Small Business Owners: Strategic Approaches to Managing Retained Earnings After Maxing Your TFSA
Navigating the landscape of tax-efficient wealth management can be challenging for small business owners, especially once the Tax-Free Savings Account (TFSA) has reached its contribution limit. Over the past two weeks, I engaged with several financial advisors and my accountant to explore effective strategies for utilizing retained earnings within my corporation. Based on these discussions, I’ve outlined a simplified and practical flow for optimizing your retained earnings.
Please Note: This is a peer-to-peer overview based on personal experience. I am not a licensed financial advisor or planner. For personalized advice, always consult with qualified professionals.
Assumptions:
– Active business income below $500,000
– No ownership of real estate
– You are the CEO and owner of your company
– Your TFSA is fully maxed out
– Most personal lifestyle expenses are handled through your corporation, reducing the need for high salary draws
Key Principles:
- Maximize Reasonable Business Deductible Expenses
- First, ensure you are recording all legitimate business expenses to lower taxable income—consult your CPA for appropriate deductions.
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Next, evaluate opportunities to reinvest within your business to foster growth before allocating retained earnings elsewhere.
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Prioritized Use of Retained Earnings
a. Contribute to Tax-Advantaged Accounts
– Fully utilize your TFSA and FHSA accounts until their contribution limits are reached.
b. Strategic RRSP Contributions
– Consider drawing a salary approximating:
– $84,000 to hit CPP’s maximum earnings threshold
– Around $102,000 to optimize withdrawal amounts while minimizing taxes
– Up to $180,000 if aiming to contribute the maximum RRSP limit of approximately $32,000
– This ensures a balanced approach to savings and tax deferral.
c. Corporate Investment Opportunities
– Invest retained earnings in a self-directed corporate investment account (e.g., via Questrade or similar platforms):
– You can contribute significant amounts (potentially over $1 million) before facing issues related to passive income thresholds or capital gains taxes.
– Gains realized are subject to capital gains tax, similar to personal investments.
– Innovative approach:
– Obtain a personal loan secured by your corporate investments.
– For example, approach your bank for a loan (e.g., $100,000) using your corporate-held investments as collateral, paying around 5% interest.
– This enables access to funds without triggering dividend, salary, or shareholder loan taxes, effectively withdrawing cash at a lower cost.
d. Corporate Insurance Strategies
– Explore premium-based insurance products that offer tax advantages:
– Critical Illness Insurance with shared ownership:
– Typically, 70% of premiums are paid by the corporation, 30% by the individual.
– The return of premiums after 15 years is tax-free, effectively providing free coverage and a lump sum deposit if no claim is made.
– For instance, contributing $10,000 annually for 15 years results in a $150,000 payout.
– Whole Life Policies:
– The cash value grows tax-deferred, and death benefits are tax-free.
– Policy loans against the cash value can serve estate planning needs.
– Always exercise caution and consult insurance specialists, as some products may prioritize agent commissions or have less favorable terms.
- Overall Philosophy and Final Thoughts
- Recognize that the Canadian tax system integrates all income sources; there are limited “loopholes.”
- The primary benefit of operating through a corporation is the ability to deduct personal lifestyle expenses in a structured manner, thereby reducing overall tax liability and deferring taxes to future, lower-income years.
- While tax optimization strategies are valuable, the most effective approach focuses on increasing revenue and business growth, which naturally leads to greater wealth over time.
Final Remarks:
Effective wealth management for small business owners involves balancing tax strategies with business growth initiatives. Explore various options, stay informed, and always seek professional guidance tailored to your specific circumstances. If you have additional strategies or insights, sharing them can enrich the collective knowledge of the community.
