Building tax relief into compensation plans

Helping reduce the government’s share of paycheques does wonders for morale

Putting out fires is an unfortunate but considerable role that HR professionals must play when valued talent departs leaving a recruitment emergency. Aside from such firefighting, time is also spent dealing with mergers, acquisitions, divestitures, layoffs and hiring campaigns. What time is left for investigating creative compensation planning ideas?

Certainly in a perfect world, one would have time to design compensation tools that encourage loyalty and motivate employees. The development of efficient and tax-smart rewards would push compensation packages to new heights.

But despite HR’s busy agenda, it is possible to position creative compensation tools for fire prevention. It is a worthy time investment to periodically review compensation offerings to ensure elements — such as flexible health top-up accounts or executive pension plans — are structured for maximum tax relief.

Flexible health top-up accounts in an era of benefit cost-cutting

Helping employees with their health-care needs was intended to be a wise and benevolent compensation strategy. It was wise, because of the smart tax implications resulting from a qualified health plan. It was benevolent, because of the assistance it gave employees who required help in maintaining their health.

Today, most programs are fraying at the edges and many are on the verge of collapse; benefits have been restricted to contain costs and costs continue to escalate. A key point when looking at this area of planning is that all health plans follow the same rules and regulations under the Income Tax Act. In a Private Health Services Plan (PHSP), the contract rests between the employer and the employee(s). The employer agrees, as part of the employment contract, to reimburse employees for an agreed list of eligible health expenses. When qualified, costs related to a PHSP are deductible to the employer, while reimbursements offered to employees are considered a non-taxable employment benefit.

The Canada Revenue Agency (CRA) reviewed a situation in 2003 that opens new potential for creative health planning. Here, the employers offered a basic health plan to all employees, but wanted to supplement the benefits offered to a smaller group of executives. Executives in this case received an annual bonus based on both the financial results of the corporation and the achievement of professional goals. The bonus plan, when approved, was declared and paid out at the end of each fiscal year.

The employer wanted to offer a health-care reimbursement program (PHSP) where executives could allocate a portion of their annual bonuses to the health plan. The election would be irrevocable and made prior to the start of each plan year. The cash bonus would then be reduced by the allocation made to the PHSP. Should the executive, or a family member, incur a health expense during the year, reimbursement would be offered on a non-taxable basis up to the allocated amount of this “top-up” account. If the claims exceeded the allocation made at the beginning of the year, they could be carried into the next year for reimbursement. If no claims were incurred, the unused allocation is forfeited and the company cleared from the obligation.

CRA responded positively to this strategy, allowing the plan to be deductible to the employer and non-taxable to the employees. It is a combination of a flexible benefit account and a PHSP. Such a plan can be integrated into the compensation strategy without increasing the payroll costs. The program offers a proactive and tax-wise choice for the executives and empowerment to better manage their health.

Defined benefit plans make tax sense

Over the past 10 years, most non-unionized employers have migrated retirement programs away from defined benefit pension plans and towards defined contribution or group RSP savings plans. While a tax-smart benefit, pension plans can be very expensive at times. Many employers made this migration to reduce the liabilities that defined benefit plans can create on the corporate balance sheet. Lost in this migration was a great compensation tool that can be used to attract and encourage loyalty from executives.

Defined benefit plans are a tool that can be applied to executive compensation packages to cultivate loyalty by enhancing remuneration plans. With a benefit based on years of service, age, and income, tenure is directly connected to the deferred compensation. These programs can be customized for each executive/employee. The contributions put into a trust exceed what could be put into an RSP program for executives over age 42. The investment return is guaranteed by the corporation, offering another benefit to the executive. Further, executives with tenure can be offered benefits on a retroactive basis, allowing for large first-year deposits when opening trust accounts.

Another element of such a plan is the ability to negotiate enhanced retirement benefits and pay the benefit into the trust accounts. These additional funds are placed into the trust based on a number of enhancements available when negotiating the retirement package. These contributions are also deductible for the corporation and form part of the deferred compensation available to the executive within the pension plan.

Some executives may opt to take the cash value (commuted value) of the pension plan at retirement and move it to a simple L-RSP account. These tax-sheltered accounts are similar to the more common RSP accounts, but differ in that they cannot be liquidated except for annual income.

Executive pension plans are an enhancement to the compensation package that can be used as an inducement to attract and retain key people. They offer greater tax sheltering than other programs and, with rich retirement packages available, can also induce long-term thinking from senior staff.

Ian Quigley is a broker/consultant and principal at Quigley Consulting Inc. in Edmonton. He can be contacted at [email protected] or He is the author of “Compensation and Tax Strategies,” published by Carswell, (800) 387-5164.

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