Financial Planning for Business Owners
In the early 1990s, at the beginning of my financial planning career, I was very fortunate to meet one of Canada’s most successful businessmen.
He was in his late 50s and had much more life experience than me. He shared that 99.9 per cent of the investment advisors he had met over the course of his career did not have the foggiest idea of how to make money nor did they understand what successful business people were looking for when they sought out professional advice.
He told me that when he took a risk he got paid for it. He could buy a piece of property for a marginal amount, get it rezoned for a shopping mall and then get franchises to sign letters of intent to lease for five years or more when the property was developed.
Once this was done he would go off to the bank and borrow on the future revenue that would be generated from these highly profitable leases to develop his properties and create a residual income.
He knew he could take his own money and make 100 times the amount with 1/10th the risk that any stock broker could offer him and he was right.
Business owners are not looking for financial advisors to give them the life they want by making a killing in the stock market; these people have been able to create the life they want by themselves.
Successful business people want their financial advisors to show them ways to keep their wealth. In essence, successful people want their financial advisors to provide them with financial, tax, succession and estate planning holistic solutions. They don’t need their advisors to sell them products such as stocks, mutual funds and life insurance to achieve their financial success. The point is they are already successful. Business people are looking for financial professionals who are positioned in the role of wealth manager. Someone who can see and understand the affluent business owner’s big-picture needs by constructing customized strategies to achieve their specific goals of wealth preservation, avoidance of unnecessary tax burdens, creditor protection, wealth accumulation and wealth distribution to themselves, their family, estate and charities.
Successful business owners have an understanding that a financial asset is something that puts money in their pocket, with minimum labor. They understand that a business can buy a car, but a car cannot buy a business! Liabilities are things that take money “out of one’s pocket.” For example a home is a liability even though you own the property with no mortgage, you still have to pay property taxes, utilities, and maintenance.
There are numerous advantages available to those who own their own business, who take the risk and have the creativity and fortitude to do something on their own. These people are compensated for it. As an employee in Canada, one’s equation of earning an income goes like this:
- you earn;
- you’re taxed;
- then you get to spend what is left over.
When one is a business owner and self-employed in Canada, our government allows you to adopt a much more favorable equation of earning an income:
- you earn;
- you spend, you income split, and you defer bonuses;
- then you are taxed on what is left over!
Business owners are different from the rest of Canadians, if for no other reason the Income Tax Act favors people who work for themselves. The biggest expense we pay in a year is taxes. Reducing taxes is not only morally and ethically right, it is also smart. There are three easy rules that keep your money in your pocket in this country and not in the government’s:
1. Find the right business structure for your business to pay less tax and protect what you have.
2. Learn to make more money by using the tax strategies of the rich such implementing health & welfare trusts, individual pension plans, retirement compensation arrangements, holding companies, charitable donations and estate freezes.
3. Pay less tax legally and still sleep at night.
The basis of success with working with a Certified Financial Planner is to have a financial plan. A true financial plan is more than simply buying and selling investments, or collecting “assets” that bring in no cash and are thus more akin to liabilities.
The way most people invest, they might as well be driving in a circle. A true financial plan is mechanical, automatic, and boring. It applies “The Total Financial Planning Process.”
Clarify your present situation by collecting and assess all relevant financial data, such as lists of assets and liabilities, tax returns, records of security transactions, insurance policies, will(s) and pension plan(s).
Decide what you want to achieve by identifying financial and personal goals and objectives. Work with your financial professional to help clarify your financial and personal values and attitudes. These may include selling your business, providing for children’s education, supporting elderly parents or relieving immediate financial pressures to help maintain a current lifestyle and provide for retirement. These considerations are important in determining your best financial planning strategy.
Identify and recognize financial problems that can create barriers to reaching your financial goals.
Understand your choices, your financial professional should provide you with written recommendations and alternative solutions. The length of these recommendations will vary with the complexity of individual situations.
Implement the right strategy to ensure that your goals and objectives are met. A financial plan is only helpful if the recommendations are put into action.
To ensure that your goals are achieved it is very important to have periodic reviews with your Certified Financial Planner and other financial advisors to see if there should be revisions to your plan.
Successful business people in this world look for and build networks of experts to help them achieve their life and financial dreams. The key to managing your financial future is to plan for it.
All highly successful people I have every work with had a very clearly defined, written life, career and financial plan. They believed implicitly and unshakably in their plan and were impervious to external circumstances.
So they didn’t alter their plan every time the wind changed direction, and continued to work their plan steadfastly, no matter how long it took, until their plan inevitably succeeded.
Financial Planning for Business Owners
At the beginning of my career in the financial planning industry during the early 1990s, I was very fortunate to meet one of Canada’s most successful self-made businessmen. He was in his late 50’s and had much more life experience than me. He told me that the majority of the investment advisors he met over the course of his career did not have the foggiest idea how to make money that lasted, nor did they understand what successful business people were looking for when they sought out professional financial advice.
He told me that when he took a risk he got paid for his risk. He could buy a piece of property for a marginal amount, get it rezoned for a shopping plaza and then get franchisees to sign letters of intent to lease for five years or more when the property was developed. Once this was done he would go off to the bank and borrow on the future revenue that would be generated from these highly profitable leases to develop his properties and create a residual income.
He knew that he could take his own money and make 100 times the amount with 1/10th the risk that any stock broker could offer him. He was right. Business owners are not looking for financial advisors to give them the life they want by making a killing in the stock market; these people have been able to create the life they want by themselves.
Successful business people want their financial advisors to show them ways to keep their wealth. In essence, successful people want their financial advisors to provide them with financial, tax, succession, and estate planning solutions. Business owners are different from the rest of Canadians. If for no other reason, the Income Tax Act favors people who work for themselves. There are numerous advantages available to those who own their own business, who take the risk and have the creativity and fortitude to do something on their own. These people are compensated for it.
If you are a self-employed individual or a business owner you might consider discussing some of these tax-saving ideas with your financial advisors to help keep the taxman out of your pockets.
Hire Family Members
If you employ family members in your business, prepare a written job description for each individual and pay them a reasonable salary and bonus for services rendered. For example, Canadians who earn less than $8,148 for 2005 qualify for the personal tax exemption resulting in them paying no provincial or federal taxes. Family members earning up to $33,375 will have, in Ontario, a combined federal and provincial marginal tax rate of 22%.
If you have an incorporated business and your spouse and children are shareholders, you may pay a dividend to them. If your family members have no other income and are in the lower marginal tax brackets, their dividend income will be taxed at a very low rate. When an individual earns regular income up to $33,375, they will pay a combined provincial and federal tax rate of 22% in Ontario. If this same individual were to earn this money as dividend income rather than as regular income, they would pay taxes of only 12% on their money. By adopting this strategy there would be a further tax reduction of 10%.
Making Mortgage Interest Tax Deductible
If you have an incorporated business and have a mortgage on your home and happen to have excess capital in your business’ bank account, consider writing a cheque from the company to yourself, depleting this capital balance. Use this money to reduce or eliminate your home mortgage. Ask the bank for a personal investment/business loan and invest the money back into your business. This strategy converts the non-tax deductible mortgage interest into a tax-deductible interest on a business or investment loan. An added plus is that it can help protect your money from creditors.
If you are self-employed and have not yet incorporated your business, consider it. This could result in tax savings and/or a tax deferral because corporations are taxed at 18.62% on the first $300,000 of taxable income in the 2005 calendar year compared with the top combined personal federal and provincial tax rates in Ontario of 46.41%. This strategy only works if money is retained within the business or the business owner decides they are going to take money out of their company for themselves and family by paying dividends. If you need all the extra money generated from your business for living expenses, then the business may not earn a sufficient amount of profit to justify the extra money that will be involved in the legal setup fees and on-going tax advice and corporate tax return filings needed to create the incorporated business.
Maximize Retirement Savings
As an unincorporated person, you may contribute the maximum amount permitted each year to a Registered Retirement Savings Plan (RRSP). However, if you are employed by your incorporated business and are earning a high income, consider creating a “super RRSP” in the form of an Individual Pension Plan (IPP) or a Retirement Compensation Arrangement (RCA). Contributions to these two vehicles may exceed the maximum allowable RRSP limits, are fully deductible by your company and are a non-taxable benefit for yourself. All the increase in the total value of assets is tax-deferred until withdrawal. IPPs and RCAs offer significant amounts of additional tax-deferred income to be set aside for your retirement.
(Note: Before implementing this strategy, it is important to seek the professional advice of an expert to perform a cost analysis to make sure that this is the best approach for your particular corporate and personal situation.)
For example, a 45-year-old MacDonald’s franchisee who has worked for their incorporated business since 1991 and has averaged a T4 income of over $100,000 per year and plans to “max-out” their IPP contribution room (using a yearly rate of return of 7.5%) will accumulate $4,800,101 in registered retirement assets. Opting for this tax solution, this individual would have a registered retirement yearly benefit at age 69 of $362,819.
In comparison, if this same individual only utilizes their RRSP option from 45 to age 69, he/she would only accumulate $3,310,822 in registered retirement tax-sheltered assets (using the same 7.5% compounded interest rate). This amount of RRSP assets on an annual basis would generate from age 69 and beyond $250,251 of retirement income.
The decision is clear; this particular MacDonald’s franchisee who implements both the IPP and RRSP tax solutions (as part of their retirement plan) would have an additional $1,489,279 of tax-sheltered assets in their registered retirement plan and have an additional $112,568 in annual retirement income.
Create a Health Spending Account
If you have an incorporated business, consider creating a personal Health and Welfare Trust (HWT). A HWT is a bank account whose deposits are spent exclusively on health care expenses. By having an HWT, you may convert health care expenses into 100 % business deductions and a nontaxable benefit for yourself. You determine both the amount of the annual contribution and how the benefit dollars are spent. Best of all, unlike traditional medical and dental plans, any unused funds remain in the account for your future needs.
Imagine an incorporated lawyer in Ontario who earns $100,000 of net income this year, who incurs $10,000 worth of medical and dental expenses. This lawyer must withdraw $18,416 in pre-tax income from their company to pay their current medical expenses. By using a Health and Welfare Trust, their company would pay only $11,000.00, which would then be 100% tax deductible from their business and a non-taxable benefit for themselves. Their company would experience an overall savings of $7,416.
The Corporate Retirement Income Maximizer
The Corporate Retirement Income Maximizer provides tax-sheltered growth within the company. Use a corporate-owned life insurance contract which creates cash values. Access these funds personally during your lifetime by collateralizing loans from a bank. Borrow funds annually to increase your retirement cash flow. Use appropriate documentation and guarantee fees to avoid a personal benefit. The bank loan is paid automatically at your death using a portion of the policy proceeds while a credit to the Capital Dividend Account (CDA) is created equal to the full policy proceeds.
Successful business people in this world look for and build networks of experts to help them achieve their life and financial dreams. So, it is highly recommended that before you implement any of these tax-saving strategies to first sit down with an expert who will advise you on your best options. The key to managing your future is to plan for it.