPI or consumer price index minus one percent. You can take that minus one percent off and purchase that full CPI indexing, so that it grows at a higher level. That terminal funding in a lot of cases can be a six figure number, so for some people, they look at it and say, "This is my last year of major active income, operating the business. This gives me an opportunity to put this large lump sum in and get a deduction to the corporation."
Fraser Lang: If it's a case that you're going to sell the business over time, before you start taking your pension or you terminate the plan, what we suggest is if you have a secondary corporation, that we could add on to the plan as a sponsor. What would be involved with that is receiving a T4 from that company to create an employment relationship. There'd be a small IPP contribution that would be attached to that T4, just to make it a participating employer. Then, in retirement, you get rid of company A, which has been the main source, company B takes it over and you don't need to collapse the plan over time.
Fraser Lang: The other options on retirement is one of them is what we call terminate to locked in retirement account or a locked in RSP. I know there's a lot of acronyms we're throwing around here.
Jason Pereira: Yeah.
Fraser Lang: Basically, it's the same form of a... It's like an RSP, you just can't collapse the whole thing if you don't care about the tax [crosstalk 00:24:25]-
Jason Pereira: Yeah, so this [inaudible 00:24:25]. This is what people see when they... When most people are in a pension, they got options. So, they basically get one option, which is take the income, and there's the different types of income levels you can take based on survivorship rules and everything else, or take a lump sum in which case part of it goes to that locked in RSP. But, part of it becomes taxable as well, right?
Fraser Lang: That's correct.
Jason Pereira: So, that's less attractive. I mean, the one thing we didn't talk about too, and the one case I'm contemplating right now, we've got to talk about it off air, sometimes I get these business owners who want to pass the business onto their kids and want to stop working, but they're not ready to relinquish it, or they may need the income. I've got one in particular who says, "Look, hey don't have to pay me for it, but they gotta pay me in my income for the rest of my life." They're just looking at getting a T4 for not working, which is not a really good position to be in.
Jason Pereira: The sales pitch on that, or the entire solution there is to say, "Well, here's a better idea," especially to the youth taking it over. Would you rather be on the hook for this salary every year or would you rather be on the hook solely for... Would you rather establish between now and the time of retirement a pension fund for your father and then be on the hook solely for market differentials between that and the 7.5?" That is potentially far less cash flow intensive than having to be on the hook for that salary indexed to inflation for the rest of their lives.
Fraser Lang: Definitely, and the other side to it is you can add the kids onto the plan, as we said, when they reach that mid to late 30s number. The advantage you have there is dad passed away in retirement, mom starts receiving his pension as a survivor pension. But, she passes away and there's remaining assets within the plan. If we didn't have additional members in there, that would be collapsed and taxable, and either split [crosstalk 00:25:56]-
Jason Pereira: Just like an RSP would.
Fraser Lang: Exactly. It's a deemed disposition at that point. If the kids are going to continue the business and continue to earn pensionable earnings, we add them onto the plan, the assets stay within the plan, there's no tax paid, there's money in there than they have earned credits to absorb. And, as long as they just continue earning that surplus comes down. Basically, you've got to pay the pension from your parents.
Jason Pereira: Yeah. It's one of the few opportunities for now paying tax like that. But, I would caution everybody highly that this is not the reason you enter it. That is, these kids better be working in that business, it better be an ongoing enterprise. There are some other risks that need to be looked into, but nevertheless, it is a definitive benefit there. Let's talk about the cost of administering these. There's what the advisor is going to charge, or whatever the investments are going to cost. What's it cost to set one of these up and maintain them going forward?
Fraser Lang: Depending on the province, because different provinces have different levels of administration. You're looking somewhere $1,400 to $1,600 per year for a single member plan, $400 to $600 per year for an additional member. That's all deductible to the corporation as an expense as well.
Jason Pereira: Which I'm always staggered by how affordable this is quite honestly given the massive difference in contribution versus an RSP over it's lifetime. I mean, your projections alone I think typically end up showing... What's the typical up side in terms of amount contributed versus an RSP to a fully funded plan?
Fraser Lang: Fully funded plan, you're probably looking about 40% more contributed over the life of it. It gets to about as high as a 64% advantage at age 65, which is-
Jason Pereira: That's... Yeah.
Fraser Lang: Where it maxes out.
Jason Pereira: Yeah, so there you go people listening. That is the equivalent of having 1.6 RSPs if you basically do this right, and you have income and the cashflow to justify it. So, that's of immense benefit. Let's move on to the second topic of the day, which is retirement compensation agreements. These often get looked at similar times as IPPs. The acronym is RCAs, and these are... I will say, I think an IPP is a little bit easier to wrap your head around because pensions are... People have an understanding what they look like, at least the basic one. RCAs are a little bit foreign. Explain to me what an RCA is and how it works.
Fraser Lang: The starting comment I'd have on that is an RCA is probably one of the most misunderstood planning options.
Jason Pereira: Agreed.
Fraser Lang: It's a huge opportunity that exists. What it is is it's a supplemental retirement plan. If you were someone that has earnings well above where an RSP or an individual pension plan or a defined benefit pension plan would allow for, and the company wants to provide you with the benefit fully up to what your real lifetime earnings are, you would put an RCA on top of that, and basically an RCA does not have a limitation in terms of funding based on $152,000 of T4. The higher your T4 on your three year average of earnings, the higher the amount you can put into the plan.
Fraser Lang: Where we see them used a lot is with executives because unlike an individual pension plan, where if you're not the owner of the business, there can be some longterm liabilities, with a retirement compensation arrangement, you have the ability, even if the room is higher than what you need, you don't ever need to fully fund that room, and you can have a signed employment contract that sets forth the limitations as to what the promise is. It can be great if you want to maintain an executive for a long period of time. They do great work, you want to give them something more than what an RSP is going to allow for, and you can throw vesting provisions and things like that. You have to be with us for five years to fully vest these dollars.
Jason Pereira: Which normally, you can only throw vesting provisions on for two years on a group plan.
Fraser Lang: Exactly. So, we see it for that. We see it a lot of these days. Part of the reason we see RCAs coming back is the fact that our tax rates have crept well above 50% in many provinces in Canada.
Jason Pereira: Just the mechanics of this, so the way this works, as you said, you guys come up with a number that they can contribute or a projection of forward schedule of numbers, and these things get substantial. I've had multiple million dollar contribution rooms open up for some of these, and it's nice that it's flexible. Use it, don't use it, up to you, but there's a cap. What happens when someone puts money into one of these things? What's the mechanics of how it works?
Fraser Lang: It's interesting. It doesn't impact your RSP room, and it's very flexible. If I say I want to put $100,000 contribution within my RCA. What makes this a little different from other retirement plans is 50,000 of that contribution would go into an investment account. We'll just call it the RCA investment account, and 50% goes to the government to what we call a refundable tax account, which is a zero interest bearing account, and it sits there in escrow until you retire.
Jason Pereira: So, essentially you're prepaying taxes on this money?
Fraser Lang: In a sense.
Jason Pereira: To a degree.
Fraser Lang: But, the idea here is that we're taking something that would be taxed at a very high right and when we retire, we have the ability to draw money out as we fit at a lower rate.
Jason Pereira: Let's go over that. So essentially, and this is where people sometimes get confused about this, like, "I'm giving the government 50%?" Yeah, but if you took the income, you'd be giving them, in Ontario, 53... Actually, in more than half the provinces now, over 50%. Automatically, there's a tiny benefit in Ontario specifically of 3.53%. In some provinces, that number is getting bigger. It's basically either a push or a benefit, or close to a push or benefit. Then, that's not the real reason we do it. We're doing that at 53. If a client retires and their tax rates drop to 30, 35, what happens when money comes out of these plans?
Fraser Lang: There is no age where you need to draw on it, there's no specific dollar amount you need to draw down on it. So, you would look at it, and what works very well is let's say I'm going to retire at 60 and I don't need to touch my RSPs and registered assets until 71. I can push the income from there, and I'm not going to have other sources of income, and I was at the top rate or pretty close to it throughout the majority of my earning years. If the money contributed to the RCA is there at retirement and you can push other income, if you draw 125,000 of T4, or not T4-able income, I guess $125,000 of income directly from the RCA in retirement and you have no other income, you're looking at roughly an average tax rate in the 28% range in Ontario.
Fraser Lang: So, if I took something from 53% and I've now reduced my end tax rate to 28%, well that's a 25% gain. So, even though half my money's not growing, you have to look at it and say, the major advantage that we have here is that spread in those tax rates. That's where we're seeing a lot of it right now with regards to executive severances. Somebody is presented with a severance offering from their employer, and they're saying, "We're going to pay you this as a lump sum." They're negotiating the severance through their lawyers and they say, "Well, this is acrimonious usually when you're being let go, but you know what, we'll play ball a little more. Can we rewrite the agreement that we'll agree to, that instead classifies this as a retirement payment?" It's not taxable, it's deductible to the company, they have no obligation beyond that agreed upon payment, and then you can save a significant amount of tax down the road.
Jason Pereira: Yeah. For the record, I wrote an article, which we'll put in the show notes. Fraser, I hope you're using that as a sales piece. But yeah, it's substantial. I mean, I think in that case, it was a $500,000 severance, and it dropped the tax bill from over 250,000 down to about 120 because now he's just spreading it out over five years. So, I mean, these are... especially when people are retiring early quote unquote, so let's call that 55, 60, whatever it might be. If you have other pension assets, everything else, those can be potentially deferred, in which case if you have... There's nothing greater for planning when you have a lot of money than a zero tax return. Then, we can just dump that money onto you.
Jason Pereira: Essentially, it's a way of... yeah, you're basically losing half the return, because half the money goes to the government and pays you nothing, the other half gets invested. Then, when the money comes out, you pay the rate of the day, which knock on wood is hopefully, if the planning is done right, is substantially lower, and we're talking significant savings here. We talked about a couple things. There's a lot of flexibility in this, and especially with the passive income issues in corporations. This is great for that, because if they have a year where their passive income is well above the $50,000 threshold, they can opt to take the entire amount, or just the amount over 50 grand, and basically push it to the RCA, and eliminate their problem, right?
Fraser Lang: Exactly. We see that as well with business owners where in advance of a share sale, they may have a lot of passive income on the books, which is going to impede their access to something called the lifetime [crosstalk 00:34:03]-
Jason Pereira: Yes, that's right.
Fraser Lang: Which is just an ability, in the $800,000 range-
Jason Pereira: It's another [crosstalk 00:34:08]-
Fraser Lang: You can have tax free basically. So, if you have a business owner, where they have a passive income issue within their corporation and they need to clean that up, an RCA can be a great way to one time fund, get those passive assets off the books, bring the company onside that when it does come time to sell the shares of that company, you now have that access to that cap gains exemption. Then, the idea there is, I've sold the company, I wait a year or two until any of the tax ramifications of that are all settled. Then I've got this money within my RCA that I can draw whatever amounts I choose. If my spouse has been employed by the company and received T4 and we're both on the plan, we can draw down money as well.
Jason Pereira: Let's go over a couple key points and differentiation points. So again, we talked about flexibility. You get the room, you don't have to use it, no issue there. What are the obligations about withdrawal of this plan?
Fraser Lang: That's the interesting thing. You can defer withdrawal through your lifetime. There's no age 71 or age 72 rule as you have with other retirement plans where you need to draw it down.
Jason Pereira: But, in fairness, you wouldn't necessarily want to do that forever because you pass away at the ripe old age of 90-something, then that gets your final tax return and then you're paying 53 anyway.
Fraser Lang: That's the interesting thing about RCAs, is unlike pension plans and RSPs, where there are very defined terms on what happens upon death, and there's something usually called the deemed disposition where you collapse it if there's no surviving spouse, or you can do a rollover. With an RCA, you can have named beneficiaries in equal shares, where they have the ability to either draw the money out. They can collapse the whole thing and draw it, and they'd be taxed on it, or they can take equal amounts out over time.
Jason Pereira: Yeah. They can spread that bill out as well. So, who gets taxed on that? Is it them or the estate?
Fraser Lang: It's the individual, not the estate.
Jason Pereira: Individual, not the estate.
Fraser Lang: Where I've seen that in an interesting situation, I had a case not long ago where we had, mom and dad are in their late 60s, they have three kids, two of them are involved in the business, the third one has very low income. The idea there was, they have real estate corporations that the other active kids are involved in. Within their RCA, what they're going to do is they're going to make the third child that has the lower income, that is not involved in things as the beneficiary on the plan. Mom and dad aren't going to draw down the money in their lifetime, so basically that child will be able to draw the money out, and they have a fairly low tax rate because they have virtually no other income. Within the estate or will, they're going to equalize the other assets to the other kids so nobody ends up getting short changed.
Jason Pereira: Yeah, and they can equally work to equalize while they're going on, because they can contribute based on... They have the room that they can contribute to, and they can fund it to the degree that they think, "okay, well the other assets are worth x amount of dollars, this one is worth $200,000 less, here's a $200,000 contribution. At some point you hit the cap, but it's interesting... I haven't seen that used. That's an interesting tool. So basically, no obligation to cash this thing out, ability to transfer some of the obligation to the next generation, income splitting with the spouse.
Fraser Lang: Yeah. You don't have the same level of income splitting as you have with a pension. They have to be employed by the company, and the portion that they take out has to be proportional to their earnings. What I mean by that is you have a business owner who [crosstalk 00:37:09]-
Jason Pereira: It's not 50/50.
Fraser Lang: Yeah. You have a business owner making a quarter of a million, the wife's making 50,000 or the husband's making 50,000. You couldn't say, "Well, we got a million in the plan, let's go 50/50 [inaudible 00:37:21]."
Jason Pereira: It's interesting. I look at RCAs as almost a Swiss army knife of planning strategies. The CRA is not too bothered by them because they're not the easiest thing to get around, and don't service the biggest population. They get 50% off the bat paying zero interest, and they know they're going to get their tax money because they already have the money, so there's zero possibility of you not paying. But, you look at this and the number of use cases for this type of structure is fascinating. Everything from the business owner who's trying to save for retirement to the ones who are trying to stay below that $50,000 passive income level. The severance cases we talked about, the big rewarding of executives, we'll see things called supplemental employment retirement plans set up, that are either unfunded or funded. If they're funded, it's basically, we'll set up an RCA because that's the only thing that makes sense. Then, cases you have now for intergenerational wealth and taking care of kids with lower incomes.
Jason Pereira: They really are, again, misunderstood, not fully understood to the degree of the use cases, and like I said, kind of the Swiss army knife of different high end planning strategies.
Fraser Lang: Yeah. I think you had really two obstacles with them in recent years. One was this idea that half the money is not growing, which means I've lost the opportunity. Now that we have a top tax rate over 50%, in fact you get more dollars in [crosstalk 00:38:29] at 50% than you do if you're paying the high [crosstalk 00:38:32]-
Jason Pereira: And if you keep too much money in your corp, now you're getting punished as well. They're designing that to push the money down. They want you to push the money, sorry up, in the [inaudible 00:38:42]. They want you to [inaudible 00:38:43] beyond a certain threshold, if you don't start taking the money out of the corporation, it's pretty punitive to the corp. So, people are going to be taking more personal income, and this is an alternative to that. If you're taking 53% at the top rate, yeah, we pay a lot of tax in this country. Let's save that political conversation later. So yeah, those are the two. Talk to me about the set up and maintenance of an RCA and the cost.
Fraser Lang: Sure. The set up of the RCA is a lot less hurdles to jump then let's say a pension plan. We have just the Revenue Canada that we're filing with. We have a fact finder that we run an illustration from. From there, the client completes a short application. It's three pages long. We draw up the legal documents. At the point that they sign those documents, if they want to make a contribution immediately, they can attach a cheque for the 50% to the government account right with the application forms and send it right in, open the account on their other side and fund it.
Fraser Lang: In terms of RCA's, we're looking at $6,000 to set one up if we're just doing a one off. If we have additional employees or business owners or whomever it is that being T4'ed by the company we want to set them up for, we reduce the cost of the subsequent ones down to $3,000 per plan. And there's a tax filing that needs to be done on the plan every year. It's a cost of $800 a year per plan. So, it's really not that expensive.
Jason Pereira: No, and again, all the paperwork, you guys handle it all. It's basically a couple of forms we see per year. When I say forms, from the advisor standpoint, literally I get a form saying confirm the contributions, confirm any withdrawals, confirm any assets you're holding, in what allocation, and I send that off. Then, some other stuff comes back for the client to sign. It's really... You guys have done a wonderful job in making that easy. I'm making it sound like you're the only ones doing that. There's several other actuarial firms I get along with too, yours is my go-to. But yeah, so overall, neither one of these strategies will break the bank, but they can have a massive impact on clients. Like we said, up to 60 plus percent difference over an RSP for the IPP, and the RCAs flexibility and the ability to all kind of things we couldn't do otherwise. It's interesting. I feel like it's the Swiss army knife, but also particularly interesting because it works really well for people retiring early, or it works really well for people who are never going to touch the money.
Fraser Lang: Exactly.
Jason Pereira: It's a weird dichotomy, right? If you've got a lot of income in retirement, it doesn't work well for you, unless you're planning to leave money to the next generation.
Fraser Lang: Exactly.
Jason Pereira: Yeah. So, Fraser, thank you for taking the time today and explaining all this. Where can people find you?
Fraser Lang: My pleasure. You can look us up at www.gblinc.ca. I'm Fraser Lang, I'm in our Toronto office. I can also be emailed at Fraser.Lang@gblinc.ca, and I'd be more than happy to help.
Jason Pereira: Thank you very much, Fraser. So, that was my interview with Fraser Lang of GBL Inc. I hope you enjoyed that. And if you're a possible candidate for my solutions, please reach out to myself or whatever qualified advisor you're currently dealing with. Until next time, as always, if you enjoyed this podcast, please review on iTunes, Stitcher, [inaudible 00:41:41] podcast. I really do appreciate it and it does help people discover the show. Until next time, take care.
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