Supplemental employee pension plans (SERPs) are an important tool for Canadian employers who want to attract and retain managers and other highly-skilled employees. While the 2005 Federal Budget proposed increases in pension and RRSP limits, these increases were relatively modest, leaving Canadian limits on tax-deferred retirement savings well below those of the U.S. and the U.K – trading partners who compete with Canada for skilled labour. SERPs are essential for Canadian employers who want to offer competitive pension benefits.

In this Special Memorandum, we call upon the federal government to consider a reduction in the refundable tax rate for retirement compensation arrangements (RCAs), through which SERPs are funded, from the current level of 50 per cent to a more tax-neutral level in the range of 31.4 – 33 per cent.

Watson Wyatt believes that the current RCA tax is much higher than required to ensure that SERP benefits are funded only on a tax-neutral basis, as was originally intended when RCAs were first introduced in 1986. As a result of reductions in corporate and personal income tax rates, the RCA tax is now a strong disincentive for employers to fund supplemental pension benefits.

In periodic surveys, we have seen the effects of the RCA tax reflected in a low incidence of funded benefits, particularly in the private sector. We conclude that the high RCA tax rate has several harmful economic effects by making SERP funding a costly and unattractive option for employers – not to mention an increasingly rare one. Employers with unfunded SERPs have higher compensation costs and a reduced ability to attract and retain skilled employees in an increasingly international labour market. For employees, unfunded supplementary pension benefits are less attractive, because of the risk that benefits may not be paid. And, by discouraging the funding of benefits, the high RCA tax rate reduces the pool of savings available to support investment and productivity growth in the Canadian economy.

The high RCA tax has far-reaching consequences for Canadian employers, employees and the economy as a whole. A reduction to the range advocated by Watson Wyatt would bring the RCA tax rate more in line with other personal and corporate tax rates and would encourage greater funding of SERPs.

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