Article written by Chris Coulter
There’s no doubt that your personal net worth will change following a divorce, especially if you run a business. The good news is that being a business owner affords you the ability to regain that net worth more quickly than people who are employed by someone else. But there are some ideal, and less ideal way to utilize your business as a means of accessing money for personal use.
With business success comes profits. Profits translate into personal earnings. How efficiently you’re able to get business profits into your hands is the real challenge.
So how do you get money out of your business while still keeping taxes low and maintaining your credit? Here are some wealth building strategies that you may want to consider.
Fund a Pension Through Your Business
As a business owner you have the ability to fund a Personal Pension Plan (PPP) through your business. This can be expensed entirely to the business. Although it is a tax-deferral, the contribution in a PPP can represent a significant amount more than an RRSP. The PPP is a Canadian tax-savings solution for business owners and incorporated professionals looking for a better way to save for their retirement. As compared to an RRSP, this pension solution allows up to 60% greater tax-deferred compounding until the individual retires.
Set Up Corporate Insured Retirement Plan (CIRP)
Another strategy is to have the corporation fund a Permanent Life Insurance policy on a shareholder of the business. This can prove to be a great tax-efficient strategy to get money out of your business. Many business owners understand the value of corporately owned permanent life insurance. The cash value grows tax-free while within an insurance policy. Over a number of years, the cash value that can accumulate can be significant. Accessing this cash by the business owner can be tricky though, and requires a leveraging mechanism called a Guaranteed Fee Arrangement. Done properly, a business owner can pay significantly less tax.
Establish Insurance in Wealth Preservation
Whether it be life insurance, critical illness or business asset protection insurance, it’s vital for a company to have key person insurance and shareholder insurance in the event that something happens to a shareholder or key employee. Insurance can provide a much-needed insurgence of capital to the business when it’s needed most. This can allow the business capital to weather a difficult period so the company doesn’t have to worry about meeting payroll or paying bills vital to the survival of a company. It can provide capital to replace individuals if needed, or fund the buyout of a shareholder and ensure money gets to the heirs of a business owner in a tax-efficient manner.
Reimbursement of Health and Dental Expenses
Many business owners offer employee benefit plans for themselves and their employees. I often see business owners participating in the same plan that they provide for their employees. But, business owners should not be paying for health and dental expenses in after-tax dollars. Items like braces, eye glasses and other expenses are often not covered by conventional benefit plans. These after-tax expenses can add up to a significant amount. If you look at cost of benefits relative to one’s salary, it makes sense. An employee that makes $40,000/year may have a benefit plan that is worth about $3,500/year, shouldn’t the owner of a business who makes $250,000 also have benefits proportionate to his/her salary? The CRA states that, provided the expenses are “fair and reasonable,” a business owner can put health and dental expenses through their business.
Set Up a Retirement Compensation Arrangement (RCA)
A Retirement Compensation Arrangement is a strategy entered into between an employer and employee (in this case the business owner). Half the RCA goes into a self-directed Investment Account, and half goes into a Deferred Tax Account. This is a tax-deferral strategy and is an expense that is charged completely to business. This allows the owner to get money out of the business and access the entire amount of money at a later time, perhaps when his/her marginal tax rate is lower than the current rate.
I often ask business owners how they get money out of their businesses. Many say they either bonus or dividend themselves money when needed. While these are options, this strategy results in higher marginal tax rate on that money. Others like to leave money in retained earnings within the business and plan to figure it out at a later date. With the new passive income rules recently introduced by the Federal Liberals, this is becoming a less viable strategy, and could result in you owing more corporate taxes as a consequence.
Many of the above strategies take time to grow and build “wealth momentum,” and unless given years to grow, lose their effectiveness as a strategy. I like to encourage owners to take some money off of the table over a long period of time. This way, they are likely to pay significantly less corporate and personal taxes over time.