Retirement Dreams Tomorrow Require Smart Strategies Today
Canadian Business Franchise
Published Jan 2005
While running your franchise may require most of your attention these days, have you stopped for a few moments to think about retirement?
If you believe that you have plenty of time to contemplate your retirement plans some other day, consider this: the median age of today’s owner-manager is 48 years – and most intend to retire at the age of 60*…. that doesn’t leave many years to plan for a comfortable retirement. In fact, a March 2004 poll** found that 73% of Canadians are worried about having enough money to survive when they retire.
Franchise owners have reason to be concerned. Unlike employed executives, who generally have a pension plan that will provide most of their retirement income, retirement planning is more challenging for franchisees …to the point that many avoid even thinking about retirement and how to fund their financial future.
But the future is approaching quickly. The sooner you begin to plan, the better your chances of achieving your dreams.
First step: think about your goals. Begin by asking yourself, “what is my dream?” “At what age do I want to retire?” “What is the minimum income I would need and what is the optimal retirement income I could use?”
Then, consult with your accountant who can help you calculate how much capital you will need to make your dream a reality. Together, you can then determine which of the following strategies should be part of your retirement plan.
Invest in your franchise
From a retirement perspective, a successful franchise is a successful investment. The rate of return on your investment in your business will potentially be higher than the return you can expect on most other types of investments.
This provides a strong incentive for franchise owners to invest in your own businesses. Doing so also produces a couple of tax advantages. First, when you reinvest earnings in business assets, this may increase the size of a potential gain that may be eligible for the capital gains exemption. Secondly, when you reinvest in business assets, you can potentially earn more business income that may be eligible for small business tax rates.
Save outside your franchise
While building your business builds your assets, saving outside your business can diversify your risk. By regularly withdrawing a certain amount of your profits, you can insulate them from potential business losses in the future.
There are, however, a couple of conditions to this strategy. First, since many franchises are income-rich but cash-poor, you have to ensure that funds withdrawn from the business do not cause cash-flow problems
Secondly, because funds withdrawn from a corporation are taxable to you as either a salary or a dividend, you may require a holding company. When you hold the shares of your incorporated business through a holding company, your franchise can distribute after-tax earnings to this entity as a tax-free inter-corporate dividend.
Invest in RRSPs
RRSPs remain one of the best ways to save for retirement. RRSP contributions reduce your taxable income and also provide tax-sheltered growth. Therefore, when possible, have your corporation pay you a salary sufficient to maximize your RRSP contributions. You will need a salary of $91,667 in 2004 to make a maximum contribution of $16,500 in 2005. Your corporation can also pay your salary directly into your RRSP, thereby reducing the income tax withholdings requirements.
Spousal RRSPs are also a good option for franchise owners – particularly in a couple of situations. First, in the case where you have provided personal guarantees for business loans. Your spouse’s RRSP is protected from future business risks, provided that he or she is not a guarantor.
Second, spousal RRSPs are valuable if your spouse is younger than you and you work past age 65. While you have to collapse your RRSP by the end of the year you turn 69, if you continue to earn income from your corporation, you may contribute to a spousal RRSP until your spouse reaches the age of 69, to the extent that you have sufficient RRSP contribution room.
Set up an Individual Pension Plan
Instead of contributing to an RRSP, you may be able to set up an individual pension plan (IPP) for yourself and other family members. This is a defined benefit pension plan that your corporation may establish on your behalf. Since contributions may exceed the maximum RRSP limits by significant amounts, the IPP provides enhanced tax-deductible contributions for your retirement. Your corporation makes the IPP contributions; these are taxed only when you withdraw them. Both the contributions and the fees paid by the corporation to maintain the IPP are deductible.
IPP contributions are generally substantially larger than the amounts that can be contributed to an RRSP when individuals earn $100,000 or more and are in their mid 40s to 60s. For example, if you are 50 years old, have incorporated your franchise, and have an annual salary of over $100,000, you can contribute $20,807 to an IPP in 2004 – versus $15,500 to an RRSP.
Use the savings component of life insurance
If you have a business need for life insurance, such as to secure a corporate bank loan or to fund buy/sell provisions of a shareholders’ agreement, you can use the savings component as a source of income in your retirement.
Permanent insurance, such as whole life or universal life, typically has both a death benefit component and a savings component. When you are the policyholder, you may pre-fund insurance premiums and income can accumulate within the policy on a tax-deferred basis. If your corporation holds the insurance, you can use a “split-dollar policy,” whereby you own the savings component, and your corporation retains the death benefit. In retirement, you may utilize these savings as income.
Sell the business and trigger the capital gains exemption
Should you decide to sell your franchise when you retire, or close to that time, you may claim a lifetime exemption of up to $500,000 against capital gains from qualifying shares of your small business corporation.
Take a retiring allowance
When you retire from an incorporated franchise or you sell it in order to retire, your corporation can pay you a retiring allowance. Provided that you worked actively in the business before 1996, a retiring allowance can be transferred to your RRSP, up to the following limits:
- $2,000 for each year of service before 1996, plus
- $1,500 for each year of service before 1989, provided that you were not a member of a company-sponsored pension plan.
Redeem frozen shares when you retire
If your franchise is a family business and you execute an estate freeze, typically, you will hold fixed-value preference shares after the freeze. When you retire, you can redeem these shares over time as dividend income from the corporation.
Talk to your accountant about putting some of these smart strategies in place today – and start planning your dream retirement…
* The BDO Dunwoody COMPAS Report on Family Business, 2003
**Survey conducted by Vector Research on behalf of the Canadian Labour Congress
Judy Haynes, CA, is a tax manager of BDO Dunwoody LLP (www.bdo.ca). BDO is one of Canada’s leading accounting and advisory firms, which helps entrepreneurs, family businesses, franchisors and franchisees succeed. If you have questions about this article or you would like to receive BDO’s “Tax Factor” newsletter, contact Judy in the Oakville office, at 905-844-3206 or jhaynes@bdo.ca.
