Law Times

Page 10 august 24, 2015 • Law Times www.lawtimesnews.com FOCUS top-hat pensions a key option for small businesses Arrangements offer an alternative to contribution limits for individuals By JuliuS Melnitzer For Law Times mid the brouhaha over the Ontario gov- ernment's proposal to set up its own pension plan, it's easy to forget some of the basics involved in setting up the best pension plan structures for businesses, especially small- and medium-sized enterprises. Small, closely held corpora- tions, including single share- holder companies, can set up private pension plans usually restricted to owner-managers but can certainly include other employees. These are sometimes referred to as top-hat pensions because the focus was originally on the owners of closely held companies. Generally speaking, there are two types of top-hat plans: a non-qualified deferred-com- pensation plan in which partici- pants defer income into the plan each year; and a supplemental executive retirement plan fund- ed entirely by the employer. "Top-hat pensions are defi- nitely underutilized and some- thing that many general practi- tioners don't consider in advis- ing business clients," says David Rotf leisch, a tax lawyer with Rotf leisch & Samulovitch PC in Toronto. "It's something that a sophis- ticated tax planner will suggest and it's one of the things I often recommend when I do tax au- dits of companies." There are two primary ad- vantages in setting up a top-hat plan. The first is that the corpo- ration can make greater contri- butions than individuals can to their own RRSP. "The RRSP limit is now 18 per cent of earned income to a maximum of $24,900, but the limit for private plans is in the high 30s," says Rotf leisch. Because of the $24,900 maxi- mum, individuals earning more than about $140,000 can't con- tribute the full 18 per cent. "High-earning individuals are in a sense disadvantaged because they can't contribute a full 18 per cent," says Kathryn Bush, of Blake Cassels & Graydon LLP in Toronto. "In a nutshell, a top hat sets up a pension for what can't be sheltered under an RRSP." The second key advantage is that past service contributions for the years before company set up the top-hat plan are eligible. "If someone has owned a private company for years, they could make contributions for the past 20 years or more," says Rotf leisch. It's also possible to convert top-hat plans into locked-in re- tirement accounts. "That gives management more f lexibility because they're not forced to buy annuities from third parties when it's time to start making payments," he says. Like any other pension ar- rangement, a top-hat plan must have a trustee. Companies must conduct actuarial valuations that determine the funding on a regular basis. "Companies who set up top hats for employees will get a whack of a deduction, but it's important to remember that these plans carry pension obli- gations just like any other kind of plan," says Rotf leisch. "That shouldn't be a problem, how- ever, for a successful [business]." Still, there are risks in set- ting up top-hat plans. Because contributions can account for not only base salary but also bo- nuses, long-term incentives, and other benefits, the liabilities can grow very quickly. Rotf leisch recommends al- locating top-hat pensions care- fully. "It's probably best to do it only for key employees who are at the level where they're prob- ably getting stock options as well," he says. A 2015 study by Mercer (Can- ada) Ltd. examined 360 supple- mental executive retirement plans from 240 organizations in the private, public, and not- for-profit sectors: 270 of them were defined-benefit plans, 80 were defined-contribution arrangements, and 10 were hy- brid or other types of plans. The study found that larger organizations were more likely to sponsor supplemental execu- tive retirement plans. Indeed, employers with at least 5,000 employees are twice as likely to provide them as those with less than 500 staff members. "The lower prevalence at or- ganizations with less than 500 employees likely corresponds to the fact that these organiza- tions have a smaller number of employees affected by the maximum pension limit and, as a result, may compensate for the impact of the limits through other elements of compensa- tion," the authors concluded. The study also found that half of supplemental executive retirement plans now cover all employees affected by registered plan limits; about half of them recognize all or some bonus in pensionable earnings; and the proportion of companies pro- viding funding has been about 50 per cent for many years. 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Visit www.carswell.com or call 1-800-387-5164 for a 30-day, no risk evaluation Untitled-3 1 2015-08-20 8:36 AM 'It's probably best to do it only for key employees who are at the level where they're probably getting stock options as well,' says David Rotfleisch. A With insightful commentary and a humorous look at Ottawa politics, veteran journalist Richard Cleroux keeps you up to date with The Hill every other week in Law Times

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