21 Apr 2016
What’s Your Retirement Plan?
Do You Have an Exit Strategy for Your Business or Corporation?
At first, I was going to headline this article, “Retirement – What is Your Exit Strategy?” But then I thought people might assume I meant: How they planned to exit life!
Now that we’ve got that straightened out, let’s talk about what I did mean: creating an exit strategy from your company or business upon retirement.
As a professional, you most likely incorporated your company in order to conduct your business. Well, just as you had a strategy when you created the company, you need a business exit strategy for how to exit the company when you want to retire.
Remember the first couple of years after you incorporated your company? You struggled to get used to the paperwork, cash flows and general uncertainty.
The first couple of years of your retirement and the business exit strategy for your company won’t be all that different.
Let’s start with your company.
What to do with those company assets?
We’ll assume you are no longer operating the business, and your company assets mainly consist of cash and various investments – stocks, bonds, real estate. What do you do with them?
What Happens When You Liquidate Assets and Close the Company
If you were to liquidate all of your investments and then close the company, you’d most likely face a significant income tax liability.
First, the company would have to pay income taxes of up to 19 percent on the accrued net gains on the various investments.
After corporate income taxes were paid, the net proceeds could be distributed to the shareholders.
This distribution would attract personal income tax in the hands of each shareholder at their respective marginal tax rate.
If they had significant other income, the additional personal income taxes could be in excess of 40 percent.
The total combined taxes would be more than 51 percent!
Simply liquidating your assets is not the best exit strategy!
Approach #1 - Make the Withdrawal of Funds Part of Your Retirement Plan
By having a strategy for the withdrawal of the funds from your company you can reduce the unreasonable tax liability associated with asset liquidation, sometimes by a significant amount.
In our previous article we talked about two approaches to reducing this tax liability:
Utilizing the tax attributes of the investments in the company.
And taking full advantage of the annual graduated personal income tax rates.
A key part of this business strategy is first knowing what you have invested in your company. Different investments trigger different income tax attributes.
For example, an investment that results in a capital gain could trigger both refundable dividend taxes and an addition to the capital dividend account. The capital dividend account can be paid tax-free to shareholders. Investments that generate Canadian dividends (think shares of Bank of Montreal or Fortis) generate dividends that are eligible for the lower rate personal taxes.
As you can see, companies that hold passive investment assets as described above may have favourable tax attributes that are eligible for lower rate personal taxes. Distributing funds from the company using the appropriate method will trigger these tax attributes, resulting in net tax savings to you and your company.
Approach #2 – Ensure Sufficient Income is Properly Distributed
The second approach is to ensure that sufficient income is distributed so that your annual graduated personal tax rates are fully used. I often assure my clients this strategy does not mean they have to spend the money they withdraw from the company! They – and you – could simply withdraw the funds from the company and deposit them to another personal, non-registered investment account. By doing so you could effectively pay lower income taxes today by using the lower tax brackets – while being able to access the funds at any time in the future.
2 Buckets for Money Coming In & Money Going Out
Now we’ll move to the personal side.
Many clients I work with are familiar with my saying, “There are only two buckets: the money-that-comes-in bucket and the money-that-goes-out bucket.”
You can either:
a) Increase what goes into the bucket for the money that comes in
b) Or decrease what comes out of the other bucket
There is no third or fourth alternative. Much of your retirement plan is going to revolve around ensuring you have sufficient resources (money-that-comes-in bucket) to live the lifestyle that you desire (money-that-goes-out bucket).
Let’s lighten the “money-that-goes-out” bucket
How the withdrawals from your company fit into the plan will depend on your various other sources of retirement funds: RRSP/RRIF, CPP, OAS, TFSA, etc.
If you view the taxes that you pay as part of the money-that-goes-out bucket (and who wouldn’t!) you will quickly see that adopting the best strategy for your situation will reduce your taxes. And that will provide you with more money for your retirement.
Ensure your Will is current and up to date for various changes in legislation. This is vital, as it can have a significant impact on how your assets are distributed upon your passing, the probate fees that may be payable and the income taxes that could result when your final income tax return is prepared.
These are only a few of the issues to consider as part of your retirement. Depending on your particular circumstances, other strategies may include consideration of an alter ego or joint spousal trust.
Benjamin Franklin said, “In this world nothing can be said to be certain, except death and taxes.”
While income taxes cannot be avoided, with a little work and planning they can be minimized. Having a good team in place is critical to any plan. Always ensure you seek independent accounting, tax, legal and investment advice that considers your particular situation and circumstances.
If you would like more information on how to set up the best exit strategy for your business as part of your retirement plan, or if you have more questions, please contact us.
The above content is believed to be accurate as of the date of posting. Tax laws are complex and are subject to frequent changes. Professional advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.