Retirement as a goal has changed a lot over the years. There was a time, it was the only goal. You’d punch the clock and count the years until you could stop punching that timecard. For most folks, it meant the beginning of a corporate pension and the start of government benefits. It was straightforward and pretty simple.
Today, things have changed. Fewer people have the luxury of a corporate pension plan and more and more Canadians have built their own businesses. From online to bricks and mortar or professional corporations many of us have created our own careers and built companies. Creating over our working years is one thing, figuring out the worth of what we have built is another. The biggest question we get from our corporate clients is, “What is the best way to realize the value of our business for retirement?”
The answer, as always, is “it depends.” The bigger question to start with is do you want to take the money and run by selling the business outright or do you want to transition your way out over a period of time? For those entrepreneurs with an obvious candidate—a key employee, a partner or a relative who is willing to take over, this might be an easier question to answer. However, for those without a clear succession plan, the solutions are more complex. First you need to find a buyer who sees the same value in your company as you do and then you need a buyer with the financial wherewithal to make it happen. Of course there are financing arrangements that can facilitate the deal, but they will have fit with your expectations.
Most of the main challenges to selling a business are valuation, financing and timing. In order for a deal to come together, all three of these need to line up. When salary or commission people decide to retire, the only real question they ask themselves is whether or not they “have enough money,” the rest is simply making choice to relinquish their days of 9-5. Business owners, on the other hand, have built an asset that they have emotional ties to, and much of its merit is often tied to intangibles like good will—ultimately that can, and does, put timing decisions in the hands of the buyer.
So what steps should a small business owner take to successfully transition their life’s work into a comfortable retirement? There are five main planning steps that will help pave the way to a smooth transition:
- Identify and Review Priorities
- Identify a Buyer or Successor
- Develop a Succession Plan
- Integrate with Personal Financial Planning
- Monitor Plan Implementation
The most important thing to remember though is start early! We can’t stress this enough; the longer you wait to start making arrangements, the less leverage you’ll have when it comes time to make the sale. The closer you get to retirement, the less control you’ll have in your hands, and the more will lie in the markets.
As our world grows smaller, the number of options we have available to us grows. The global market has connected us to events that in past years would often be buried in the back pages of the newspaper, but today are front and center.
Nowhere has this become more evident than in the stock and bond markets.
Interest rate changes in India, housing demand in China, weather and natural disasters, technology – all contribute to the daily gyrations of the prices of stocks and bonds. When I was first studying to be a financial advisor, the only place I could get historical bond prices to do yield calculations was in the public library in the periodical archives. Today, it’s not only available to anyone with a wireless connection, but you can get real time updates, historical pricing and forecasts all with a couple of clicks on your browser.
So what does all this mean? In the investment world it means that time, in many cases, has been removed as both an advantage and a buffer. Technology has delivered most information into the hands of anyone willing to look for it. In the past, having access to certain information could bestow the holder with a tremendous advantage when buying and selling securities; today that same information is readily available to almost anyone. Don’t get me wrong, there are still great advantages to be had in holding information, it’s just that the valuable content is purposefully buried even deeper and thus harder to get at.
As a buffer, we are all victims of the noise now. We are bombarded with information that for many of us has little impact to the medium and long term fortune of our lives. In fact, if we are holders of strategic investments rather than traders—who purposefully buy and sell currency or stocks—much of the data we are exposed to is of little use. We may think it’s important to know what the Fed or Bank of Canada has to say at their meetings, yet few of us are able to determine how this information is of any value to us in the short, medium and long term for our retirement prospects.
Our advice is always the same. Return to your original objectives and remember what your plans were when you made them. When you hear that the US Federal Reserve might raise the Fed funds rate or that OPEC isn’t going to decrease oil production levels, ask yourself: does it matter to how you manage your life or your investment portfolio? Do you need to react to this information somehow and if so, what should you do? Sure, if it constitutes a trend and you can identify interest rates may start climbing dramatically or that oil prices will fall for an extended period of time maybe you should look at your maturities or asset allocation for some fine tuning. If it’s just day to day noise though, you may want to filter it out and lower the level of static in your life. Everything we hear or read isn’t necessarily important; just because we can see it doesn’t mean we need to do something about it.
If you are a small business owner, you may want to consider the transfer of your business at retirement. Many factors such as tax will come into play when a business is transferred and it is very important that you have a plan in place to ensure that the business is transferred to whom you want in an efficient manner
Corporations and Transfer of Ownership
As a shareholder of a Corporation you need to consider your retirement implications. You will want to ensure that should you want to sell your interest, there will be a mechanism in place to ensure that you receive the fair market value. This is of particular interest to shareholders of small private companies where there is no ready market for the shares as there is in the public Corporation sphere. Sole owners of Corporations have various mechanisms available to them to pass on an ownership interest to family members in a tax-efficient manner where no actual outlay of cash is required. A common strategy is the use of the Section 85 Rollover.
For those shareholders wishing to sell their shares on retirement rather than pass them on to family members, it is a common strategy to institute a Buy/Sell agreement with the remaining shareholders. Creating a formal Buy/Sell agreement achieves several goals. First, it ensures that there is a ready market for the shares. Finding an outside buyer for private Corporation shares can be difficult. Secondly, it ensures an orderly transition for the remaining shareholders. Where the remaining shareholders have the first right of refusal or obligation to purchase the shares, they can maintain control of the Corporation on their own terms and not have to deal with the potential problems and complications of having a new ‘outside’ shareholder becoming part of the ownership structure. There are various ways to structure and provide funding for a Buy/Sell agreement upon retirement.
Deferred Compensations Arrangements
You will probably want to set aside funds for your retirement years in addition to selling your Corporation and there are various measures in place to create retirement savings. Many of these can be done through your Corporation. Each one of these plans has particular features and advantages. The alternatives are:
- Individual/Group Registered Retirement Savings Plans (RRSPs)
- Deferred Profit Sharing Plans (DPSPs)
- Individual Pension Plans (IPPs)
- Registered Pension Plans (RPPs)
- Retirement Compensation Arrangements (RCAs)
Voluntary Retirement Savings Plan (VRSP)
Both the Federal and Provincial governments have become concerned about the amount of retirement savings of Canadians, particularly those who do not have access to traditional pension plans offered by employers. The Federal government recently introduced the Pooled Registered Pension Plan (PRPP) to provide small employers with a flexible savings alternative for employees. The Province of Quebec, as part of their 2012 budget, introduced a similar vehicle for small business owners in their province titled the Voluntary Retirement Savings Plan (VRSP). This will be a mandatory program for employers with five or more permanent employees.
While initial participation for eligible employees is required, those employees may “opt out’ if it doesn’t suit their retirement plans. Employers have the option of making tax deductible contributions on behalf of their employees and any employee contributions will be a tax deduction. As registered plans, VRSPs will be subject to the usual federal restrictions on contributions (a maximum of 18% of earned income up to the statutory limits).
This publication is intended as a general source of information and should not be considered as estate, tax planning, personal investment or tax advice, nor should it be construed as being specific to an individual’s investment objectives, financial situation or particular needs. We recommend that individuals consult with their professional financial or tax advisor before taking any action based upon the information found in this publication. The information and opinions contained herein have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. While we endeavour to update this information from time to time as needed, information can change without notice and Dynamic Funds® does not accept any responsibility for any loss or damage that results from any information contained herein.
© 2013 1832 Asset Management L.P. – All rights reserved. Reproduction in whole or in part of this content without the written consent of
The federal government has increased the annual contribution limit of Tax-Free Savings Accounts (TFSA) to $10,000. Going forward, the annual limit will no longer be indexed to inflation. Canada Revenue Agency (CRA) recognizes these changes as effective January 1, 2015 meaning financial institutions may immediately allow clients to take advantage of the new increased limit.
Canadians can grow their savings much faster because realized income or appreciation from a TFSA are completely tax free. Withdrawals from a TFSA will not affect your eligibility for federal income-tested benefits such as Old Age Security (OAS). Furthermore, amounts withdrawn will be added back to your available contribution room starting the year following the withdrawal. For example, a $6,000 withdrawal in 2015 can be replaced in 2016 without reducing that year’s $10,000 contribution room. Therefore, you can deposit $16,000 in 2016 without over-contributing (assuming no unused room).
Saving for Retirement – RRSP or TFSA?
It is usually beneficial to contribute to both plan types. Deciding one over the other will depend on your savings needs and your current and future financial situation. Generally, if you expect to be in a lower tax bracket during retirement, then RRSP contributions provide a benefit in deferring tax until those later years. Should the reverse be true, TFSA contributions may be more attractive.
RRSPs must be converted to Registered Retirement Income Funds (RRIFs), an annuity or withdrawn by the end of the year you turn age 71. TFSAs have no such end date and can continue to accept contributions and shelter income indefinitely. The minimum annual withdrawal requirements from RRIFs, LIFs and annuities are considered taxable income. TFSAs can benefit pensioners looking to minimize their taxable income, especially if they are receiving income from part-time or consulting work.
TFSA contribution limits are the same for everyone regardless of how much you earn or contribute to your pension. If you are already contributing to your RRSP, it might be a good option to save the refund generated into your TFSA. Ultimately, there may be no need to choose one over the other. A TFSA complements your RRSP strategy, as well as other sources of retirement income. Using TFSAs and RRSPs can bring you closer to your goals as part of your overall financial plan.
TFSAs are Not Just for Retirement
Short and Medium Term Goals
TFSAs can help to fund a major purchase, such as buying a home, vacation, or emergency fund. Early or unplanned RRSP withdrawals can result in significant taxes owing. RRSP withdrawals are taxed at your current highest tax rate, also known as your marginal tax rate. In most cases, for short-term needs you should access funds in your TFSA before using your RRSP.
TFSAs allow an effective way to split income among family members such as your spouse and adult children. You may provide a gift to help them make a contribution to their TFSA. They are responsible for their own account and contribution room. Income tax attribution does not apply on earnings as they are tax-free.
A Registered Education Savings Plan (RESP) is a great tool to save for a child’s education. It offers tax deferred growth and matching Canada Education Savings Grant (CESG) of up to $7,200 lifetime while contributions are made before age 18. TFSA savings can supplement your family’s education plan without worrying about additional tax burden on you or your child. When using RESPs it is important to be aware of the restrictions and possible penalties if your child does not pursue post-secondary education. However, TFSA savings are accessible at any time and for any reason.
You may want to consider transferring investments held in a non-registered (taxable) account to your TFSA, known as an ‘in-kind’ contribution. Please note this transfer could trigger a taxable capital gain, or if you incurred a loss you will not be allowed to claim the capital loss on your taxes. Consult your tax advisor for more information.
TFSAs can help minimize taxes upon your death and maximize your estate. If you name your spouse as successor holder on your account, he or she will inherit and maintain its tax-free status without affecting his or her own contribution room.
Naming children as beneficiaries allows them to inherit the account directly, avoiding probate fees. Note the tax free status is lost on death when the account passes to a beneficiary. Your children could use inherited TFSA funds to contribute to their own TFSA as a tax-free method of inter-generational wealth transfer.
TFSAs are significant savings vehicles for Canadians 18 years or older. Take the time now to consider using it as part of your overall savings and investment strategy.
This publication and all the information, opinions and conclusions contained in it are protected by copyright. This report may not be reproduced in whole or in part, or referred to in any manner whatsoever, nor may the information, opinions, and conclusions contained in it be referred to without in each case the prior express consent. Scotiabank refers to The Bank of Nova Scotia and its domestic subsidiaries.
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