Small Business Succession Planning: Retirement Planning

Authors: Alain Gaucher, Q.C., Erin Smith

This post was written prior to our January 2017 merger, under our previous firm name, MacPherson Leslie & Tyerman LLP.

A major concern for business owners is ensuring they have sufficient retirement funds to maintain their desired standard of living. This post, the sixth in our ongoing series of blog posts on small business succession planning, will discuss three arrangements that business owners should consider when planning for retirement.

Previous posts in this series have stressed the importance of succession planning for owner-managed businesses and reviewed how each of the following can assist in the succession planning process:

  • Estate Freezes and Family Trusts;
  • Marital Contracts;
  • Powers of Attorney and Wills; and
  • Corporate Governance

The following are three arrangements that can be put in place to help ensure that a business owner has sufficient retirement funds.

  1. Individual Pension Plan (“IPP”)

An IPP is a registered defined benefit pension plan that allows the plan members to accrue retirement income on a tax-deferred basis. IPPs generally have higher contribution limits than registered retirement savings plans (“RRSPs“). Additionally, IPP assets are protected from both the company’s and the pension recipient’s creditors. However, there are administrative costs that must be considered, and individual pension plans are subject to strict regulatory requirements.

  1. Retirement Compensation Arrangement (“RCA”)

An IPP is a registered defined benefit pension plan that allows the plan members to accrue retirement income on a tax-deferred basis. IPPs generally have higher contribution limits than registered retirement savings plans (“RRSPs“). Additionally, IPP assets are protected from both the company’s and the pension recipient’s creditors. However, there are administrative costs that must be considered, and individual pension plans are subject to strict regulatory requirements.

Supplementary retirement plan arrangements can be established in addition to an IPP. Such arrangements can be as simple as an agreement that the company will pay a retirement benefit. If funds are set aside by the company, the plan will likely be a RCA.

A RCA is an arrangement whereby the company makes contributions to a custodian, who holds the funds in trust with the intent of eventually distributing them to the owner as a retirement benefit. An owner may want to establish a RCA for the following reasons:

  • Contributions to a RCA are 100% tax deductible to the company, and are not taxable to the owner until they are paid out.
  • A RCA may also reduce the value of the company and therefore the capital gains tax liability that may arise on the owner’s death or on a sale or gift of the shares to the owner’s children.

Amounts contributed to the RCA and the income earned on such amounts in the RCA are subject to a 50% refundable tax. The tax is refunded to the company when the benefits are paid out. For every $2 in benefits paid out, the RCA receives a refund of $1. Depending on the applicable top provincial tax rate for an individual, the 50% refundable tax rate could make RCAs less attractive as a RCA requires an individual to pay the 50% tax rate up front and the (interest free) refund is not received until the benefits are paid out—often years later.

  1. Retiring Allowance

A business owner may want to receive a retiring allowance on his or her retirement in recognition of long service. In addition to providing additional retirement funds, a retiring allowance may also reduce the value of the company and therefore the owner’s future tax liability on the shares. For owners with years of service before 1996, a retiring allowance may qualify for a tax-free rollover to a RRSP.

Individual pension plans, retirement compensation arrangements and retiring allowances are all retirement arrangements that will assist in creating a successful succession process. Those with owner-managed businesses are encouraged to talk to a legal professional about how these retirement arrangements can ensure they have sufficient funds once they are no longer an active manager of the business.