Successful entrepreneurs do a lot of things well – sales, product development, executing big ideas – but many fall short when it comes to saving for their own retirement and addressing personal and family wealth planning. That’s no surprise: as any business owner knows, most of their time is spent thinking about their company and many don’t have a personal wealth strategy that is as refined as their business strategy.
But while it may not feel like it now, at some point, you will need to slow down, which means having enough money to fund your post-working life. “Corporate business owners don’t spend enough time looking at their personal situation, ” says John Paniccia, Vice President, National Director of Business Advisory and Succession Planning at BMO Private Wealth.
So, what can you do now to ensure you’re building up a nest egg? Here are some ideas.
Make use of traditional investment accounts
We all know that Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs) are key components of the retirement playbook, but they may not be top of mind for business owners who would rather put their extra cash straight back into their business. “Many business owners feel the largest return on their investment is achieved by reinvesting money in the business,” says Paniccia.
However, these tax-sheltered vehicles should be the starting point of any retirement plan as they provide compound returns over time. “Gains in the TFSA are fully tax-sheltered similar only to the principal residence exemption and lifetime capital gains exemption on the sale of private company shares, whereas RRSPs have the benefit of being an effective tax deferral strategy,” Paniccia explains. You will have to remove money from the company to fund those personal accounts – and RRSP room accumulation relates to annual personal income – so there could be tax implications to consider depending on which mix of these accounts you use. “These are your first common elementary strategies,” he explains.
Set up an Individual Pension Plan
There are also ways to save for retirement within the corporation, Paniccia notes. For instance, entrepreneurs can set up an Individual Pension Plan (IPP), which is a defined benefit plan specifically for incorporated business owners. Unlike defined contribution plans, where the value of the account can fluctuate with the markets, a defined benefit plan will give you a set amount of money for life.
One of the big benefits of an IPP is that you can put more into it than you can an RRSP. For instance, with an RRSP, no matter how much you make, you can only contribute 18% of your income into the account up to the annual maximum. With an IPP, those who are 45 – the recommended age to open an IPP – can contribute up to 21% of their income. And, this amount increases with age. By 65, for instance, you can put in 29% of your income.
The other big benefit is that all contributions and administrative costs are tax-deductible to the business. “Clients have used this as long as the cash flows are there to support it,” says Paniccia. “It’s a solid strategy to fund retirement in the right circumstances.”
Develop a corporate insured retirement strategy
As a business owner, a significant portion of your net worth is likely tied up in your company. Even though you may have maxed out the tax sheltering opportunities provided by RRSPs and TFSAs, there are other options that provide flexibility for accessing funds accumulated in your company to help fund your retirement.
Consider a corporate insured retirement strategy, which lets you access funds from a permanent life insurance policy purchased by your company. It’s a highly sophisticated endeavour that can provide tax-free access to those funds before you pass away and also gives a tax-free benefit to your estate. Given the complicated nature of this approach, you’ll want to talk to a tax advisor to get more details as to how it works.
Consider a holding company
Another strategy involves setting up a holding company that owns the operating business and then investing funds generated by the business that’s not required to support operations through the holding company. Here’s how it works: money that’s not used to run your company can be a dividend to the holding company on a tax-free basis. (And that money would already be taxed at a lower business rate than income earned personally.) You would invest those funds into stocks and bonds or whatever other investments you’d like and you can pay those funds out and receive them as taxable dividends at your discretion. You can control the frequency of those payments to manage the personal tax you’ll have to pay when you withdraw those funds.
Using a holding company instead of simply investing within the operating company has certain benefits, explains Paniccia. Firstly, it serves to protect your retirement assets from any litigation the operating company may be exposed to that could put those assets at risk. Secondly, it removes redundant assets from the business, helping to ensure you meet the lifetime capital gains exemption tests when you eventually sell the shares of your private business.
The current lifetime capital gains exemption limit on the sale of private company shares is $1,016,836, but thanks to this year’s 2024 Federal budget, the limit will be increased to $1.25 million after June 25, 2024. The numbers are also indexed to inflation. But while those gains can be transferred tax-free out of your corporation, the majority of those assets must have been used in business operations. If you accumulate too many passive assets, you could end up offside on the exemption.
Take advantage of tax efficiency
There are several tax-efficient withdrawal strategies from a private corporation to consider, too. Like all retirement and tax strategies, it’s best to talk to your tax advisor before making any moves, but here are some strategies appliable to business owners:
Paid-up capital (PUC) reduction – essentially, it represents the amount originally contributed for share acquisition plus or minus certain adjustments in the Income Tax Act. PUC attaches to a class of shares and not to a shareholder. The PUC can be returned to a shareholder tax-free, and anything returned to a shareholder in excess of the PUC would be considered a deemed dividend.
You could also take advantage of shareholder loans, which are after-tax funds loaned to your corporation. That money can be returned tax-free to a shareholder.
It’s also important to ask your advisor about capital dividends, which are tax-free dividends paid by private corporations to a Canadian-resident shareholder. It’s a notional tax account which includes the non-taxable portion of net capital gains/losses and other amounts, such as life insurance proceeds. “This is a common tool used to effectively strip money out of the company in a tax-efficient manner,” he notes.
Sell your business
While investing in stocks and bonds in an RRSP, IPP or holding company are important, your biggest asset will likely be your business. Many entrepreneurs do indeed fund their retirements from the sale of their company, but to do that, you need to start preparing for your exit today.
Paniccia advises planning at least three to five years before selling to get the business to a place where you maximize the commercial transferable goodwill and value to achieve the highest price in the marketplace. “Setting your exit plan early is critical for success,” he notes.
One area where many owners struggle is to create an organization that can operate successfully in their absence. To do that, you may need to de-risk the company by putting a management team in place that’s capable of running the sales and operations to ensure business continuity before you leave. “This will translate into a higher exit multiple and may also serve to provide more upfront cash consideration on the sale of the business,” he says.
Ultimately, you will need to think about what you’ll do in your golden years, and for some, that will mean leaving the business and enjoying retirement. But to do that, you need to start saving. “Successful entrepreneurs live and breathe the businesses as their legacy,” says Paniccia. “Part of our role is to educate them, and have discussions with them early in the process – often years before – to ensure parallel planning to address both personal and business objectives well in advance of any business transfer.”
