Ottawa’s proposal to alter the tax structure for integrated businesses has a lot of owners looking at alternative approaches to protect earnings for retirement and estate planning.
Tax experts are fielding an increasing number of calls from small-business owners concerning the advantages and disadvantages of setting up vehicles like Individual Pension Plans (IPPs) and corporate-owned life-insurance policies.
The questions come as the Liberal government proposes to restrict the usage of private corporations for making passive investments unrelated to the organization. Some business owners are using their businesses as a retirement vehicle by investing earnings within the business in a lower tax rate than when they had been pulled out and spent personally.
While some business owners are being invited to draw funds from the company and optimize their tax-free savings account and registered retirement savings plans (RRSP) annually, experts also point to IPPs and corporate-owned life-insurance plans as other choices if the government changes the rules on passive investments.
Pros and cons of IPPs
An IPP is available to certain small business owners and behaves like a “supersized RRSP,” states Navaz Cassam, president of GBL Inc., which sets up IPPs.
“It’s for men and women that wish to save for retirement,” Mr. Cassam states.
An IPP is modelled after the defined-benefit retirement plan which some salaried employees get, providing a set yearly earnings in retirement. It is held in the name of this corporation, that’s the plan sponsor. Like an RRSP, you invest in an IPP, the company receives a tax deduction and it develops tax-free. You do not pay tax on the funds until you take them out.
Experts say business owners looking in an IPP must pay themselves T4 employment income of at least $100,000 annually and be between 40 years old and 71 years old to get the most benefit. Business owners would have to hire an actuary to make calculations on when to begin an IPP, according to their unique conditions.
“It is not for everybody,” says Tarsem Basraon, a high-net-worth planner at TD Wealth’s Wealth Advisory Service.
Typically, the older the company owner is, the more contribution space there is offered within an IPP versus an RRSP. The maximum RRSP contribution for individuals earning at least $145,500 is $26,010 in 2017, no matter age. Having an IPP, the highest contribution is dependent upon numerous factors but at age 50, it would be approximately $34,000 and at 60, it would be approximately $41,000.
“Often, it is not until you are about 50 that it is sensible to perform the IPP in terms of maximizing deductions,” Mr. Basraon states.
That is because the actuary must think of lots of how much cash to spend the IPP to finance your retirement and the possible tax deductions relate closely to your age and previous earnings together with the corporation, he says.
“Generally, the older you are, the more cash you are going to have to put in since the less time there is for the IPP to grow and make the retirement income you’ll need,” Mr. Basraon states. “There is no magic number, it is dependent upon your situation, how much cash you’ve got in the business and what your retirement and age horizon is.”
Other advantages of an IPP are that it is lender evidence and the administration costs are allowable to the corporation.
The drawback is the complexity. “It is not as straightforward as an RRSP,” Mr. Basraon states. Additionally, there are the administration costs.
Mr. Basraon warns business owners to wait and see what Ottawa does about passive-investment income before establishing an IPP alternatively.
“On paper, right now, it looks like a viable choice for a retirement vehicle to use it, but we do not know what the last legislation will look like,” he says. “It might account for IPPs and dissuade people from using them too”
Pros and cons of corporate-owned life insurance
Corporate-owned life insurance is typically used for estate planning. It allows business owners to collect investments in the coverage tax-free. Upon death, typically, the whole benefit can be paid out tax-free to the shareholder through a capital-dividend account, says Jamie Golombek, managing director of taxation and estate planning in CIBC Wealth Strategies Group.
“It’s a fantastic way to maximize the value of property. In case you’ve got permanent capital that you are never going to invest in your lifetime, that is sitting within your company, then having a corporate-owned life-insurance policy may be a very tax efficient way to pass that money on to your estate in a tax-free fashion,” he says. “If you do end up having the money in the future, there are methods to get the money by borrowing against the policy, but that’s extremely intricate.”
1 problem with corporate-owned life insurance is that it is not liquid, Mr. Basraon states. “Even if you are going to use it as an alternative investment to finance retirement, it is going to be tricky to place the money in and take out another year,” Mr. Basraon says, adding that it would typically have to be in the coverage for around 10 to 15 years.
The premium may also be too high if the company owner has health problems, making the yields less attractive.
“It is very much tied into the cost of insurance, which might be outside of your control, based upon your health status,” Mr. Basraon states.
Similar to IPPs, business owners are invited to wait and see what changes Ottawa comes up with, if any, prior to purchasing corporate-owned life insurance instead to passive-income investing.
“There is no assurance that corporately owned life insurance couldn’t be captured in when the principles are finally drafted. You need to be careful,” Mr. Golombek says. “Do not do anything yet. We are still in the consultation phase with this one.”