Where to park excess income is one challenge that owners can face in coordinating their business and personal financial planning.Getty Images
For Dave Giles, his professional life became personal in 2019, when his wife, a chiropractor, opened her own practice in Burlington, Ont. He had spent the previous 10 years at Giles Financial Solutions Inc., part of Sun Life Financial, advising entrepreneurial clients on setting up their overall finances. Now he had to apply those lessons in his own household.
Mr. Giles says he and his wife became laser-focused on what was required to maintain the business and, by extension, their financial well-being. “It’s imperative knowing your numbers, within the business but also the personal.”
Most business owners spend their working lives growing their companies, not their personal finances. Their business is their fortune. While each entrepreneur’s needs and circumstances are unique, many of them face similar challenges. That calls for a playbook to successfully negotiate the complexities of managing both their businesses and their personal finances, when so often the two appear to bleed into one another.
Benefits of a holdco
One of the first things the Giles family did was establish a holding company, or holdco, apart from the operating business. That allowed them to create a separate corporate entity to house income and assets.
Mr. Giles says the holdco is the ideal go-between, separating the business and the family’s finances. It’s where corporate earnings can accrue tax-efficiently, and it can also serve as a legally protected vessel for investments and assets held by the business owners.
It’s almost always more beneficial to leave income or excess earnings within the holdco, says Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth. “We issued a report on that called ‘Just Leave It.’”
Owners receive a significant tax deferral by not withdrawing the money, which would trigger a taxable event. Instead, they can invest the untaxed amount in financial vehicles inside the business until they’re ready to be sold.
The general corporate tax rate in most provinces is 11.5 per cent to 16 per cent, and it falls to just 0 per cent to 3.2 per cent on the first $500,000. That’s substantially lower than personal income taxes in many provinces.
“Your corporation acts as a sort of a retirement store of wealth for you,” Mr. Golombek says.
Another advantage is using that after-tax corporate income to fund a life insurance policy held inside the corporation, enabling the business to fund the policy rather than doing so from personal income. The proceeds from insurance policies, unlike many other investments, are not taxed.
“It’s just another strategy business owners can or should be using, so that on death they effectively can turn that into a tax-free distribution,” Mr. Golombek says.
Leaving money inside the corporation or holding company can also allow the lower-taxed proceeds to be used to fund individual pension plans or retirement compensation arrangements.
“Our general advice is business owners should maximize their RRSPs and TFSAs. But for the rest of the money, if you don’t need it for spending, you’re better to leave in the business from an investment perspective,” Mr. Golombek says.
Consider the range of insurance solutions
The insurance piece is another vital one for entrepreneurs, says Fred Banwell, senior advisor and portfolio manager at Banwell Private Wealth in Toronto, part of Wellington-Altus Private Wealth. Leaving a windfall for beneficiaries through life insurance is not the sole consideration.
“The biggest risk to an entrepreneur isn’t if they die prematurely. It’s if they get sick and are unable to work,” he says.
Critical illness insurance is an important security measure. “In the event you suffer one of these diabolical illnesses like cancer or heart attack or stroke, you’re going to get paid ‘x’ amount of money on a tax-free basis to help get you through,” Mr. Banwell says.
For businesses that are co-owned, another priority is key person insurance. It’s designed to fund the buyout of a partner or co-owner’s spouse or surviving beneficiary should they die. That financial security does come with costs.
“In order to take out key person insurance, you have to value the business properly,” Mr. Banwell says. “In year one, maybe the business is worth $1-million. But in year five, it might be worth $5-million. You need to make sure that you’re continually increasing that insurance so it reflects the value of the business.”
Transferring money between corporate and personal accounts
Mr. Banwell stresses the importance of a strict wall between corporate and personal accounts. “Keep everything separate. You don’t want to intermingle them.”
He says the risk is that the Canada Revenue Agency will reassess you and potentially issue penalties and fines. “You’ll regret having not paid more attention to undertaking the correct process.”
To help mitigate taxation in general, Mr. Banwell recommends adding spouses and family to the corporate payroll. “That’s a great way of income splitting, and when you transfer money from the corporation to you and your spouse, you can do it in the form of salary and dividends. You want to use dividends when possible because they’re taxed at an advantageous rate.”
The current effective tax rate on capital gains is 35 per cent, while the effective rate on dividend income is slightly less, he says.
Another strategy to efficiently transfer money from the company to an owner’s personal use is an individual pension plan, or IPP. An actuary will assess the financial situation of the business and the owner, factoring in criteria such as age and life expectancy, to determine how much can be committed and paid out. Once set up, the corporation contributes to the IPP annually, and all of it is tax deductible to the corporation.
“It is a fantastic vehicle for reducing taxes to the business,” Mr. Banwell says. “And the pension plan is put in place for the benefit of the owner of the company.”
With the range of business and personal financial implications and goals, entrepreneurs will require the guidance of professional accountants, lawyers, tax planners and advisors, and possibly investment bankers (if they’re looking to sell).
“For all entrepreneurs, the takeaway is this is a very complex area. People shouldn’t do it alone,” Mr. Golombek says.