While your business may be running along smoothly today, an important, but often overlooked facet of any successful business, is putting funds away for life after business. Can you count on the proceeds from the sale of your business to keep you financially independent during your retirement? How will your business be affected by significant challenges including increased competition, rapidly advancing technology and changing regulations? It is important for business owners to have a separate savings strategy to ensure they have sufficient funds for their retirement.
In the case of a corporation where one of the shareholders is retiring, funding to repurchase the shares and provide income to the retiring shareholder may come from a number of sources. A loan may be arranged at the time of retirement by the corporation with the proceeds paid to the retiring shareholder in exchange for the outstanding shares. This strategy may place a significant burden on the business and its ability to grow in the future. If there are a small number of shareholders this strategy may also have significant tax implications for the remaining shareholder(s).
Using the firm's existing cash flow at the time of retirement to fund the repurchase of shares is another strategy to be considered. This strategy while potentially workable depends on the available cash flows. This may place a burden on the corporation and its future growth and with few shareholders may result in a potential tax liability for those remaining.
Accumulating funds within the corporation on an annual basis in anticipation of retirement may be another means to fund a share purchase. Funds accumulated within an active company enjoy a favourable rate of taxation and may result in a greater accumulation. However a deferred tax liability may be created for the remaining shareholders once these funds are used for the re-purchase of shares. Furthermore, any funds which are held within the corporation leaves them subject to the claims of creditors.
Funds accumulated on an annual basis outside of the business can avoid many of these potential problems. As mentioned above, the limited liability of an owner of an incorporated company may not be sufficient to protect the owner's personal assets in the event a personal guarantee has been given by an owner. Segregated funds if properly structured, can provide the required protection for non-registered funds. Offered by insurance companies, segregated funds are similar to mutual funds in their returns and selection but provide additional benefits such as creditor proofing which will ensure your funds are not at risk to the claims of creditors. The returns generated on these funds would be taxable both annually and upon disposition in the hands of the individual. Sheltering funds within an RRSP plan, generally protected from creditors, can also be an effective option.
Because taxation may considerably reduce the investment's return, tax efficiency, in addition to creditor proofing, is an important consideration in selecting a retirement savings strategy. A product available for a number of years now gaining in popularity as new features are introduced and its appropriate uses are more clearly understood is the Universal Life insurance policy. This permanent form of insurance has both an insurance and investment component. Premiums after the cost of insurance have been paid are deposited into the investment portion of the policy and may be invested in a variety of guaranteed and variable investment options. Once deposited these funds are effectively sheltered from taxation until withdrawn at which time withdrawals can potentially be made on a tax advantaged basis.
The policy's flexibility lies in its ability to adjust both its face value and investment options to provide a tax effective means to save funds for retirement. As is the case with segregated funds, all funds within a Universal Life contract are protected from the claims of creditors in certain circumstances.
Particularly when formalized within a shareholders agreement, a retirement funding strategy provides the retiring shareholder with the security that funds will be set aside and the remaining shareholder with the security of knowing that the issue of ownership has been addressed. Furthermore, the tax implications can be assessed and addressed in advance.
Darryl Prociuk B.Comm(hons)CFP, R.F.P.,CLU,TEP is a registered financial planner and may be contacted at [email protected].
