This is part one of a two-part article on supplementary or supplemental executive or employee retirement plans (SERPs).

SERPs have been used for a number of years to ‘top up’ executive pensions. The use of SERPs among employers with defined benefit (DB) registered pension plans (RPPs) is on the rise given that the maximum benefit that may be provided under an RPP is quite low due to the limits in the Income Tax Act (ITA). Except for a modest increase made after the 2005 Federal Budget, the maximum benefit has not increased in any meaningful way since the 1970s. In fact, many SERPs that once applied only to executives now apply to a wider class of employees.

SERPs come in different shapes and sizes depending on whether the underlying RPP is a DB or defined contribution (DC) plan and whether the SERP consists of a bare promise or is funded or secured. In this context, ‘secured’ refers to a mechanism that provides financial assurance that the promise will be fulfilled without the need to maintain assets equal to the present value of the promise. This could take on the form of a guarantee from the employer’s parent to uphold the SERP promise. It could also take on the form of a letter of credit held in order to back-stop the promise.

Where the SERP is funded or secured with a letter of credit, it constitutes a retirement compensation arrangement (RCA) and is subject to a discrete tax regime meant to discourage the funding or securing of the SERP promise. The ITA requires that half the amount contributed to the SERP be remitted to the Canada Revenue Agency to be held in a refundable tax account. Amounts held in the refundable tax account are released only when SERP benefits are actually paid to the member, and consequently there is no opportunity for investment return on these amounts. However, as SERPs have grown in number and in value, RCAs have become a planning vehicle in their own right.

Where the SERP is of a DB nature, it is designed to make up the difference between the pension that would be received from the underlying RPP if the ITA imposed no limits and the pension that may be received from the RPP. Where a SERP is of a DC nature, it is usually designed so that a fixed amount, with interest, is to be added to the pension that will be received from the underlying RPP. Where a DC SERP is not funded, notional interest is added to the notional amount that will be paid to the executive at retirement. Either variety of SERP may recognize compensation elements such as bonuses that the underlying RPP may not. The SERP may apply to one or more individuals. Individuals within the same organization may have different SERP promises.

Certain approaches should be kept in mind when designing a SERP. First, determining whether pension standards legislation applies is extremely important. In most cases, the pension standards legislation that would potentially apply would belong to the province where the SERP member is employed (except where the SERP member’s employment is federally regulated, in which case the legislation to keep in mind would be the federal equivalent). In most cases, pension standards legislation does not apply to benefits or contributions in excess of ITA limits, but there are slight nuances from jurisdiction to jurisdiction and one should not necessarily assume that pension standards legislation will never apply. In addition, determining whether pension standards legislation applies does not become an issue only when an executive becomes a SERP member. If pension standards legislation does apply, compliance will be necessary and this may include a requirement to pre-fund the SERP.

Second, it is important to remember that a SERP is a part of the employee’s terms and conditions of employment. Given this and the fact that pension standards legislation does not apply in most cases, the SERP can be designed to provide the greatest amount of flexibility and integration with the underlying RPP. For example, the SERP may provide that no ‘top up’ will be payable if the SERP member is dismissed for cause. It may reduce the ‘top up’ by any surplus amount that may become payable to the SERP member from the underlying RPP following its termination. A SERP can serve as a retention tool by increasing the vesting requirements beyond what is applicable to the underlying RPP or by causing the forfeiture of the promise unless the SERP member remains employed until a certain triggering event such a pre-determined number of years of service. Indeed, although based on limited case law, non-compete provisions tied to a SERP may be more likely to be upheld by a court as there is ongoing consideration for the SERP promise.

Finally, as reported in a previous edition of McCarthy Tétrault Co-Counsel: Business Law Quarterly, the Canada Revenue Agency’s recent displeasure with RCAs that provide for contributions or benefits it believes to be excessive should be kept in mind.

In part two of this article, which will be published in the next issue of McCarthy Tétrault Co- Counsel: Business Law Quarterly, we will provide insights on the terms of a SERP