Planning for Executive Benefits: Cowan Insurance Group

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Sept., 2010 – Supplementary Employee Retirement Plans (SERPs) are generally considered one element of a total rewards strategy for senior executives whose contribution levels are limited by the Income Tax Act (ITA). For this reason, providing a SERP can be a key benefit in attracting and retaining high income employees as the workforce ages and retirement income continues to become a higher priority. It is an essential element for Canadian employers who want to offer competitive pension benefits.

SERPs are not registered and therefore are not within the same regulatory environment as registered pension plans. Considerations for employers include funding, accounting, documentation, administration and transparency. Security, adequacy, clarity and understanding are considerations for employees. SERPs can be unfunded, partially funded or fully funded.

Design Considerations

Defined Contribution SERPs (DC SERPs) are non-registered saving plans where the annual DC SERP contribution is typically equal to the company’s contribution less the maximum allowed contribution under the company’s registered pension plan. Contributions can be handled in a number of ways in a DC SERP. The treatment mainly depends on the company’s objectives.

1. Cash

Contributions may be paid in cash as a pension bonus or contributed to a non-registered savings plan. The practice of paying the member the excess amount as a pension bonus may be advantageous from the organization’s perspective as it allows their liability to be discharged annually. However, this is cash compensation to the employee rather than retirement savings and may have negative impacts for the employee based on taxation rates during employment years compared to retirement years. Also, if deposited into a non-registered account then the investment growth is taxable to the employee. The issues of taxation may be partially alleviated through the use of a Tax Free Savings Account (TFSA). Immediate vesting is also required as employees are taxed up front.

2. Notional Accounts

Notional DC SERPs are closest to matching what could be accumulated in a registered DC pension plan and are often favoured when there are a small number of executives earning large DC SERP benefits or when a company wants to include deferred vesting in the DC SERP.

In these arrangements the excess contributions are allocated to notional account balances. When companies accumulate notional account balances for employees, a decision must also be made with respect to the notional investment return. Generally, the employer will allow the plan member to choose which investment option, available from a menu of options, to track the account growth.

The notional account balances are held as a liability in the company’s financial statements.

Funding Options for SERPs

The tax relief that makes funding registered pension plans attractive is not available when assets are set aside to fund the benefits promised under a supplementary arrangement. Therefore, historically, few SERPs have been funded.

1. Unfunded SERPs

SERPs can be based on a promise and be unfunded. Basically the strength of the promise may be detailed in as little as a letter or a Board of Directors’ Resolution to the employee.

There are several reasons supporting the decisions by some organizations not to secure their SERPs, including:

  • Benefit security is not viewed as an issue for the organization;
  • The organization can generate a greater return on the capital within the business;
  • The SERP liability is not large enough; and
  • Current cost constraints.

2. Funded SERP

If the intention is to fund the SERP then CRA will consider the SERP a Retirement Compensation Arrangement (RCA). An RCA is a vehicle used to prefund the portion of the retirement benefit that cannot be paid from a registered pension plan. Contributions to an RCA are not subject to payroll tax. RCA assets are separate from company assets and are protected from the Employer’s creditors. Additional features of an RCA:

  1. Employer gets a tax deduction for contributions to an RCA;
  2. Contributions are subject to a 50% refundable RCA tax. The employer remits the 50% tax to CRA and CRA returns it to the employer when there are distributions from the RCA trust.
  3. All distributions from an RCA to a beneficiary (member) are taxable.

Documentation

Although SERPs are not subject to provincial pension benefits legislation which requires formal documentation, a SERP document should be drafted to provide details regarding the plan provisions.

This article has been reprinted with permission from the September 2010 Employee Benefits Bulletin, and was authored by Olga Knight, Senior Pension Consultant at Cowan Insurance Group.

About Cowan Insurance Group

Cowan is one of the largest privately-owned insurance brokerage operations in Canada, specializing in business and personal insurance (including home, auto and boat insurance). They provide additional services through a consulting team that specializes in assisting employers with their retirement and group benefits requirements with a team of financial advisors specializing in financial planning and risk management solutions. Visit www.cowangroup.ca.