There are many steps involved when selling a business. What is sometimes overlooked is creating a plan for the proceeds received from the sale. Preserving capital, building a wealth roadmap, and creating a family legacy are some of the first steps to preserve and growth wealth.
In this article, we summarize tax, philanthropic, and estate planning strategies to help you develop a comprehensive wealth plan that caters to your lifestyle now and in the future.
When you've sold and have a large sum to invest, the asset mix and types of different assets are a big part of tax planning and optimization, says Jonathan Townsend, a partner in BDO's Wealth Advisory Services practice. In terms of asset classes, there are income-producing investments, public equities, infrastructure, real estate, alternative investments, and private equity.
Risk and diversification are important factors to consider when building an investment portfolio. Most entrepreneurs are taking on a large amount of risk because they have all their eggs in one basket and may depend on one major customer. “When putting your money in a well-diversified portfolio, you've lowered your risk,” he explains.
Your portfolio will generate capital gains, income (whether it be dividends or interest), and return of capital. As a result, you should consider what types of investments should be held in which vehicles, whether it's a family trust, investment holding company, registered accounts, or non-registered accounts.
Another strategy is to purchase permanent life insurance, which provides three major advantages.
First, it offers liquidity when you pass away. A complex estate may take 12 to 18 months or more to settle and having life insurance means other family assets won't need to be sold off.
Second, the proceeds can be used to pay capital gains taxes or extract from an investment holding company tax efficiently, which helps protect the estate from tax erosion.
And third, it can be part of the fixed-income side of the portfolio. “The after-tax returns are pretty hard to beat,” says Jeff Noble, a director in BDO's Wealth Management practice. He notes that life insurance is a good alternative to bonds in today's low-rate environment.
Other tax strategies may involve the creation of an investment holding company for the family or income splitting with your spouse/partner and family members.
Charitable giving is a strategy to offset taxes and to get the family involved—from choosing which causes to support to working as a trustee or board member on the foundation you create. There are generally four donation options: setting up a private foundation, a community foundation, a donor-advised fund, or gifting a significant amount of your wealth all at once. Here's a short overview of each one:
- Private foundation—Despite the name, it isn't really private, says Noble. A private foundation must release information to the public. Also, there are large set-up costs, annual tax filings that need to be submitted, and financial statements that need to be prepared. While it may feel more prestigious, it's a more complex structure compared to other options.
- Community foundation—This type of endowment is typically set up to benefit a certain geographic community. You have the option to have little to complete control in deciding the charities that will benefit from the fund. A community foundation is typically more hands off than a private one.
- Donor-advised fund—This allows you to make a charitable contribution and receive a donation receipt immediately without specifying the organizations you want to support. Instead, you can make recommendations about which charities you want to help at a later date. Like a private family foundation, a donor-advised fund (DAF) may be used for annual giving.
- Gifting/one-time donations—You can give funds to your adult children without you or them having to pay any tax. Or you can make a one-time donation to a charity.
Having a will is an important part of an estate plan. “There have been situations where high-net-worth family members don't have a will,” says Noble. “Wills need to be in place for all family members 18 and older and should be reviewed every five years. Three is even better.”
There may also be a need for a primary will (for assets that require probate) and a secondary will (for assets that don't need probate). This is an important strategy for business owners.
At a high level, you should communicate the contents and the intentions of the will with your family as well as its location. You should also choose the right executor (or a liquidator as it's referred to in Quebec). A spouse or partner may not be qualified or even want to take on the additional stress while they're grieving.
You should choose an executor who's qualified, has the capacity, and is willing to do all the administrative work. For blended families, a third-party executor can make the process smoother if there is the potential for disputes among family members.
There's also something to consider regarding tax-free savings accounts (TFSAs). You should designate your spouse or common-law partner as a successor holder so that the TFSA is transferred automatically to him/her, Townsend notes. If they're designated as a beneficiary, there will be forms to fill out and they may need to pay taxes on any growth in value after your death if transfers aren't completed within a specified time period. Note that only spouses or common-law partners can be designated as a successor holder.
You can also consider designating another family member as a beneficiary if your spouse predeceases you or you both pass away at the same time. They will get the funds outside of the estate, which will save probate fees and provide timely liquid funds to manage the estate.
Whatever options and strategies you take after the sale of your business, planning your finances months in advance will help preserve and grow your wealth. This financial planning will also help you understand how you and your family will benefit from and enjoy living from the wealth created during years as a business owner.
The information in this publication is current as of May 11, 2022.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.