10 key decisions to maximize your personal and business wealth

Whether you’re already a business owner or thinking about becoming one, the decisions you make will have far-reaching implications. Our guide explains ten key decisions for wherever you may be, on your challenging and rewarding business journey, including:

  • Multiplying the $866,912 lifetime capital gains exemption by adding family members as common shareholders of your company through a family trust.
  • Benefit from the tax-deferral opportunities of the corporate taxation structure – use the additional funds in the corporation to pay off debt, purchase capital assets, acquire investments or fund an insurance policy
  • Greater tax-deductible retirement contributions – by contributing to an Individual Pension Plan instead of a regular RRSP.

Key decision 1: What is the best structure for your business?

 
Make the right choice for yourself

Whether you already own your business, are thinking of starting a business from scratch or are buying an existing business, choosing the right business structure can have a major impact on the future success of your enterprise as well as your personal tax and estate planning.

Your decision should take into account a range of factors including the nature of your business and where it’s located, the number of people involved, taxation considerations, your potential exposure to liability and the company’s financial requirements.

Consult an experienced legal professional and tax accountant. Your professional advisors can help ensure that you are well informed on the legal and taxation issues you may encounter and that you understand the personal and business implications of your decisions.

Sole proprietorships

A sole proprietorship is the simplest form of business organization and is often the most inexpensive to set up. This can be a good option for small enterprises or when you are just starting your business because you, as the business owner, have direct control over business decisions and receive all the profits. However, with this kind of structure, you are legally responsible for the debts and obligations of the business. This means that both your business and personal assets may be subject to the claims of creditors. This is called “unlimited liability”.

How is a sole proprietor taxed?

You must file a personal tax return to report your business income. You should include the income, or losses, from your business on your personal tax return as part of your overall income for the year. Your net business income is taxed as personal income, so there are limited tax planning opportunities; however, you may be able to deduct your business losses from your other income sources.

Partnerships

Partnerships can be relatively easy to set up and often have low startup costs. A key advantage of having partners is that they generally bring additional sources of investment capital and provide a broader management base. However, finding suitable partners can be a challenge. In addition, this kind of business structure can mean a division of authority, so there is potential for conflict between the partners.

A written partnership agreement, though not required, can help minimize potential conflict. In many cases it sets out the terms of business, protects the interests of individual partners in the event of disagreement or dissolution of the business and generally defines how the partners will share the business profits.

Your personal liability for the business and the actions of your partners can differ depending on the type of partnership. Be prepared for the possibility that your partners’ decisions will be legally binding on you, and ensure you discuss all aspects of this decision with your legal advisor.

If you are considering investing in a partnership, you should review the tax and legal implications carefully with your professional advisor.

How is a partnership taxed?

A partnership is not a taxable entity. This means that instead of the partnership paying tax, the partnership’s income or loss flows to the individual partners, who report their proportionate share of income or loss on their personal tax returns.

Corporations

Corporations are a very popular business structure. A corporation is a separate legal entity from its shareholders and has the legal characteristics of an individual. It can own property, incur legal liability, lend, borrow and carry on a business.

If you’re thinking of starting or investing in a corporation, there can be a number of advantages. It can provide greater business continuity as shares can be bought and sold without affecting the company’s continued operation. It is also easier to raise investment capital for a corporation, and you may find that the size and resources of an incorporated business make it easier to attract specialized management expertise. In addition, as an owner-manager and a shareholder, your liability is generally limited to your shareholding, so your personal assets are protected from the company’s creditors unless you have provided personal guarantees for loans to the corporation.

It’s important to obtain legal advice when setting up or acquiring an incorporated business. Corporations are more closely regulated than sole proprietorships or partnerships and may be more costly to set up. You will be required to hold annual shareholder meetings, meet certain record-keeping obligations and comply with requirements under the legislation governing their corporation. This can mean more administrative, legal and accounting expenditures.

If you are a professional and are thinking of incorporating your practice, please review Appendix 2 for information specific to professional corporations.

How is a corporation taxed?

Since a corporation is a separate legal entity, a corporation files its own corporate tax return and pays taxes on the income it earns. A corporation’s income is calculated separately from the business owner’s or shareholder’s personal income.

Tax planning for corporations

As an owner-manager, you may be able to benefit from some of the tax planning opportunities available to incorporated businesses:

  • The small business deduction provides potential tax-deferral opportunities and a reduced corporate tax on active business income up to the small business limit that is retained in the corporation.

  • If your business qualifies as a qualified small business corporation (QSBC), all or a portion of any gain realized on the sale of the shares can potentially be sheltered from personal taxation using the capital gains exemption.

  • By incorporating, you may have the opportunity to split income and reduce taxes by paying dividends to adult family shareholders.

  • Adding other family members as common shareholders directly or through a family trust (referred to as an “estate freeze”) can allow you to transfer future tax liability on the growth of the company to lowerincome family members and multiply the use of the capital gains exemption on the sale of QSBC shares.


Key decision 2: How can you reduce taxes?

 
Organize your business assets in the most tax-efficient manner

As a business owner, you may have substantial personal assets invested in your business in addition to the longterm commitment you have made to your business and its employees. This can have significant implications, not only for you and your business but also for your family’s financial security.

To protect your investments, both business and personal, your business strategy should include carefully structured tax and estate planning components to ensure you have organized your assets in the most taxeffective manner and utilized the tax planning strategies that are available for the benefit of your business and your family.

Personal tax planning

There are several income-splitting strategies available to owners of private corporations in Canada that may benefit you and your family. They include:

Income splitting by paying a salary to family members

Consider income splitting with lower-income family members by employing them in the corporation and paying them a reasonable salary based on the services they perform. The salary they receive will also create Registered Retirement Savings Plan (RRSP) contribution room for them and generate Canada Pension Plan (CPP)/Quebec Pension Plan (QPP) pensionable earnings. Note that the tax rules provide a disincentive to paying a salary or bonus that exceeds the value of the services rendered.

Income splitting by paying dividends to adult family members

If you have an active corporation, you may be able to transfer some or all of the future growth of the business to the next generation of your family using an estate freeze with a family trust. This common business succession strategy allows you to income split by paying dividends from the corporation to your spouse and adult children. If they have no other income, they may be able to receive substantial tax-free dividends from the corporation (the amount varies depending on the type of dividends and the family member’s province/ territory of residence). While this strategy may help you minimize and defer tax, there may be situations in the future where you may wish to unwind or dissolve the structure. Ensure that this flexibility is available in the design of your estate freeze before it is initially put into place.

Multiplying the capital gains exemption

It is possible to “multiply” the capital gains exemption available to you and your family on the sale of the qualifying shares of your business. This could significantly increase the family’s after-tax assets following the sale. One way to do this is by having your operating company owned by a family trust where your family members are the beneficiaries of the trust. When you sell the qualifying shares owned by the trust, the resulting capital gains can be allocated to each beneficiary and they can each claim their capital gains exemption. For example, a family of four can claim four times the capital gains exemption versus the business owner, who can claim the capital gains exemption only once. This results in additional tax savings for the family.

You may also wish to consider some potential estate planning opportunities. Freezing the value of your estate can help you limit your tax liability on death. You can also defer capital gains on the future growth of the business and attribute them to the next generation while retaining control of the business. This may also allow other family members to use their capital gains exemptions.

Remember that for these strategies to be effective, the interest, dividends and capital gains must be paid or payable by the family trust to the beneficiaries. The funds will no longer belong to you as the parent or business owner, so ensure this is a practical strategy for your circumstances.

Tax planning for your business

If you’re the owner of a private Canadian corporation earning active business income, consider whether the following strategies would work for your business:

Setting up a retirement plan

Consider setting up an Individual Pension Plan (IPP) as part of your retirement plan. An IPP is a defined benefit pension plan that, in certain situations, provides greater annual contribution limits than an RRSP. IPP contributions increase with the age of the plan holder.

Contributions to the IPP are taxdeductible for your corporation. The investments in the IPP grow on a taxdeferred basis and are only taxable when you start withdrawing from the IPP.

If investment earnings in the plan are lower than expected, you may be able to make additional contributions.

IPP assets may offer creditor protection and typically suit business owners who are age 40 or older and earn significant employment income. This means that you will need to draw a salary from your business.

Maintain the status of your corporation as a qualified small business corporation

By maintaining your operating company’s status as a QSBC, when you eventually sell its shares, you may be able to take advantage of the capital gains exemption. This exemption is available to individual shareholders of active Canadian private corporations and can represent sizable tax savings.

To qualify for the exemption, ensure your corporation meets the QSBC status. Certain corporate structures may make this easier. Since surplus assets may limit your ability to claim the exemption, you may want to transfer non-business investments to a holding company. This can “purify” the operating company and reduce the accumulation of non-qualifying assets.

Earning Canadian dividend income in a corporation

Canadian source dividends from corporations that are not controlled by the shareholder corporation are subject to a flat refundable corporate tax. If you are earning Canadian public company dividends in a corporation, consider paying out a dividend in the same year if you will be paying taxes at a lower tax rate personally.

Life insurance as a tax-exempt investment in the corporation

If you have surplus funds accumulating in your corporation, you may be taxed at a higher rate on the investment income earned in the corporation than if you earned this income personally (depending on the province/territory). You may also face double taxation on the assets within the corporation on death. Tax planning solutions are available that may help you address this problem.

A corporate-owned tax-exempt life insurance policy can provide income protection for survivors, fund buy-sell agreements or pay capital gains tax on death. Life insurance premiums are generally not taxdeductible, but it can be advantageous to purchase life insurance through a corporation rather than personally. The corporation’s surplus assets can be invested in the insurance policy, grow on a tax-sheltered basis during your lifetime, provide a supplementary source of retirement income and be paid to your beneficiaries as a tax-free death benefit.


Key decision 3: What should you do with surplus cash?

 
Preserve and maximize your surplus assets

If you are the owner-manager of a private Canadian corporation and have surplus cash accumulating in your company, you may be wondering whether to retain the funds in the company or withdraw them while paying as little tax as possible. If so, there are a number of questions you should consider before you take action.

Is there a business need for the cash?

If you have surplus cash in your corporation, ask yourself if you will need it for business purposes in the short term. Will you need to use the cash to pay instalments of income tax or GST/HST? Does your business experience seasonal slow periods when cash flow will need to be supplemented? Consider whether you will have to pay down debts or make any major purchases in the near future.

If you have excess cash that won’t be used for business purposes, the investment income earned on this surplus cash will be taxed at the corporate investment tax rates, which may be slightly higher than top personal tax rates, which vary by province/territory.

Do you need the surplus cash for personal purposes?

Do you have personal expenses that are coming due, such as income tax installments that must be paid on time? You may also be considering a major purchase like a vacation property or planning to help out with a family member’s education costs, wedding expenses or house down payment. If you know you will need to withdraw surplus funds from the corporation to meet these personal expenses, consider when you will need the funds. It’s important to understand the tax consequences of making the withdrawal and whether it will be possible to make several withdrawals over a period of time to minimize tax costs.

What are the funds going to be used for?

If you don’t need the surplus funds immediately for business or personal purposes, what are your reasons for moving funds out of the corporation? Sometimes, it may be beneficial to withdraw the funds from the corporation, as investment income earned on the excess funds remaining in the corporation may be taxed at a slightly higher rate than the highest personal tax rate. A good starting point is to analyze your long-term goals, which could include:

  • Planning for retirement – Are you going to use the funds for your retirement by contributing to an RRSP, IPP or RCA?

  • Estate planning – Do you want to enhance the value of the estate you will pass on to your family? Many potentially effective estate planning strategies involve insurance-based solutions. The funds may grow on a tax-sheltered basis and may be accessed at retirement to supplement retirement income, or they may be paid out tax-free on death.

  • Asset preservation – If you want to mitigate the risk of funds being subject to claims from corporate creditors, consider transferring excess cash to a holding company. There are various ways to accomplish this.

  • Tax planning – Keeping excess investments or an insurance policy in a corporation may disqualify your shares from being QSBC shares so that you are not entitled to the capital gains exemption on the sale of your business. Therefore, you may want to withdraw excess funds from the corporation. A properly structured corporation may allow you to extract cash from the operating corporation on a taxdeferred basis.

Withdrawing funds from the corporation

If you’ve decided to take funds out of your corporation, consider potential strategies that could help you make the withdrawal and minimize the tax consequences.

Tax-free strategies
  • Expense reimbursement – Keep records of business expenses you paid personally. If your corporation reimburses you, you won’t pay tax on the funds you receive and the corporation may get a tax deduction for the business expense.

  • Repayments of shareholder loans to the company – Shareholder loans, such as personal assets you transferred to the company without payment or dividends declared but never paid to you, can be repaid without tax consequences.

You could also consider other nontaxable methods such as paying a capital dividend if your corporation has a positive capital dividend account balance.

Taxable strategies

Taxable methods of withdrawing funds from the corporation include paying yourself a higher salary or dividend. Although paying a taxable dividend results in personal tax, it may at the same time create a tax refund to the corporation if the corporation has a “refundable dividend tax on hand” (RDTOH) balance. In some circumstances, the refund to the corporation may be greater than the personal tax paid on the dividend. Income-splitting opportunities may also be available, for example, by paying a reasonable salary to a lower-income family member for services rendered or paying dividends to adult family member shareholders.


Key decision 4: How can you build employee loyalty?

Provide enhanced benefits to attract and retain top talent

As a business owner you know how important it is to recruit, reward and retain your top talent.

It can help ensure business continuity and protect the knowledge you have accumulated within your organization, and it may help you make effective succession planning decisions when the time comes. The loss of a key employee can be very expensive to an organization, so give some thought to how you can motivate key employees and keep them focused on the company’s priorities.

Employer-sponsored savings plans

Employees are increasingly conscious of the necessity to provide for their retirement. Employer-sponsored savings plans are one of the most important aspects of retirement planning and can help you ensure that your employees enjoy a financially secure retirement. Before setting up a retirement plan, discuss the options with your professional legal, tax and/or financial advisors. Here are some of the more common types of retirement plans offered by employers.

Group Registered Retirement Savings Plans (Group RRSPs)

Group RRSPs are one way you can encourage your employees to save for retirement throughout their careers. They could be an option even for a small business owner. These plans operate like regular RRSPs, possibly with additional restrictions, and can be more cost-effective and easier to administer than pension plans.

Registered Pension Plans (RPPs)

RPPs are employer-sponsored pension plans. In general, employer and employee contributions are taxdeductible and the income earned within the plan grows tax-deferred. Funds accumulating within the plan for individual members are generally locked in by provincial/territorial or federal legislation. There are two kinds of RPPs:

Defined contribution (DC) and Defined benefit (DB) pension plans

Employees with DC pension plans choose the investments within their individual plans, and the retirement benefit is based on the value of the investments in the plan when the employee retires. This can be a less costly option than a DB plan for you as an employer and is easier to administer.

In contrast, DB plans guarantee a specific benefit to the employee at retirement, calculated using a formula based on earnings and years of service. DB plans generally specify an age, usually 65, at which employees are expected to start receiving retirement income. As an employer, you face a potentially greater obligation with a DB plan than a DC plan because you are making the investment decisions and guaranteeing a fixed benefit to the employee at retirement. If there are insufficient funds in the plan, you may also be required to top up the plan by making a greater current cash flow commitment to the DB plan than expected. If there is a surplus in the plan, you may have reduced payments.

Enhanced retirement benefits

The following options may help you enhance the retirement savings plans of your key employees:

Supplemental Executive Retirement Plans (SERPs)

Limits on registered plan contributions and benefits can leave your higher-income employees with retirement benefits that are inadequate to maintain their standard of living. A SERP may help bridge the gap between the maximum pension available under the company’s RPP and what a higher-income employee would otherwise have received. It can also be a way to help you retain your valuable employees and encourage their long-term loyalty.

One of the most common forms of SERPs is an RCA. An RCA is a nonregistered pension arrangement that can help you provide supplemental pension benefits for key employees.RCAs have no contribution limits (provided contributions are “reasonable”) and no investment restrictions. Employees may also be able to benefit from certain investment strategies involving life insurance. This can provide supplemental tax-exempt investment income and may yield better results than alternative investments.

Individual Pension Plans (IPPs)

As previously mentioned, an IPP is a DB pension plan.

It can be set up for a business owner but also for key employees to provide for their retirement.

IPPs are typically suited for those who are age 40 or older and earn significant employment income.

Learn from experience

While financial compensation often attracts your key employees, nonfinancial benefits often help you retain them. Sufficient tools and time to do the job are essential to employee satisfaction, while training and career development help to keep them motivated. Aim to foster a social environment and a sense of team, and demonstrate your commitment by ensuring that work/life balance can be achieved.

If you lose a key employee, hold an exit interview so you understand the reasons for their departure. Their dissatisfaction may indicate problems among other key employees and may save you from another costly loss.

We can help you assess the advantages of enhanced employee benefits, including RCAs, IPPs, Group RRSPs, and assist you in setting up these plans. Please contact us for more information.


Key decision 5: How will you reduce your risk?

 
Safeguard your personal and business assets from creditors

As a business owner, you’ve worked hard to accumulate your assets, so it’s important to take precautions to protect them from risk. Review your situation and consider if you need to “creditor protect” your business. If you operate as a sole proprietor or a partnership, your personal as well as business assets may be at risk from creditors with a claim against your business.

There are a number of potential solutions. One is to keep your personal and business assets separate wherever possible and carefully structure your holdings to minimize your potential liability before any insolvency issues arise. This can be an effective way to protect yourself, particularly if you undertake such planning in the ordinary course of your business. The following are some other strategies that may help:

Protect personal assets
  • Gifting assets – If you gift assets to family members, you may reduce the number of assets that may be available to your creditors, but bear in mind that those assets may now be at risk from creditors of the family members who receive them. Unless the gift is to a spouse, it’s considered a sale at fair market value for Canadian tax purposes and could potentially trigger a capital gain.
  • Using insurance – Depending on the province/territory you live in, placing funds in an insurance policy (life or segregated funds) may safeguard them from potential future claims. In many cases the investment component of an insurance policy and the interests of the beneficiaries under the insurance policy may offer protection from the claims of creditors.
  • Sheltering assets within registered plans – Funds in an RRSP are potentially protected from creditors in certain provinces/territories. In very specific circumstances, some RRSPs have received a favourable judicial ruling following the death of the plan holder, particularly where there was a named beneficiary. Remember that registered pension plans governed by pension legislation may also offer protection from the claims of creditors, subject to specific exceptions.
  • Transferring assets to a formal trust – The legal ownership of the assets passes to the trustee, so, if properly structured, these assets could be protected from future creditors. However, you may lose control of the funds transferred, depending on the nature of the trust. Determine whether you can afford to transfer control of those assets. If you can, choose a trustee who you know will manage them appropriately. Remember there could be significant tax implications in placing assets in a trust, so obtain professional advice to ensure you understand the consequences before you make a decision.
Safeguard your business

When you’re working on a strategy to protect your business assets from risk, certain actions can create the impression that you intend to put assets beyond the reach of creditors. This can work against you in the event of a lawsuit and can be particularly important if your company is experiencing financial difficulties. Try to avoid the following:

  • Transferring property for less than fair market value
  • Paying for property by cash instead of cheque
  • Transferring property without proper documentation
  • Transferring property where the transferring person retains an ongoing interest or continues to behave like the property owner
  • Transferring property without a change in possession

Protecting your corporate assets may involve transferring them between a number of separately incorporated businesses. The idea is that if one business fails, it won’t leave another in a vulnerable position. It is important to demonstrate that each corporation is a legitimate legal entity, carrying on business independently.

Ensure that transfers between companies occur at fair market value and are documented as though they occurred at arm’s length. To reinforce this, if you have a number of corporations with a common trade name, ensure that all documentation is prepared in the correct corporate name and signed by the authorized signing officer. Each corporation should have separate management, so try to avoid shared processes like accounting, banking and inventory management.

To protect your valuable business assets, an operating company should aim to own only the minimum number of assets necessary to carry on its business. If possible, these assets should be owned by another company and leased back to the operating company so they are not available to creditors in the event of a claim.

Benefits of incorporation

Incorporating your business may be one way to protect personal assets. As an owner-manager, you are only liable to the extent of your shareholding, so you are not personally liable for the debts of the company. Compare this with sole proprietors, who are personally liable for all the debts and obligations of their businesses, and partnerships, where you can be personally liable for the actions of other partners. If you do incorporate, be careful about giving personal guarantees for loans to your business. The protection provided by incorporation can be lost in such a case and you could be personally liable for the repayment of the loan.

Surplus assets in your business

Consider keeping cash reserves low. If you have accumulated surplus assets in your business that you don’t need for operating expenses, consider transferring them to a holding company. This can help protect them from creditors of the operating company. You should also consider the pros and cons of having your company contribute to an IPP. This can help boost your retirement funds and assets in an IPP are creditor protected.


Key decision 6: What can you do to deal with the unexpected?

Prepare a plan to protect your business before adverse events occur

Would your business be prepared if a catastrophic event occurred? Do you have a plan to cover the potential loss of a key person who leaves by choice or due to a serious illness, a disability or death, or to mitigate the consequences of a divorce, which can have a substantial impact on a family business?

Planning ahead can help you limit the damage to the business you have worked so hard to build and to which you have committed so many resources. You protect yourself by insuring against risks like fire, damage to your premises and theft of equipment, but an unforeseen event for which you haven’t planned can seriously affect your ability to deliver services to your customers. Lack of planning can be detrimental to the value of your business, company morale and business performance.

Insurance solutions

Insurance can provide some financial security if you are unable to work or earn an income due to an accident or illness. As a business owner, your continued presence may be critical to the company’s ongoing success. Several insurance strategies may be particularly significant in ensuring business continuity and security:

  • Purchase insurance to help you pay overheads and specific expenses you will continue to be responsible for, even if you are temporarily incapacitated.
  • Fund a buy/sell agreement through an insurance policy. It can be a cost-effective way to enable business owners to purchase the shares of a partner or shareholder in the event of their death, a disability or a serious illness. This may allow you to take immediate steps to minimize the potential damage by reassuring employees, creditors, suppliers and investors; and ensure that the family of the partner or shareholder receives financial support.
  • Insure against the loss of a key person. Key person protection can be a cost-effective way to help protect your business against the consequences of losing a critical individual, whether they leave by choice or due to death, a critical illness or a disability. You estimate the financial impact of this loss on your company and insure against the occurrence of specific events. Your business may receive compensation to the extent of the coverage you have purchased, and this can help you manage unexpected expenses resulting from the loss.
  • Consider the potential benefits of providing group insurance for your employees. This can be a valuable addition to your compensation structure, can help ensure longterm employee loyalty and may make your company attractive to talented prospective employees.
Retaining top talent

Many organizations misunderstand what employees and prospective employees are looking for from an employer. This may be one reason why organizations have difficulty attracting employees with the skills they need.

For a large percentage of organizations, mental health is a major cause of short-term disability claims. The trend appears to be increasing. Employees claim that the main reasons for leaving their employer were stress, lack of confidence in management, dissatisfaction with opportunities for promotion, base pay and lack of work/ life balance.

Analyse the potential business consequences of losing your most talented employees. To retain these valuable people, get to know them, reward them, keep them challenged and engaged, foster a team environment, offer them growth opportunities and provide a comprehensive and competitive remuneration package. These factors may help you maximize productivity and ensure business continuity.

Consider a family business divorce strategy

Divorce can have a major financial and emotional impact on a family business. It can also have an adverse effect on non-family members who work in the business. Consider the impact a divorce could have on the company morale, relationships and business performance. You may be able to minimize some of the negative effects through careful legal, succession and tax planning, but don’t overlook the benefits of a comprehensive family business divorce strategy. It can be an invaluable piece of forward planning.

Consider a pre-nuptial agreement as a way to avoid some of the conflict associated with divorce. While it may be difficult to discuss the subject, such an agreement can be a great tool.

If the family business is the family’s largest asset, a divorce can result in the sale of the business and division of the proceeds between the former spouses. In such a case the valuation of the business is often the central issue. It can be highly contentious and should be an essential element of a family business divorce strategy.

A business valuation expert used in a family business divorce strategy can help:

If you plan for the unexpected, you can help your business weather developments that may otherwise have a potentially negative impact. In addition to insurance and strategies to retain your key employees and mitigate the effects of divorce on the family business, don’t forget basic precautions. Ensure that computer systems are backed up and that important business and operational information is effectively communicated throughout the company to reduce risk in the event of the loss of key individuals.


Key decision 7: Do you intend to retire from your business?

 
Create an exit strategy for a smooth transition into a well-funded retirement

If you should ever decide to retire, consider that some business owners develop a strategy for exiting their business, but many who are approaching retirement age haven’t yet discussed their plans with family or business partners.

Whether you intend to sell the business to a third party, transfer it to family members, structure a management buyout or wind it up, advance planning can help you make better long-term decisions and increase the chances of a successful transition. It can increase the funds you will be able to withdraw to help fund your retirement, make management transitions easier and give you a wider range of options. In the next few decades, many small businesses will be changing hands. If you haven’t yet discussed a business succession plan, or even considered your intentions for the business when you retire, now is the time to think about it.

Will your business provide enough to fund your retirement?

A family-owned business often represents more than half the value of the owner’s estate. Consequently, if much of your net worth is tied up in the business, you may be less well diversified than those who have a more traditional retirement portfolio. Remember that unlike a salaried employee, it’s up to you to fund your own retirement. Do you have a strategy? Are you relying on being able to sell your business for a sum that will enable you to enjoy a financially secure retirement? If you haven’t given further thought to that far-off day, consider that many business owners are unable to sell their businesses for a variety of reasons. These include difficulties finding a suitable buyer and obtaining financing for the successor once they have been identified.

To avoid the situation where you’re ready to retire but can’t find a purchaser of the business, consider grooming your own replacement so that they’re ready to step in and buy the company when you’re ready to retire. Your options could include a current co-owner, key employees or a younger family member who is already active in the business.

If members of your management team are interested in purchasing the company, consider a management buyout or setting up a share ownership plan to transition your business. This may help you ensure business continuity, harness the business experience of your management team, and by reducing disruption during the transition period, you may increase the likelihood that the company will retain its existing customers and suppliers. For these and other reasons, management buyouts are often more successful than passing the business to family members or third parties.

Don’t leave the planning to the last minute

Don’t expect to put together an effective succession plan in a short period of time. Many business owners underestimate how long it takes to create a plan. Now is the best time to start thinking about succession planning for your business. This may seem a low priority when you’re consumed with the pressures of dayto- day operations, but it’s the best time to do it. Begin by writing down your goals and get professional legal, tax and accounting advice on setting up a succession plan.

Be conservative when you’re planning for retirement. It’s often natural to be optimistic, particularly if your business has always provided well for you and your family and you’ve assumed that it will be your main source of retirement savings. Maximize other sources of retirement income, like RRSPs or IPPs for example, and however much you love what you do, don’t leave your retirement planning too late. Allow time to find potential buyers to ensure you get the best possible offer for your business. Here are some tips to consider:

  • Start working on your succession plan as early as possible
  • Set realistic goals
  • Review your plan regularly
  • Identify the qualities you’re looking for in a successor (e.g. skills, resources)
  • Assemble a team of professional advisors (e.g. business broker, experienced legal advisor, tax specialist, financial advisor) to help you put your plan together
Where is your business in its life cycle?

Where your business is in its life cycle can influence your retirement planning. Your focus will change as the business moves through different stages, so be flexible in your approach.

Early on you may have few resources or little time to give to retirement planning. Later on when you’re established, you may have more time and resources – however, it’s never too early to start planning for retirement.

During the early years and periods of growth, build retirement planning into your decisions by diversifying and directing surplus assets to RRSPs, IPPs, tax-exempt life insurance and/ or non-registered investments. Obtain professional tax advice to help maximize cash flow to build these assets. You may also be able to split income with family members and that can be beneficial when you eventually sell the business. Build a comprehensive estate plan, including putting Wills and Powers of Attorney/Mandates in place, and keep them up to date as circumstances change.

If your established business is generating surplus cash flow, you could be paying taxes in the highest tax bracket. While you’re focused on further expansion, remember to continue to diversify and direct surplus assets to retirement planning. You may now have funds for more sophisticated strategies that may help you save tax and further your retirement and estate planning objectives.

By the time your business is mature, you should have an exit strategy. Consider the following:

  • Can the business generate enough income to fund your retirement?
  • If you intend to sell the business, will you sell shares or assets? On the sale of QSBC shares, you may be able to utilize the capital gains exemption.
  • Can you utilize opportunities like a payment of a retiring allowance and repayment of shareholder loans to help fund your retirement?
  • Will you transfer the business to a family member? Have you identified a potential successor?
  • Is an estate freeze a possibility? See “Key decision 2 – How can you reduce taxes?” to learn more about estate freezes.

Key decision 8: Will you sell your business?

 
Get top dollar by making your business more attractive to potential buyers and minimize taxes on the sale

If you are planning to sell your business to a non-family member, you are not alone. Many business owners in Canada will exit their business by selling to a non-family member, but only a small percentage of owners planning to transfer their business in the near future have a succession plan. This apparent lack of succession planning is often due to the difficulty in finding a suitable buyer with financing to close the purchase.

If you’re selling your business outside the family, consider the factors that can make your business more attractive to a prospective purchaser. It will be easier to find a buyer for a business that has potential for future growth. Other corporations in your business sector may also be interested in acquiring your business with a view to improving its profitability.

Valuation is of central importance. You can get an indication of this by researching the selling price of similar businesses in your area. Remember that small businesses can sell for significantly less than the asking price. Buyers may evaluate your business on its projected cash flow for the next few years and assess the value of that cash flow against the business risks.

To help you find a purchaser and obtain a better offer:

  • Have a valid reason to sell – But try not to disclose personal information that could weaken your negotiating power.
  • Don’t wait until you’re under pressure to sell for economic or emotional reasons – This can force you to accept a poor offer.
  • Gather essential information – This may include:
    • Three years’ financial statements and tax returns
    • Lists of fixtures and equipment
    • Lists of employees and customers
    • Copies of leases for premises and equipment
    • Franchise agreement
    • Lists of loans and payment schedule
    • Names of professional advisors, for example, business broker, qualified legal advisor and tax specialist
  • Have financial statements audited or reviewed by a professional for the sale - This will increase the confidence potential buyers will have in the accuracy of the documents you provide.
  • Consider hiring a business broker to help you identify a purchaser – A broker can act as your agent while you’re looking for a purchaser and during the negotiations.
  • Maintain confidentiality – Don’t divulge information about your day-to-day business activities that can be used by competitors. Ask a potential buyer to sign a non-disclosure agreement and provide financial information only to potential buyers who have paid a deposit
  • Don’t let the business decline while you’re preoccupied with the sale – Maintain your premises, inventory and normal business hours.
  • Learn to judge whether a potential buyer is serious – Don’t waste time on tire kickers.
Assemble a team of experts to help you

Your team of experts should include an experienced tax advisor to ensure you have planned your sale in the most tax-efficient manner, a qualified legal professional to prepare legal documentation and a business valuator. By working with your RBC advisor, you can create a financial plan that can give you an idea of what level of after-tax sale proceeds will be adequate to meet your retirement goals. They can also help you manage the investment of the sale proceeds.

Hiring a business broker

Give your broker information about your business and then follow their advice. Here are some factors to consider:

  • You can maintain confidentiality during the early stages of the sale process and let the broker deal with potential purchasers on your behalf until they identify an acceptable prospect.
  • Potential buyers may be more comfortable talking to an intermediary.
  • Some brokers specialize in a particular industry and may have contacts at corporations that may be interested in buying your company.
  • Brokers’ fees are usually a percentage of the final sale price. Weigh this expense against the benefit they provide before you hire them.

We strongly advise you to consult an experienced legal professional when you’re selling your business. A professionally prepared document summarizing your business for potential purchasers can be invaluable and may help you avoid potential litigation and suggestions of misrepresentation if the purchaser finds the business less successful than expected. Your legal advisor should also prepare the sale and purchase agreement so that all contingencies are covered and you minimize the risk of future litigation.


Key decision 9: How can you keep your business in the family?

 
Plan ahead to maintain stability in the business – and the family
What are the challenges to keeping a business in the family?

There are a number of challenges unique to running a family business and planning its future. Consider the interaction of family, business and ownership values and interests. There are long-standing relationships between family members that will still be there long after the transition, so don’t overlook family dynamics. Is there a suitable successor within the family, and if so, can they work with others in the family who may also be involved in the business?

The high failure rate of intergenerational business transfers can be attributed to a combination of factors. These include the lack of a formal succession plan, a tendency to leave succession planning too late and the absence of clear communication. When you involve family members and discuss their concerns, such open communication helps clarify expectations of everyone’s roles and commitment to make the transition a success. Don’t assume that you understand the needs and perspectives of your relatives and employees. Address potential issues, perhaps by means of a family council, rather than avoiding them.

Involve your heirs and key employees in your succession planning

Owners of family businesses often assume they are “on the same page” as their chosen successors. This may be one reason why they are less likely to have a formal succession plan than those selling the business outside the family. It’s a risk to assume that one of your children or another family member wants to take over the business. They may have other plans. When you have identified a successor, involve them in your succession plan and share your long-term goals with them, your family and key employees. Their input can minimize potential conflict and help maintain stability in the business and the family.

It’s never too early to start building your succession plan

Don’t underestimate the value of starting the process early. If you start to design your succession plan many years ahead of your expected exit date, you can build the interest of potential successors within the family by involving them in meetings and asking for their input. This can help them make an informed decision about whether they want to participate and to what extent.

If you don’t have one family successor in mind yet, consider splitting the business and its responsibilities between family members. Who has been actively involved in the business and shown an aptitude and desire for leadership? Given the differing levels of commitment that your children may have shown, should you divide the business equity equally between them? The business may be your largest asset. Can you recognize their contributions in other ways and is it appropriate for children who are not actively involved in the business to be shareholders?

Obtain professional advice from your legal advisor, tax specialist and possibly a family business facilitator. A facilitator can help you discuss issues with family members, provide objectivity, find constructive ways to resolve conflicts, review plans, establish priorities and involve stakeholders in the succession process.

Create and implement a business succession plan
  • Develop a leadership profile – What do you want to see in a future leader?
  • Identify suitable candidates – Who demonstrates the commitment and leadership qualities you’re looking for? Assess their experience and the gaps in their education. How can these be remedied?
  • Prepare management and personal development plans – Project the company’s future management needs and guide the career paths of individuals to meet them.
  • Mentor and evaluate candidates – Develop their skills and leadership qualities. It can be difficult for a parent to do this objectively due to conflicting roles of parent/business owner. Choose someone else as mentor.
  • Select a succession – Your choice could be clear due to years of preparation, or if not, use set criteria to make your selection.
  • Your business facilitator can help.
  • Communicate your plan – Ensure everyone understands the plan and their proposed roles. A business facilitator can help with communication and coaching.
  • Manage the transition – Withdrawing from daily business activities can be difficult. A gradual transition may work best.
Continuing involvement after succession

Will you have an ongoing role after the transition, perhaps in an advisory capacity? This is common among entrepreneurs. The longer they have been in control, the more personally attached they are and the more likely they will want to stay involved. This can gradually reduce the business’s dependence on you and may make it easier to separate your identity from the business role you’ve held for so long. It can also help you gradually transition into retirement.


Key decision 10: What will you do once you’ve retired?

 
Develop a plan to ensure your retirement is as successful as your business

Retirement planning requires you to consider a whole new lifestyle with new priorities and perspectives. A common misconception about retirement planning is the idea that money is the most important element and that you should focus your planning on creating after-tax cash flow. There are many other essential factors to consider.

Build an estate plan

If your business interests represent a significant part of your estate, have you thought about how the transfer of this wealth will affect you, your family, your relationships and your personal legacy? Family members may have played different roles in the business. Consider these differences when planning your estate and deciding how you will treat active and non-active family members; for example, equal versus fair treatment. In considering what income you will need, remember to provide for possible unplanned events. Try to be proactive in planning for an unforeseen event, such as a health crisis, and do your planning well in advance of your potential retirement date. Ensure you review your Will and Power of Attorney/Mandate on a regular basis so they continue to meet your estate planning objectives.

What are your plans after you exit your business?

As a business owner, the demands of running a successful business keep you very busy and engaged. Have you thought about how you want to spend your time after you retire? You may have a succession plan for your business, but do you have a plan to help ease the personal transition as well? It is a good idea to develop fulfilling new hobbies and interests while you’re still working. You have left your mark on a successful business. Now you have an opportunity to leave your mark on your community and other areas of interest that are important to you.

Discuss your personal goals with your family and friends if possible. Working together to plan for the next phase of your life can be beneficial for everyone. If you have a spouse who has not been involved in the business, their transition may be different from yours. Remember to include them and develop a post-retirement plan together. This should include fine-tuning your personal finances for the last few years before you retire to ensure you’re in good financial shape to proceed with your plans after you exit the business. Establishing clear personal goals will make this process simpler.

Financial considerations

There are a number of financial factors to consider as you plan your retirement. Tax and estate planning should be ongoing considerations throughout your working life to ensure that your plan continues to reflect your changing circumstances and is still on track to help you achieve your retirement goals. As a business owner, however, in addition to assessing your sources of retirement income, you will need to review your succession plan periodically to ensure that the projected proceeds from the sale or transfer of your business will last as long as your retirement does. It can be difficult to replace an income stream in later years. Remember to factor in the effect of inflation and consider strategies that can increase the value of the funds you will receive from the sale, well before your planned retirement date.

What are your sources of retirement income and when will they be available?

It’s important to understand your sources of retirement income and how much recurring income will be produced by these and by existing income sources. These could include the CPP/QPP, OAS, RRSPs, proceeds from the sale of the business, income from an ongoing interest in the business, income from a new business, an IPP or an RCA.

Consider how to manage these sources of retirement income to maximize their efficiency. Where will you obtain funds if you have a cash flow shortfall? A common strategy is to withdraw funds from non-registered investments before redeeming funds held in tax-sheltered plans. This ensures you continue to defer paying tax on registered investments and preserves the power of tax-free compounding as long as possible.

Your RBC advisor can help you decide how to draw on your various sources of retirement income in the most efficient manner to minimize tax, maximize flexibility and make the most of the available tax credits. They can also help you identify the issues that are relevant for your situation and keep your long-term financial plan on track.

Plan your retirement early

Will you need all the proceeds from the sale of the business to fund your retirement? Ensure your succession plan has taken this factor into account. How will you convert the funds received from the sale into an income stream so it’s available for you in retirement?

If you are transferring the business to family members, perhaps for little or no cost, your planning should incorporate this and the need to ensure that there will either be sufficient income from the business to meet everyone’s needs or that other sources of income will be available.


Succeeding in business succession

Planning for succession in advance is imperative to maximizing your business’s eventual sale price, protecting the legacy of what you’ve built, transitioning your business smoothly and funding your future plans.

Watch this video to learn about the key elements of a successful business succession plan.

Business owner's guide

Business owner's guide

Learn more

Tax-Free Savings Accounts

With a Tax-Free Savings Account (TFSA), your investments grow tax-free and you can make tax-free withdrawals at any time, for any reason.

Who can open a TFSA?

  • Any Canadian resident 18 years or older with a Social Insurance Number.
  • The age of majority is 19 for residents of Newfoundland and Labrador, New Brunswick, Nova Scotia and British Columbia which may delay the opening of a TFSA. However, the accumulation of contribution room will start at age 18.

What are the benefits?

  • Tax-free investment income, including interest, dividends and capital gains
  • Any unused contribution room can be used in future years
  • No upper age restriction on contributions, unlike an Registered Retirement Savings Plan (RRSP)
  • Make withdrawals any time for any purpose (e.g. car purchases, vacations, home renovations)
  • Previous year's withdrawals are added back to your unused contribution room
  • Income earned and withdrawals have no impact on federal income-tested benefits or credits (Guaranteed Income Supplement, Child Tax Benefit, Old Age Security, etc.)
  • Canadians can contribute to their spouse's or common-law partner's TFSA subject to available contribution room

What are the considerations?

  • Unlike an RRSP, contributions are not tax deductible
  • Capital losses within the TFSA cannot be used to offset taxable capital gains outside the TFSA
  • Interest on funds borrowed to fund the TFSA is not tax deductible
  • Penalty tax on excess contributions

What investments are qualified for the TFSA?

  • Cash, mutual funds, guaranteed investment certificates (GICs), publicly traded securities, and government and corporate bonds.

For more information, please contact us or visit the Canada Revenue Agency website.

Tax planning strategies for high-income earners

Depending on your province of residence, you may be subject to tax at a rate of 50% or higher when your income exceeds a set amount.

Discover several strategies that make for a tax-smart wealth plan.

Family Wealth Management guide

Family Wealth Management guide

Learn more

10 strategies to build and protect your family's wealth

When you are responsible for $1 million or more in assets, there are some unique financial planning issues and strategies that you should consider. In our Family Wealth Management guide, we highlight 10 strategies to help you protect your assets, reduce taxes, plan for retirement and maximize your legacy.

The Family Wealth Management guide covers topics such as:

  • Managing your higher tax burden
  • Reducing additional risks such as lawsuits
  • Avoiding the common pitfalls of owning vacation property
  • Minimizing taxes when passing on family assets
  • Teaching financial responsibility to younger family members

Strategy 1 – Comprehensive financial planning 

 
Gain confidence in your family’s financial future

If you have $1 million or more in investment assets, your financial situation is more complex than the average Canadian. You may pay higher taxes and have a higher standard of living. Maybe you are an executive with a complicated compensation package or a business owner with an interest in a private corporation. In addition, you possibly own or plan to own more than one real estate property and likely have a larger estate to be transferred and charitable giving desires. Furthermore, you are very busy with your day-to-day work and family life and may not have spent the time to determine if you are on track to achieve your retirement goals and other important financial goals such as minimizing taxes or planning for the eventual transfer of your estate.

Creating your financial plan

One of the best ways to start mapping out your financial planning strategy is to step back and look at your overall financial situation by having a comprehensive written financial plan prepared for you and your family. This type of financial plan addresses all aspects of your financial affairs, including cash and debt management, tax and investment planning, risk management, and retirement and estate planning. It ensures that you leave no stone unturned related to your financial situation and potential strategies to enhance your wealth.

A comprehensive financial plan can address the following questions:

  • Can I retire when I want to and maintain my desired retirement lifestyle?

  • How can I ensure that I don’t outlive my money?

  • How can I minimize the taxes I pay each year?

  • Is my investment mix appropriate?

  • If I were to die unexpectedly, would my family be taken care of?

  • How can I protect the value of my estate?

A higher level of customization

In many cases, the key to a comprehensive financial plan is the level of customization it offers. A customized, comprehensive financial plan should involve the following:

  • In-depth discovery discussion to ensure that your goals, aspirations and objectives are clearly identified

  • Projection of your financial situation (investment, retirement and estate) based on your current strategies and savings rate

  • Recommendations of key investment, tax, estate and retirement planning strategies that are aligned with your goals • Projection of your financial situation if the recommended strategies are implemented

  • An action plan that summarizes the key recommendations and acts as a clear guideline for you and your RBC advisor to help monitor their implementation

Speak to us if you require more information about having a comprehensive financial plan prepared for you. Depending on your situation, you may only require a simple retirement plan or projection to determine if you are on track to meet your retirement goals.

Family wealth management tip

A comprehensive financial plan is essential if you are a business owner as you have more complex financial issues due to owning an active business. This includes business succession issues, withdrawing money from the corporation tax-effectively, the taxation of the corporation at death and more. Like many business owners, you may not have a retirement savings strategy since you are relying on the equity in your business to fund your retirement. A financial plan will include both your business and personal needs to ensure you are able to meet your goals.


Strategy 2 – Consolidation of assets 

 
Simplify your financial life

Diversification is one of the golden rules of investing to reduce risk, and it may boost your return potential over time. Investor surveys indicate that wealthy investors open multiple accounts of the same type, with different financial institutions and different advisors, either because it simply happened this way over time or because they believe it to be an effective way to diversify. But diversification is really about how you invest your money – not where you keep it. Investing through multiple accounts and multiple advisors instead of consolidating your assets with one trusted advisor may impede proper diversification and potentially expose you to greater risk.

The benefits of consolidating your assets with one advisor may include:

Reduced costs

By consolidating your investable assets with one trusted advisor, you will typically pay lower fees, assuming the fees are based on a sliding scale as they are with many investment accounts and programs. By spreading your investments among multiple advisors and multiple financial institutions, you lose this advantage.

Simplified administration and consolidated reporting

With consolidation, you bring together all your investment accounts with one advisor, which makes it much easier to keep track of your investments and their overall performance. The paper statements you receive in the mail are minimized and the tax reporting related to your investment income and dispositions becomes easier to manage. Your tax preparation fees may also be reduced since your accountant will be spending less time sorting through all the statements and determining the average cost base of identical investments.

Easier estate settlement process

Having investment and bank accounts spread among many different financial institutions will make your estate settlement process administratively more difficult for your executor/liquidator and potentially more costly. By consolidating assets, you can have peace of mind knowing that, after you pass away, your surviving spouse or other beneficiaries will have one point of contact that you trust who will manage their overall assets to ensure they have adequate income.

Access to comprehensive wealth management services

Consolidation may help you reach a certain level of assets with an advisor so that you may be eligible for certain specialized services, such as advanced tax and estate planning, comprehensive financial planning, managed investment programs and private banking.

More efficient retirement income planning

Consolidation also enables you to manage your investments more effectively, helping you structure your investments to generate the retirement income you need. In retirement, you could have many different income sources, such as government pensions, employer pensions, locked-in retirement savings plans, registered retirement income funds, non-registered income and part-time employment income. If you have one trusted advisor managing your investments, it’s easier for that advisor to determine how and in what order you should be withdrawing from all the different income sources to maximize your after-tax retirement income.

For convenience alone, consolidation is a strategy worth considering. With consolidation, you work with one advisor who sees the big picture – who understands your overall financial situation and provides the customized advice you need. Family wealth management tip Sometimes, investors decide against consolidating their assets with one advisor, thinking that they can diversify by advisor. This is particularly true of investors with portfolios of $1 million or more. The idea is that if one advisor doesn’t do well, the other might.

Unfortunately, this is a myth. By dividing your investments among multiple advisors, you actually make it more difficult to properly manage your investments. Since each of the advisors doesn’t know what the others are doing, it often results in over-diversification, conflicting advice and needless duplication of your investments. Furthermore, it’s difficult to know how your investments are performing overall by having your assets spread among more than one advisor.

A better option is to consider consolidating your assets with one knowledgeable advisor who can provide you with a properly coordinated financial strategy.


Strategy 3 – Financial education for children

 
Raise financially responsible children

When it comes to your children, affluenza is a concern shared by many parents. Affluenza is the term, often used by parents, to describe a child’s distorted sense of value and less motivated attitude towards working hard and building their own financial resources as a result of being raised in a privileged environment. Most people who have built a relatively high level of wealth have done so through hard work, either as a business owner, executive or professional. Many of these people are concerned that their children won’t grow up to recognize the value of money or hard work, and they have therefore taken steps to restrict trust funds and inheritances.

As a parent you want nothing but the best for your children. Equipping them with the skills they need to be successful adults is a constant focus, and a solid financial education is a key part of every child’s successful future. The best way to protect your children from affluenza is to prevent it in the first place or to “cure” it as early as possible.

Here are some strategies you can adapt for your children, whether they’re still youngsters, are in their teens or are young adults:

Provide a reasonable allowance

An allowance to your children can provide much more than a pool of spending money. You can use an allowance to teach money management skills to your children. For example, your 12-year-old might get $24 per week ($2 per week for each year of age can be a starting point), divided as follows:

  • Save $8 each week for a full year. Introducing the concept of “paying yourself first” at a young age will help kids manage expectations and recognize the value of saving for the future. Along this line, consider having your children read well known and easy-to-read financial planning books.
  • Spend (or accumulate) $8 allowance each week. Figuring out how to stretch this amount over the week will develop valuable budgeting skills.
  • Share $8 with charitable causes. Children will develop a social conscience as they decide which organizations and causes to suppor

This system is flexible enough to work for kids of all ages and can be easily modified to suit your family’s specific objectives.

Set limits

Parents with above-average financial resources aren’t able to say “No” with that old parental standby: “We can’t afford it.” But they still need to teach the lesson that we don’t always get what we want. One solution is to sit down as a family and draw up a monthly or semi-annual budget that accommodates reasonable activities and purchases for everyone in the family. When the kids invariably ask for something that’s not part of the plan, you’ll have an ironclad answer: “No, that’s not in the budget. But maybe we can include it next time.”

Teach them about financial statements

When children start earning income, they should understand how to read and prepare their own financial statements. In general, they can prepare their own networth statement and cash-flow statements, which should help them with budgeting. You also can consider having them take part in preparing or reviewing the preparation of their own income tax return.

Educate them about money management

Instead of giving your children a large sum outright during your lifetime or after death, consider having your children sit down with an RBC advisor to discuss strategies to invest their gift or bequest based on their own financial goals. Then, give your children the opportunity to spend all or a percentage of the annual income or reinvest it. Your children can access the capital at certain ages or after certain milestones are achieved.

Family wealth management tip

Establishing a family charitable foundation is a great way to instil philanthropic values and money management skills at the same time. The children can take an active part in determining the best methods for using the funds in the foundation to support charitable causes. They can also work with an RBC advisor to determine strategies to invest the foundation’s capital to meet the annual disbursement quota. See “Strategy 7” for more information on charitable foundations.


Strategy 4 – Effective use of surplus assets

 
Protect your assets from taxes and creditors

By preparing a financial plan (“Strategy 1”), you can determine if you have adequate income and assets to meet your retirement income needs for your and your spouse’s estimated life expectancy. If you determine that you have surplus assets you are unlikely to need during your lifetime, even under very conservative assumptions, you may want to consider ways you can protect these assets from high taxes and other potential liabilities (discussed in “Strategy 5”) that could adversely impact your net worth.

Three options include:

  • Lifetime gifts and trust planning
  • Purchasing a tax-exempt life insurance policy
  • Charitable giving
Lifetime gifts and trust planning

Do you have surplus assets that you will definitely not need during retirement? Are you also planning on providing funds to your children or grandchildren in the future to help with things such as paying for education, purchasing their first home, starting a business or paying for their wedding? If so, then it probably does not make sense to continue exposing the income from these surplus assets to your high marginal tax rate. Instead, consider giving some of these surplus funds to family members now, either directly or through a trust if you do not want the children to have control of these assets. There will be no attribution of any investment income earned on the gifted funds if the child is 18 or older, and if the trust is structured properly, no attribution of capital gains if the child is under 18. If you are concerned about direct gifts to your children, then lending funds and providing your children with only the income earned on these funds is another effective strategy as you can call the loan principal back any time. See “Strategy 9” for more information about income splitting with family members.

Tax-exempt life insurance

Do you have surplus assets that you know will be passed on to your heirs when your estate is settled? You may be able to shield these assets from your high marginal tax rate through the use of insurance. If there’s an insurance need, consider speaking to your insurance advisor about putting these highly taxed (typically interest-bearing) assets into a taxexempt life insurance policy where the investment income can grow on a tax-free basis. This way, the amount of tax that would normally be paid to the Canada Revenue Agency (CRA) on the income earned on these surplus assets could instead be paid to your beneficiaries in the form of a tax-free death benefit. If need be, you could access the investment account in the life insurance policy either directly or through tax-free loans, which could be repaid after death with part of the death benefit. Speak with your RBC advisor if you would like a referral for insurance.

Charitable giving

If you want to give some of your surplus assets to charitable organizations, you have many options that can help you create a charitable legacy, while providing some tax relief. These include giving directly to qualified charitable organizations, creating a private foundation or donating through a public foundation.

There are rules in the Income Tax Act that make it more attractive to donate publicly listed securities such as shares that have appreciated in value. When you donate publicly listed securities directly to a qualified charity, you are generally exempt from capital gains tax. See “Strategy 7” for more information about tax-effective charitable giving strategies with surplus assets.

Note that due to potentially escalating healthcare and long-term care costs, it is essential that you are prepared for these contingencies before redirecting your surplus assets. Critical illness insurance, long-term care insurance and easy access to credit are a few options to consider with your advisors.

Family wealth management tip

If you have assets accumulating in a corporation, bear in mind there may be a higher tax rate on investment income earned in a corporation than on investment income earned personally depending on the province/territory. Furthermore, there is a potential for double taxation related to the assets inside a corporation at death. As a result, corporately owned tax-exempt insurance may be an attractive solution for surplus funds accumulating in a corporation if there is also a need for insurance. This way, the surplus assets in the corporation can grow tax-free during your lifetime and may also be paid to your beneficiaries as a tax-free death benefit.


Strategy 5 – Risk management

 
Ensure your family’s continued financial security

You have worked hard to accumulate your assets, so it’s important that you take precautions to protect them from the various risks that are a part of life. When it comes to protecting your wealth, there are three primary risks that you should plan for:

Risk Risk Common wealth protection strategy
Unforeseen liabilities Asset protection
Market downturn Diversification
Income loss Insurance
 
Unforeseen liabilities

Depending on your employment business and personal activities, there is always the chance that you will be faced with unforeseen liabilities. Unexpected liabilities can arise in different ways, including from lawsuits, negligence claims, obligations connected to acting as a director of a public company and giving warranties on the sale of your business. It is critical to note that asset preservation planning is not about defrauding legitimate creditors – it’s about restructuring the ownership or deployment of your assets using common and legal strategies at a time when you have no existing or foreseeable claims. In addition to any professional, business, car or house liability insurance you can purchase, the following are some typical strategies that may protect your assets:

  • Gifts. Although giving assets to a family member reduces the amount of assets you have that are available to cover your personal liabilities, it also increases the assets subject to the family member’s creditors. Furthermore, other than gifts to a spouse, making gifts to family members may potentially trigger a taxable capital gain, which is a tax implication that needs to be considered.
  • Trusts. Transferring assets to a trust results in a change of legal ownership of the assets transferred, thus reducing your personal assets subject to creditors. There may also be a loss of some or all of your control over these assets. It is important for you to be confident that the trustee is someone who will protect and manage your assets in the best interests of your beneficiaries. Consider a corporate trustee for this purpose due to their reputation and expertise in managing trust assets. In addition to domestic trusts, offshore trusts may provide protection from creditors, as those trusts are governed by the laws of another country, and it may be difficult for a creditor to pursue a court action in a foreign jurisdiction.
  • Life insurance. Based on provincial laws and court precedents, if an insurance policy is structured properly, the investment component of an insurance policy is not subject to creditors.
  • Corporation. If you are a business owner and you have accumulated surplus assets in your business that are not needed for operating expenses, then consider transferring these assets to a holding company. This can help protect the assets from the operating company’s creditors. In addition, consider the pros and cons of having your company contribute to an Individual Pension Plan (IPP) in order to boost your retirement assets. As a bonus, the assets in an IPP are creditor protected.
Risk of market downturns

As indicated in “Strategy 2” diversification is one of the golden rules of investing to reduce your risk of losing capital due to market downturns. Traditionally, diversification has meant allocating your assets among the three main asset classes (cash, fixed income and equities) as well as among different geographic areas and sectors of the economy. More and more people with $1 million-plus investment portfolios are considering alternative investments for further diversification to protect assets and boost returns. Speak to your RBC advisor about different alternative investment options.

Risk of income loss

If you become disabled or die, are you confident that your family will have the financial resources to maintain their lifestyle? Adequate disability and life insurance coverage should be a top priority when it comes to planning your finances. Without the proper coverage, you risk rapidly depleting assets you have worked so hard to accumulate and having a much lower standard of living. You should also have a discussion with your insurance representative on the costs and benefits of critical illness and longterm care insurance.


Strategy 6 – Vacation home planning

 
Maintain family harmony while reducing taxes

Many families own a vacation property or would like to purchase a second property as a family cottage in Canada or a winter home down south. If you would like to know how the purchase of a vacation home can impact other financial goals such as your retirement goals, speak to your RBC advisor about incorporating this purchase into your financial plan. The following are some key issues and planning ideas you need to be aware of related to owning a vacation home.

Vacation home purchase strategies

Before committing a large amount of money to purchasing a second property, consider renting in a few desirable areas for a period of time to test the location and neighbourhood. Once you are comfortable with the location and have selected an appropriate property to purchase or build on, the next major decision is how the property should be financed.

If you require a mortgage to assist in purchasing the property, speak to your RBC advisor. The mortgage interest will not be deductible if the property is used strictly for personal purposes. In order to make the loan interest deductible, consider the following strategy:

  1. Use existing cash or sell investable assets to purchase the property (note: disposing of investible assets may trigger capital gains or losses).
  2. Take out a line of credit to purchase income-producing investments. In this case, since the loan is used directly to purchase income producing investments and not the personal property, the interest on the loan is potentially deductible.
Succession planning

In straightforward situations, a person often acquires ownership in a vacation property either solely or jointly with their spouse for control and ease of administration. As people get older and no longer actively use the vacation home, they sometimes decide to transfer the property to their children. However, if the transfer of the property is not structured correctly, disharmony among family members can occur.

Here are some succession planning strategies to consider related to a family vacation home:

  • If your children will inherit the property and you expect it to significantly appreciate, consider gifting the property to your children today directly or through an intervivos family trust if you wish to maintain control. Although this results in a disposition at market value, triggering accrued capital gains that are taxed to you today, the future capital gain tax is deferred and probate taxes are avoided. If the property is sold to the children, the capital gain can be spread over five years in some cases.
  • Speak to your tax advisor about the tax advantages and disadvantages of transferring the property to either a Canadian corporation or to a nonprofit corporation.
  • If the property value is high and you are over age 65, consider the cost/benefit of rolling it into an alter-ego or joint partner trust today in order to avoid probate taxes related to the property at death (particularly in provinces with high probate taxes).
  • You may leave the vacation home to one or more family members under the terms of your Will. Some of your options include granting one or more children the option to purchase the property, allowing a child to take the property as part of their share in the estate or creating a trust to hold the vacation home under the terms of your Will.
  • Life insurance can be used to pay any capital gains taxes triggered by the disposition of property when your estate is settled. It also creates a pool of funds to pay children who are not interested in inheriting the property (alternatively, children who are interested in the property can take out a mortgage to buy out siblings who are not interested). In addition, life insurance can be used to provide the children with the money necessary to pay for the maintenance and expenses related to the property. Since your children will benefit from this insurance coverage, consider asking them to pay the premiums.
  • If more than one child will own the property, they can enter into a co-ownership agreement to determine when and how they can use it, as well as how expenses will be paid.
  • Regardless of the succession planning strategy chosen, two strategies to minimize capital gains tax on the disposition or deemed disposition of your vacation home, either during your lifetime or at death, are:
    • To ensure that any vacation home renovation costs are tracked as these costs may add to the cost of the property for tax purposes and will reduce any future capital gain; and
    • To use your principal residence exemption to reduce or eliminate the capital gains tax on the property. However, only one principal residence can be designated per family unit for years after 1981. So if the principal residence exemption is used for the vacation property to minimize the capital gains tax, then it cannot also be used to reduce tax on the disposition of the city home related to years after 1981.

Speak to us if you require more information on vacation home planning.

U.S. real estate planning

The U.S. has an estate tax on the fair market value of property located in the U.S., even if it is owned by a nonresident. Furthermore, U.S. states may also impose a probate tax at death based on the value of real estate located in that state. To avoid state probate tax, some cross-border experts may recommend owning the U.S. real estate through a revocable living trust.

U.S. estate tax ranges from 18% – 40% of the fair market value of the U.S. assets; however, there are generous U.S. tax exemptions (indicated in Figure 1) that are available to minimize or potentially eliminate the U.S. estate tax.

If your worldwide assets are in excess of the US$11.18 million (2018 threshold, indexed to inflation) exemption and you have considerable U.S. assets, you may want to consider the following strategies to minimize or eliminate the U.S. estate tax:

  • Purchasing U.S. real estate (and other assets such as U.S. stocks) through a Canadian corporation, trust or partnership. There are pros and cons to all three of these structures, but in particular you should be cautious about purchasing U.S. real estate through a Canadian corporation.
  • Having a “non-recourse” mortgage against your U.S. real estate. This special type of mortgage reduces the value of U.S. real estate subject to U.S. estate tax dollar for dollar.

Many Canadian residents purchase life insurance to cover the Canadian income tax liability that arises upon their death. Similarly, one of the simplest methods to pay for the U.S. estate tax is to maintain sufficient life insurance. Note that the ownership of a life insurance policy must be structured properly; otherwise the death benefit will form part of your worldwide estate, and this may increase your U.S. estate tax liability.

For more information, ask us for a copy of our article discussing U.S. estate tax for Canadians.

Figure 1 Canadians should keep these two thresholds in mind:

US$60,000

If your U.S. assets (typically U.S. real estate and U.S. stock) are US$60,000 or less on death, then no U.S. estate tax is payable, regardless of the value of your worldwide assets.

US$11.18 million
(2018 threshold, indexed to inflation)
If your worldwide estate is less than this threshold upon death, then no U.S. estate tax is payable, regardless of the value of your U.S. assets. If your worldwide estate is greater than this threshold upon death, then there could be U.S. estate tax on the value of the U.S. assets.

Strategy 7 – Charitable giving

 
Make the most of your family’s charitable legacy

When it comes to charitable giving, you have a number of different options that can help you achieve your philanthropic goals, while at the same time providing you with some tax relief.

Donating securities

The federal government has implemented several tax incentives to encourage charitable giving by Canadians, including the elimination of capital gains tax when you donate publicly listed securities to qualified charities. Not only do you receive a tax break, you also receive a donation receipt equal to the fair market value of the donated security.

Furthermore, if a corporation makes an in-kind donation of a listed security to a qualified charity, in addition to the capital gains exemption and the fair market value donation receipt, the corporation gets an addition to their capital dividend account equal to the full capital gain. The balance of the capital dividend account can be paid out to the shareholders as a tax-free dividend.

We can help you determine which securities are best suited for donation.

Charitable foundation

Another tax-effective charitable giving strategy is setting up your own charitable foundation. A private foundation gives you a high level of control and flexibility with respect to charitable giving, and enables you to create an enduring charitable legacy. You can make donations to your own foundation, and you will receive a donation tax receipt as you would for any other donation. In addition, in-kind donations of publicly listed securities to a private foundation are eligible for a full capital gains tax exemption. Furthermore, you will receive a donation tax receipt equal to the fair market value of the security at the time of the gift.

While providing a great deal of control and flexibility, a private foundation also involves certain costs and administrative requirements that must be considered. Potential associated costs may include legal, accounting, foundation registration, office space, staff, investment management fees, donor’s time, and trustee or custody fees.

An alternative to a private foundation is making tax-deductible donations to a public foundation. Public foundations are very similar to private foundations in many respects, but may involve fewer costs and less administration. Although you do not have outright control now, you can still recommend to the public foundation’s directors which charities should receive grants.

Depending on your age and needs, there are other creative charitable giving strategies, especially those using life insurance, to reduce taxes and significantly increase your charitable contribution after death to your favourite charity. Speak to us if you want more information on charitable giving and legacy planning strategies.


Strategy 8 – Testamentary trusts

 
Manage the transfer of your estate

For families concerned about intergenerational wealth transfer, an updated Will with a testamentary trust provision is an indispensable tool. A testamentary trust is a type of trust established through your Will that enables you to give assets to your beneficiaries with certain conditions that you have specified.

A testamentary trust can provide significant estate planning opportunities. You specify an amount of money or other property to be held for a specified period for beneficiaries you have identified and on the terms directed by you. This allows you to create solutions to complex family situations. For example, you may wish to leave your children a portion of your estate, but you may feel that they should not receive their inheritance until they are old enough to manage it responsibly. Through your Will, you would direct your chosen trustees to hold and invest the inheritance in a trust for your children until they reached the age that you specified. Alternatively, you could give your trustee full discretion as to the amount and timing of trust distributions to the beneficiaries.

Previously, testamentary trusts had access to graduated rates. However, in 2016, these graduated rates for testamentary trusts were replaced with flat top-rate taxation, subject to two exceptions. An estate that designates itself as a “graduated rate estate” will generally be subject to graduated rate taxation for the first 36 months of its existence. As well, graduated rates will continue to apply in respect of testamentary trusts for the benefit of disabled individuals who are eligible for the federal Disability Tax Credit where the trust and the qualifying beneficiary have jointly elected for the trust to be a “qualified disability trust” for a particular taxation year.

Family wealth management tip

A testamentary trust provision in a Will may make sense for the following people:

  • Individuals in second marriages
  • Disabled or minor beneficiaries
  • Parents concerned about spendthrift beneficiaries
  • Parents concerned about an inheritance being accessed by a son-in-law or daughter-in-law
  • U.S. citizens living in Canada
  • Parents who wish to provide for successive generations or preserve the continuity of ownership of family property

You may choose to utilize the services of a professional trust company such as RBC Estate & Trust Services* to act as your trustee for your testamentary trust. One of the key benefits of using a trust company is the security of knowing you are engaging experienced professionals to protect the interests and requirements of your testamentary trust. If you would like the input of a family member or friend on personal matters related to your trust, you can name RBC Estate & Trust Services as your trustee and appoint a family member or a friend as co-trustee. This will relieve the co-trustee of worries about managing the trust assets alone, and they will have access to the sound financial insights of the trustee. Speak to your RBC advisor regarding the trustee services available at RBC Estate & Trust Services.

* Naming or appointing Estate & Trust Services refers to appointing either Royal Trust Corporation of Canada or, in Quebec, The Royal Trust Company.

While these measures may increase the amount of tax the trust will pay on investment income, the negative tax effects may be reduced by taking certain steps. For example, where the terms of the trust allow income to be distributed to the beneficiaries, the trustee can elect to pay out the trust income to the beneficiaries. In this case, the income will be taxed at their marginal tax rates. This may result in some tax savings if their marginal tax rate is lower than the trust’s tax rate.

Testamentary trusts are generally created with assets passing through an estate. Therefore, probate taxes (negligible in Alberta and Quebec) will likely have to be paid. However, there will be no probate tax for a properly structured testamentary trust funded with insurance proceeds.

If you intend to have your assets pass through your estate so they can fund a testamentary trust, then Joint Tenancy with Rights of Survivorship accounts (not applicable in Quebec) may not be appropriate, and you may also need to restructure the beneficiary designations.

Speak to your RBC advisor if you are interested in having a Will and estate review from an RBC Wealth Management Will and Estate Consultant. Based on your situation, this specialist can provide Will and estate planning recommendations such as the suitability of a testamentary trust, vacation property succession planning strategies, the benefits of a secondary Will to avoid probate tax on private company shares and more.

For more information, ask us for a copy of our article on testamentary trusts.


Strategy 9 – Family income splitting

 
Reduce your family’s tax burden

There are two reasons why income splitting is so important in Canada to reduce the family’s tax burden:

  • Canada’s tax system is based on graduated tax rates
  • Everyone in Canada has a tax-free basic exemption amount

A graduated tax rate system basically means that there is a higher marginal tax rate on taxable income as income increases. Furthermore, each Canadian resident can earn about $10,000 (varies by province/territory) of taxable income every year tax-free due to the basic exemption amount. As a result of these two factors, if income can be shifted from a high income parent to a low-income spouse or child, then the family can realize tax savings annually by shifting income.

In order to prevent abusive income splitting arrangements, the Income Tax Act has income attribution rules. These rules attribute taxable income back to the high-income family member who actually supplied the capital for investment; thus the income splitting will achieve no tax savings.

Business owners can split income by paying reasonable salaries to lower-income family members based on the services they perform. However, if a low-income spouse or child is not actually working in the family business or their services are minimal, then paying them a salary or bonus that is in excess of the services rendered simply for income-splitting purposes is not permitted.

If your business is incorporated, you may be able to pay dividends to family members who are shareholders of the corporation, but you have to be aware of the tax on split income (“TOSI”) rules, which limit splitting certain types of income with family members. Speak to a qualified tax advisor to determine if this strategy is right for you.

A common strategy to split investment income with a low-income spouse, whether you own a corporation or not, is the spousal loan strategy. With this strategy, the high-income spouse loans capital to the low-income spouse for investment at the CRA prescribed interest rate in effect at the time the loan is made. In this case, all future investment income is taxed to the low-income spouse. However, the high-income spouse must declare the interest received on the loan as income on their tax return.

Although capital gains income earned on funds gifted to a minor child may not trigger the income attribution rules, interest and dividend income earned on funds gifted to a minor child will be taxable to the parent. It may also be difficult to set up an investment account for a minor.

If you are concerned about gifting monies to your child, consider loaning the funds to a family trust using a prescribed rate loan. This will accomplish the same capital gain income-splitting benefit as an outright gift if the trust and loan are set up properly, and you can call back the loan principal any time.

Further, with a prescribed rate loan all future investment income, including interest and dividends and capital gains, may be taxable to your child. The parent must declare the interest on the prescribed rate loan.

Contact us if you require more information on family income-splitting strategies or would like to set up a family trust.


Strategy 10 – Business succession planning

 
Plan a successful transition of your business

Many Canadians have built their wealth by operating a small business or will realize substantial wealth when their private business is sold.

Having a business succession plan can help a business owner plan for their family’s future. In addition, other benefits of a succession plan include:

  • Minimizing tax
  • Improving the financial stability ofthe business
  • Maintaining family harmony

Here are some key issues that you should consider for a successful business succession plan, along with the tax and estate planning strategies:

Choose your successor wisely

Communicate openly with your children and determine which child is most interested and most capable of leading your business. In some cases, you may have to choose a non-family member, such as a key employee, to take over your business, or you may need to sell the business outright.

Let your chosen successor lead the plan

In Dr. Dean Fowler’s book Successful Habits of Family Business Succession, he proves that the traditional succession plan where the senior takes the lead, focusing on estate planning, tends to fail. However, plans where the chosen successor takes the lead, focusing on management succession and strategies to buy out the senior, are much more successful.

Groom and transition out

Have your chosen successor gradually take on more responsibility, and meet key business contacts well before you transition out. Then be willing to let go of the lead. Have faith in your chosen successor to take over the business.

Hire an external advisor for assistance

There are professional family business succession facilitators with years of experience to assist your family with the succession plan. Having a neutral third party facilitating the discussion in many cases can help open the lines of communication between the parents and children and lead to a more successful transition.

Fair does not mean equal

In order to maintain family harmony, it may make sense to give children who aren’t involved in the business non-business assets, such as securities or life insurance proceeds, as part of their inheritance, instead of giving them active business shares.

Succession planning should start five to ten years before your anticipated retirement age. For more information on planning for business owners, ask your RBC advisor for a copy of the guidebook “Business Owners Guide to Wealth Management.”

Common financial planning strategies within a business succession plan
  • Financial plan. A financial plan for the owner is a critical component of a business succession plan and will determine if the owner has adequate resources to support their retirement lifestyle and highlight which, if any, additional retirement saving strategies (e.g. an IPP, Retirement Compensation Arrangement (RCA), etc.) are required.
  • Estate freeze. An estate freeze using a family trust is a common business succession and income-splitting strategy that transfers some or all of the future growth of the business to the next generation, helping to minimize and defer tax. Ensure that the estate freeze is flexible enough so that you can possibly reverse the freeze if necessary.
  • Shareholder agreement. A well drafted shareholder agreement provides a framework for the smooth operation of a business and addresses business ownership issues when certain triggering events occur (death, disability, retirement, marriage breakdown and so on).
  • Insurance. Appropriate disability, key person and life insurance are imperative to ensure that the business can continue and your family members are able to maintain their lifestyle should death or disability occur prematurely. Insurance is also a low-cost solution for funding taxes at death and funding buy/sell agreements. It can also be used to transfer surplus corporate assets to your beneficiaries on a tax-effective basis.
Family wealth management tip

Many business owners tend to procrastinate when implementing a business succession plan since running and growing their business is their top priority. According to the CFIB, one of the main reasons for failed successions is the lack of adequate time to plan and execute the succession of the business. Therefore, it is never too early to start planning.