Many organizations strive to treat their employees equally, believing this to be the most equitable approach. On the surface, this appears to be a sound policy. However, an important lesson from the pandemic is that workers have individual needs and that structuring the workplace and benefits programs to be more flexible helps to serve those varied needs. Therefore, equal is not always fair.
Executives have additional concerns. Benefits related to income such as disability insurance or retirement plans are often discriminatory because replacement percentages are designed for median salaries. This design flaw leaves a chasm between an executive’s before and after income when they rely solely on RRSPs or standard group disability coverage. Employers would be wise to consider the reverse income discrimination experienced by senior executives and look to implement enhancements when designing a more equitable compensation plan for your leadership team.
The blog will discuss the inherent structural constraints associated with retirement and disability benefits, which create the reverse discrimination experienced by high-income earners. As well as ways your organization can update your benefits plan to provide fairness to your leadership team.
Most organizations offer long-term disability coverage as part of their employee benefits program and most employees rely solely on those workplace benefits to provide them with an income in the case of a severe injury or illness. Unfortunately, these benefits are generally designed to cover the average worker and leave high-income earners woefully underinsured.
In a typical plan, long-term disability benefits will have an overall plan maximum determined by the size of the employee population and other factors such as industry. Plans typically top out at $10,000 of non-taxable benefit per month for mid-sized groups but we regularly see limits at $5000 or less. For a worker earning $70,000 per year, a $5,000 per month maximum is fine as it replaces approximately 85% of their net pay. However, someone earning $200,000 will receive a much lower replacement percentage, leaving a senior person in your firm struggling financially as they try to recover their health and return to work.
One way to address the low maximum is to request an increase from the insurance company. Depending upon the size of your company, this is likely available. There will be a small increase in the LTD premiums if your firm has an insured plan. However, even with a plan maximum increase, executives may still be under-insured or run into the second problem with Group Long Term Disability plans: the all-or-nothing rule.
The all-or-nothing rule is found in the contractual definition of disability. Typically group plans only cover total disabilities. Executives who would like to continue to work part-time, if they are able, must either forgo their insurance payments or survive on a partial paycheque. There is also a change in the definition of disability in most group contracts after 24-months. The wording changes from the inability to do the duties of an employee’s regular occupation to the inability to perform the majority of the duties associated with any occupation. Thus a highly skilled person may find themselves declared fit to work even though they cannot work in their chosen field.
So how can the issue of low replacement and restrictive coverage be addressed?
- Enhance limits and add features such as coverage for part-time work or regular occupation
- Look to a specialty carrier who can generally provide higher plan maximums, coverage for working reduced hours, and a regular occupation definition to age 65
- Consider “topping-up” or replacing the Group LTD with personal disability insurance, which allows for higher combined maximums and an enhanced definition of disability
Retirement Savings Plan
Canada has some of the lowest retirement plan limits in the industrialized world. In 2022, an individual is subject to a maximum RRSP contribution limit of $29,210 ($30,780 into a pension plan) Thus, anyone earning more than approximately $162,500 ($171,000) saves less than 18% of their income, resulting in a proportionately lower retirement income.
In comparison, a worker in the US has both a personal limit and an employer limit, allowing for a higher level of savings. In 2022, the combined total employer and employee contributions into a 401K plan cannot exceed $61,000 for those under 50 and $67,500 for employees age 50 and older. More than double what is allowed north of the border.
So how can the Canadian retirement savings shortfall be addressed? One common way is to provide enhanced benefits such as stock options or employee share purchase plans. While these are solid programs and have the added benefit of aligning executives’ objectives with those of the firm, they are not as fundamentally secure as a pension plan or a trust. They also reduce asset diversification, given that a portion of an individual’s investment portfolio, as well as their income, is linked to one organization.
Two structures that many companies are unaware of but that are designed to support higher income earners are:
- Individual Pension Plans
- Retirement Compensation Agreements
Individual Pension Plans (IPPs)
IPP’s are often called supersized RRSPs. Technically, an IPP is a defined benefit pension plan. The pension plan rules set out by Canada Revenue Agency (CRA) and the various provincial pension authorities, permit substantially higher IPP contributions for the right candidate. Generally speaking, IPPs are best suited to those over 45, with an annual income in excess of $170,000 and/or a number of years of past service within the organization.
IPPs are typically established for senior executives or shareholder-employees of privately-owned companies. Executives participating in an IPP are carved out of any other company-sponsored Group RRSP or Pension Plan.
There is a fair amount of flexibility available when designing IPPs. Within the legislative parameters, plans can be tailored to the needs of each executive, allowing employees to substitute tax-deferred compensation for taxable income.
Retirement Compensation Arrangements (RCAs)
RCAs are a type of trust that allows part of an executive's income to be redirected into a tax-preferred vehicle. RCA’s can be layered on top of an existing Pension plan. While not as tax efficient as an IPP, certainty is still provided to the executive through the establishment of a trust. An RCA also relieves an employer from the liability associated with any funding shortfalls within the IPP should investments not perform as expected.
RCAs provide a greater degree of flexibility to the employer since there are no minimum funding requirements as with an IPP. However, RCAs offer less retirement security to the executive and investment returns tend to be lower than an IPP due to structural restrictions.
For most organizations, all-for-one-and-one-for-all is the motto for their benefits plan which often leads to inequalities for high-income earners. The limits on retirement plans are often overlooked except in large organizations and, let’s face it, disability benefits are generally an afterthought. When looking at employee benefits, most organizations (and employees) place the emphasis on health and dental coverage. However, a significant shortfall in income can lead to potential liabilities to a firm either financially or through reputational damage. It is crucial that companies proactively address any shortfalls within their plan to protect themselves and their senior people.