A Retirement Compensation Arrangement (RCA) utilizing a leveraged life insurance policy is a sophisticated tax-planning strategy designed for high-income business owners and shareholders to fund retirement, secure capital, and provide a tax-efficient estate benefit. By using an “Insured” or “Leveraged” RCA, the corporation can provide ongoing retirement income, with the accumulated policy cash value serving as collateral, while the death benefit eventually repays the loan.
How the Leveraged RCA Strategy Works
- Establish the RCA and Policy: A corporation sets up an RCA trust and purchases a permanent life insurance policy (often Universal Life) on the shareholder.
- Fund with Tax-Deductible Contributions: The corporation makes contributions to the RCA trust to pay for the insurance policy. These contributions are 100% tax-deductible to the corporation.
- 50/50 Tax Split: 50% of the contribution is deposited into the RCA Investment Account (to pay for the policy), and 50% is remitted to the Canada Revenue Agency (CRA) as a non-interest-bearing refundable tax.
- Tax-Free Growth: The permanent life insurance policy within the RCA grows on a tax-deferred basis.
- Leverage/Loan: The RCA trust or the corporation uses the cash surrender value (CSV) of the insurance policy as collateral to secure a loan from a financial institution.
- Retirement Income: The loan proceeds are paid out to the shareholder as retirement income.
- Death Benefit Repayment: Upon the death of the shareholder, the tax-free death benefit proceeds are used to repay the outstanding loan.
- Excess Proceeds: Any remaining death benefit proceeds (above the loan amount) can be paid to the corporation and, in many cases, distributed to beneficiaries via the Capital Dividend Account (CDA).
Key Benefits
- Creditor Protection: RCA assets are protected from company creditors.
- Unrestricted Contributions: Contributions are not capped by RRSP or Individual Pension Plan (IPP) limits, allowing for higher savings.
- Tax-Deferred Growth: Investments within the insurance policy compound without immediate taxation.
- Income Splitting: If the shareholder is over 65, RCA benefits may be eligible for pension income splitting.
Risks and Considerations
- CRA Scrutiny: The CRA has increased scrutiny on RCAs, particularly regarding whether contributions are “reasonable”.
- 50% Refundable Tax: The requirement to remit 50% of contributions to the CRA can reduce immediate liquidity.
- Loan Interest Risk: If the policy is surrendered, the policy owner may be subject to tax, and if the loan is not repaid, the lender can call it.
- Interest Deductibility: Loan interest may not be tax-deductible if used for certain personal purposes rather than investment.
Disclaimer: This strategy is complex and requires guidance from specialized tax and legal advisors to ensure compliance with the Income Tax Act.
Contact us for more information and to schedule ZOOMwithMario insurance and options review.
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