Business Advisor: August-September 2013

How to better plan for your retirement when you don’t have the luxury of a guaranteed pension

How to better plan for your retirement when you don’t have the luxury of a guaranteed pension

Small business owners don’t have the benefit of guaranteed pension plans to fund their retirement.  When they reach the age of 60 they may find their peer group winding down, planning their winters and arranging to spend time with grandchildren. Meanwhile they will contemplate having to work much longer, some into their 80s, just to ensure financial stability.

The trend to delay retirement is correlated to current financial markets. 

Business owners are coached by their advisors to take sufficient salary to maximize their RRSP contributions. Currently the earned income threshold to maximize RRSP contributions is approximately $132,000, which can leave minimal cash flow for other retirement planning.  There are a few disadvantages associated with RRSPs, and these include the restriction on eligible investments that can be purchased in the plan as well as minimum withdrawals from the plan at age 72. 

When considering investments, generally investors will want their portfolios to be more conservative in later years. Unfortunately the return on safe investments such as GICs, T-Bills, etc., is very low, resulting in a lower annual income stream on the principal investment. This means business owners will have to work longer to build their nest eggs.

The winds of change have blown in a new concept that utilizes a corporation to assist with retirement planning.  The main benefit of this strategy is a tax deferral. Let’s assume a Canadian Controlled Private Corporation with taxable income of $500,000 taxed at favourable small business rates of 15.5 per cent. Also assume that a portion of the income is available for investment as it is not needed for day-to-day requirements. With the highest marginal personal tax rates at 46 per cent, approximately 30 per cent of tax is deferred by leaving money in the corporation.

Other benefits of using a corporation for planning your retirement include the ability to income split with a spouse, who if he or she is a shareholder with no other income can receive approximately $40,000 of tax-free dividends. A corporation also provides the opportunity to choose when funds are withdrawn from the corporation to pay for retirement expenses. This allows for funds to be withdrawn from the corporation during retirement years when personal tax rates are generally lower.

In addition to having more money to invest, there is increased flexibility with funds held in the corporation. For example, investments such as rental properties and shares in other private corporations are commonly purchased. These investments would not qualify as eligible investments in RRSPs. The benefits of these alternative investments are that they usually yield a higher annual return and can appreciate more over time.

The flexibility of a corporate retirement plan over a personal one includes the use of pension and other products that are not available as individuals. “Individual pension plans” (IPPs) and “retirement compensation arrangements” (RCAs) are plans that would otherwise not be available to an individual. The major benefit of these plans is that contributions to catch up to an arranged target return are a tax-deductible expense to the corporation.

Knowing that the Canada Pension Plan and Old Age Security will not be enough to help you enjoy a comfortable retirement, you need to start planning for the future. If your business is your only source of income, then it’s time to think about how you can use it both to help you save for retirement and as a means to leave money for your family. There is a major focus in the investment and insurance marketplace to create corporate plans that have the benefits of a defined benefit pension plan that can be tailored to the individual needs of you and your business. The key is to plan and speak to your advisor about your options.

Simon Francis is an audit and assurance partner at Fuller Landau LLP, Chartered Accountants. His practice focuses on helping business owner-managers achieve their growth plans. He can be reached at sfrancis@fullerlandau.com or by phone at 416-645-6583.