Executive Severance: Preserving the Retirement Nest Egg with a Retirement Compensation Arrangement (RCA)
Fraser Lang, CFP, CHS - Senior VP Sales and Business Development – GBL
Published: May 5, 2017
Retirement planning in the 21st century requires adaptability and careful financial planning. Company executives tend to have multiple jobs throughout their careers. We also see companies which were once seen as invincible, being forced to downsize due to today’s ever changing business environment. With that in mind, examining more effective methods to stretch out and maximize severance payouts is now more critical than ever to the executive financial plan.
One means of deferring and bracket managing severance payments is through the use of a Retirement Compensation Arrangement (RCA). Given that many executives’ severance payments are usually in excess of what they require to live on in the given year, saving or sheltering some of this unneeded lifestyle income can be advantageous.
When an RCA is used to receive a severance payment, the executive is allowed to withdraw the money as needed. As there is no requirement to withdraw income from the RCA, it can remain in the plan and be withdrawn in future years when income is lower or nil.
Employment lawyers are increasingly seeing the value and functionality of the RCA in these matters. Especially since with an RCA, severance payments, or a portion thereof, can be deposited into the RCA and drawn out in smaller amounts at a later date, and over several years as needed. We highlight this in the following example.
Example: A senior executive in Ontario is terminated and paid out $375,000 as a lump sum severance.
Option A – No RCA
The payment amount is considered income in that year and subject to full taxation.
Assuming the executive has already received income and is in the highest tax bracket, the tax rate on severance would be 53.53%, equal to $200,738 of tax owed.
After-tax amount would be $174,262.
Option B –RCA
Executive retires and takes income solely from the RCA over the next 3 years at $125,000 per year.
Average income tax rate reduced to 28.84%.
After-tax amount would be $266,850.
In this example, using an RCA provides an after-tax increase in income of $92,588 versus the traditional lump sum option.
The flexibility of the RCA ensures that if the individual were to find employment soon after termination, they may not need to access the RCA for many years and can save the funds for retirement. On the other hand, if the plan member requires income after their severance, they may take as much income as needed from the RCA, in amounts of their choosing. This leads to more money in their pocket and helps to preserve their much needed and deserved retirement nest egg.
Disclaimer- the above example is for illustration purposes only and is not to be considered tax advice. For tax advice specific to your situation, please consult your accountant.
For questions on how an RCA might affect your plan, please contact email@example.com to book an appointment
For further information on RCA's, please contact Fraser Lang at firstname.lastname@example.org
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