Author Topic: Any Canadians using corporate retained earnings as a retirement plan?  (Read 5214 times)

totoro

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I'm looking at using retained corporate earnings as a retirement plan as low corporate tax rates may make retained earnings a better vehicle to build wealth than RRSPs and you can dividend out what you need later on.   

Some folks do a HELOC on their home to invest into income producing assets and take out money from retained earnings to cover the tax deductible interest resulting in zero tax payable (of course you need to add the interest costs on though - very low on a HELOC).

I'd be interested in any comments on this from people who are using these strategies.

http://www.canadianbusiness.com/investing/when-business-owners-should-and-shouldnt-make-rrsp-contributions-2/

sachac

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Re: Any Canadians using corporate retained earnings as a retirement plan?
« Reply #1 on: February 24, 2014, 08:24:06 PM »
I've been thinking about it. I paid myself just enough salary this year to take advantage of my unclaimed RRSP contributions and stay within the personal exemption, so the rest is in retained earnings. When you're looking at Mustachian-level expenses, does it still make sense to use dividends as your main compensation strategy? I calculated that paying myself a salary with before-tax corporate dollars was slightly better than paying myself dividends with after-tax corporate dollars since the dividend tax credit is non-refundable, but I'm not an accountant, so I might have misunderstood.

Note that investment income has a different corporate tax rate, so I'm not sure if you can grow things that much in a corporation. I'm planning to pay myself a salary while I have active business income, and then dividend out the rest of it (however much makes sense) and invest personally. I should probably crunch the numbers to see whether it makes more sense to pull more money out now, though - I'd pay more in tax, but I'd have more growth opportunity in investments.

If you do come across other people or advice, please share!

totoro

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Re: Any Canadians using corporate retained earnings as a retirement plan?
« Reply #2 on: February 24, 2014, 09:50:37 PM »
Hey, thanks for responding!

The thing is that you have to pay tax in the year you earned the income whether you are a corporation or individual.   This means that if your corporation earns $200 000 and you only take $50 000 you must pay tax on the other $150 000. 

It is not like you get to defer it as income taxed at a lower rate because you only take out the minimum.  Here is how it works:  http://sbinfocanada.about.com/od/incorporation/f/Salary-Or-Dividends.htm

I haven't figured it all out myself yet.

totoro

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Okay, been looking into it further.

If you invest in something that makes passive income through a corporation you are taxed at the highest marginal tax rate on profits (in BC approx. 47%!).  So if you made a private loan at 6% half would go to taxes.  On the other hand I guess it is better than getting nothing on the retained earnings...

You can invest and grow your business.  Active business income gets the corporate tax rate.

You could buy a building for your business with retained earnings using a holding company (can dividend out the RE to the company):  http://www.mnp.ca/en/media-centre/blog/2012/12/12/do-i-need-a-holding-company

http://www.cga-canada.org/en-ca/AboutCGACanada/CGAMagazine/2007/Jan-Feb/Pages/ca_2007_01-02_dp_taxstrategy.aspx

If you borrow to invest personally the interest is tax deductible.  If you get a loan at 6% this tax deduction reduces your taxable income which means you could withdraw more from the corporation to pay it without tax consequences.  Not fabulous, but better than paying corporate/personal taxes and then investing.

thorin_ii

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Re: Any Canadians using corporate retained earnings as a retirement plan?
« Reply #4 on: December 29, 2015, 11:20:55 AM »
This is the closest existing thread to what I want to start discussing so I thought I'd revive it.


I'm a Canadian engineer who just left a steady employment scenario in order to consult on a temporary full time basis (I'm a construction manager so I work projects; 80 hour weeks on the road or nothing at all).  I incorporated last summer for a multitude of reasons that will become apparent.

Eventually I'd like to not have to travel to work, and settle down in my low-cost home town (that is low cost due to poor economy).  I'd gladly FIRE on a hobby farm and spend my time canning/brewing for sustenance and maybe artisinal food and drink sales.  If I can telecommute and work professionally from home then that's fine but I can't count on being able to ply my trade locally.  I'd like to be stable enough to have a solar home, a green house, a permaculture system, etc.  self sufficient to the highest degree.  Of course, like MMM I have no problem working around town on odd projects doing home renos and what not.


As it stands, I personally only have about $25k in annual costs, owing to my work covering most of my cost of living any time I'm on contract.  My personal expenditures are no where near as mustachean as they could be, but generally my lifestyle has been too high-paced to be efficient (think of MMM's experience when Mrs. MMM had jury duty, only magnified by the 80 hour work week lifestyle).  My work pays very well and almost all of my employment income went into investments (40k TFSA, 40k RRSP, 30k equity in my Calgary condo; I'm only 5 years out of school).  Now as a corporation, my personal income is a minimal dividend to cover my costs, with the remainder of corporate revenues staying in the company as cash.  That gets us to today.


Ideally I'd like to be able to roll this surplus of cash into a real investment opportunity that will diversify my holdings and also help me get to my FIRE objectives (ie, buy the hobby farm in the corporation or buy a residential/commercial rental property for example).  the trouble is, the investment opportunities that I can think of (above) are on too small of a scale to be considered active income per CRA (rental businesses have to have more than 5 full time employees to be deemed active, and the farm idea is even more messy and too big to be considered FIRE but more like more stress than running a construction project).

So I've come to the conclusion I have to personally hold the farm (or rental property) while being able to continue covering my costs by way of corporate dividends.  the surplus inside the corporation should be invested in corporate class ETFs (the most tax efficient, passive, sure fire, and scaleable investment I can come up with).

I guess my whole purpose in posting all the intimate detail is to garner some criticism.  I expect to continue consulting with tax accountants to hone the details but can anyone see any fatal flaws?  Specifically, what would be the best case scenario for using the corporation as a vehicle to buy real-estate?  and would that structure still be worse than personal ownership?  the prospect of capital gains on massive increases in property value are nil in this area so I don't expect to lose out on potential personal income late in life.  It's just me for the moment, and I have no burning need to marry, and definitely no desire for kids.  of course I don't to close doors but the path I'm on has me just taking care of myself and that's it.

so, anyone out there have any thoughts?

totoro

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Re: Any Canadians using corporate retained earnings as a retirement plan?
« Reply #5 on: December 29, 2015, 01:50:51 PM »
You should consider taking the corporate draw as income and not dividends.  Take out the max you can remit CPP on (around 53,000) so as to grow your CPP entitlement.  Put part in an RRSP and the remainder you don't need after tax in a TFSA. 

As far as owning the property personally, it is possible to do a mortgage to yourself from the corporation at market in specific circumstances.  It may not be much of an advantage as you pay highest marginal tax rate on the interest income and you might be able to get more with another passive investment which will also be taxed at the highest marginal rate.

If you buy a building with money from the corporation that you then use to run your business (at least 50% of the space) the appreciation on the building can be tax exempt.  Tax Interpretation 2009-0307931E5 “Asset used principally in an active business”:

Stasher

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Re: Any Canadians using corporate retained earnings as a retirement plan?
« Reply #6 on: December 29, 2015, 06:00:38 PM »
Totoro touched on some good stuff.

Here is a few things I have learned with our businesses
  • Taking dividends as income doesn't contribute to you
  • Taking dividends doesn't go towards income calculation for RRSP limit
  • Dividends are not a taxable expense benefit to the company
I suggest taking enough income that you maximize you CPP contributions and earn enough to reach the maximum


« Last Edit: December 29, 2015, 06:02:41 PM by Stasher »
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thorin_ii

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Re: Any Canadians using corporate retained earnings as a retirement plan?
« Reply #7 on: January 08, 2016, 09:29:57 AM »
while i appreciate where you're both coming from, I've been more of the mindset that a salary of 23k (thereabouts) max, and then the 40k or 60k in dividends (i forget the exact numbers) would suffice for immediate and ongoing needs.  my lifestyle allows me to max out my TFSA with that, plus I have 25k in space left in my RRSP that needs to be repaid in the next decade (Home Buyers Plan).  I am of the mindset that my corporation essentially replaces the need for an RRSP, as I plan on growing a business that I can continually pull dividends from.  I never shy away from having my ideas challenged, but I just don't see the benefit of pulling a 50k salary (and having a marginal tax rate of,.. what.. 35% say?) just so that I can build RRSP room and get CPP.  Recognize that I'd have to pay into CPP for another 35 years as not only an employee but an employer just to maximize that benefit.  what's the point?

What I'm more curious about is the corporate tax strategies that would allow me to work as a consultant in the near term, building a cash reserve / corporate class investments until such time that I can diversify my business in other ways.  I don't care to take on corporate loans in order to get into capital intensive areas of commerce.. I'd rather build up that wealth myself and have the corporation finance itself.  I recognize that the capital gains will likely be an issue at the time of selling the corporate class ETFs.  I can't think of (at this time) a more efficient way to do this.  Ideally I'd be able to diversify into property ownership/management, residential renovations, the hobby farm, or something similar to that pace of life. 

I'm also curious about the potential for the corporation to hold an employee's property, with the employee entering into a mortgage contract with the corporation.  there isn't much information that I've found about this strategy, outside of this (http://madanca.com/blog/how-to-buy-a-home-with-a-corporation-in-canada/).  As you can tell, I very much look at the corporation as a tool to build up a large cash reserve or passive income reserve for the purpose of self financing the corporation's activities, or my own.

it shouldn't come as a surprise that I'm in the process of setting myself up with a PHSP rather than a conventional medical insurance plan.

I hope this post doesn't come off as dismissive.  I'm all for discussing the merits of different strategies.  I can understand why most entrepreneurs in canada will pull a salary because they're married with dependents and have a pile of personal deductions.  I don't.  I'm single.  I have no personal deductions.  I live on the road.  I literally own the cheapest piece of property I can because I need a legal address.  When I went to my lawyer/accountant team with my personal situation and business plan, they were giddy with the possibilities given my personal flexibility and entrepreneurial spirit.  I bring my situation to this group because I often wonder if they aren't thinking creatively enough about the possibilities.  So, any thoughts on what someone can do when they have little in the way for social responsibilities and a pile of earning potential?  I'm 30 today, and I'd like to FIRE by 40, with 35 being the stretch goal.  My definition of FIRE being passive income and dividend generation while i'm gardening/canning/brewing my own food and drink.  totally self sufficient monetarily, nutritionally, etc etc.

further thoughts?

totoro

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Re: Any Canadians using corporate retained earnings as a retirement plan?
« Reply #8 on: January 08, 2016, 10:36:51 AM »
My thoughts are that you may need to do more research.

If you are taking out 63-83K a year you will be taxed anyway at the same rate as a salary - there is no tax advantage to dividends anymore.  You might as well take out $52,000 as salary and get the max CPP credit although if you are doing a very early retirement it might make less sense.  You can write to CRA and get a statement of expected CPP at 60 and 65 by providing them with your specific scenario and giving the option of remitting or not.

Corporate retained earnings do not replace a RRSP.  Corporate retained earning investment gains are generally taxed at the highest marginal tax rate (close to 50%) while RRSP gains grow tax exempt until withdrawn and you are in control of the withdrawal rate and therefore the marginal tax rate.  RRSPs are a much better investment although you are paying for them with after tax dollars.  You need to do the math but it generally works out better long-term to withdraw more, pay the income tax, and invest money personally than through a corporation.

If you need the retained earnings to grow the business this is a very good use for them.  I don't.  My plan is to buy a building for corporate use (capital gains exemption available) or buy another business.

A corporation can hold property but you'd need to pay fair market rent for it if you occupied it and the rents are taxed at the highest marginal tax rate unless you have five full-time employees engaged in property management.  In addition corporate loans if you don't have 100% are at a higher rate than personal mortgages, for shorter terms and require about 40% down.  You as an employee can take a mortgage from the retained earnings at the going rate. The corporation pays the highest marginal tax rate on the interest.  You have to offer this benefit to all employees and if you are the only employee it will be likely to be deemed a shareholder's loan and must be repaid within the next tax year or it will be deemed income.

I had a PHSP and didn't like it - I just discontinued it.  I have employees and you have to offer it to everyone.  Our family didn't have big health expenses so it was more expensive than a group health insurance plan would have been to give it to everyone.  If it is just you working for your corporation age it might well be worth it.

As for your lawyer's and accountant's being "giddy" about your possibilities based on your entrepreneurial spirit and flexibility - good for you. 

As for "not thinking creatively enough about the possibilities"... that in conjunction with what you have written does come across as somewhat ego motivated.

thorin_ii

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Re: Any Canadians using corporate retained earnings as a retirement plan?
« Reply #9 on: January 08, 2016, 02:32:39 PM »
pramble: terribly rambly post.  hope you don't lose too many brain cells on it, cause I'm just highlighting (again) the differences between our two situations, but you certainly know more about how to handle my situation than I do.  I guess for conversation purposes its best that we just focus on the whole retained earnings in CC funds issue.... now to it.

I definitely won't deny that I'm uninitiated to the corporate world.  I've only been a business owner for 6 months now so I'm very much trying to figure out what all the possibilities are.  I won't deny that there's a pile more research I can do.  It's why I'm engaging conversation with folks such as yourself.  And my comments about getting creative aren't meant to be cocky but to challenge others to think to some extremes.  Specifically in my line of work I find most people often revert back to the established ways of doing something because it works for more situations.  My situation is definitely not like most people, nor is it like most business owners (as you acknowledge too).  If that sounds egotistical, I don't know what else to say on that front.

I'm curious as to why you'd say there's no advantage to dividends when the dividend tax credit exists.  (http://www.taxtips.ca/dtc/enhanceddtc/amt.htm#non-eligible-dividends) seems to indicate that $36,160 can be received in dividends from a small business with no tax owing (provided you live in ON).  After that floor, I understood that there's a bit of an optimization required to balance the remuneration to achieve the most efficient taxation.  Either way we're talking about more than enough cash for my lifestyle (which is why I left a $100k/a profession to go into business for myself).  The rest is retained earnings that I can use to diversify my business and secure those dividends (and *eep* salary if needed) into the future.  the 40-60k that i was mentioning previously was from some hastily jotted down notes I took when discussing a structure with my accountant.  I'll have to get a better understanding from him as to where those numbers came from.

so on the front of retained earnings (which is where you started this thread), have you found any better interim use for retained earnings other than Corporate class funds while you're accumulating for the next business venture?  the capital gains hit at the end is simply unavoidable (and its a preferable situation to be in rather than having a capital loss with which you can offset the gain I assume?). 

my previous post was not about the company holding the real estate for rental purposes but being the mortgage financier.  the logic for both situations follows, in that the employee must pay a market equivalent rate, and yes the corporation would have a capital gain on passive investment.

Totally understand why you'd drop the PHSP if you have employees.  I basically have no health concerns; no ongoing medications even.  PHSP was essentially half of the financial benefit for me to go on my own; the ability to provide an efficient at-cost option for anything our great healthcare system doesnt cover already, while avoiding the added cost of "insurance" during a time in my life when i'm already an exceptionally low risk.

again, sorry for how my comments had come across.

I guess the grand purpose of my posting is that I'm curious as to your thoughts about the options that are available to someone like me.  you can see that I retain a very high amount of earnings (in fact i will have personally gone a year on my own savings before needing to withdraw any of the corporate earnings).  I can comfortably get by on the combined basic personal amount (or a bit more if paid by dividend).  I guess what I'm saying is, getting back to your original comment about retained earnings, is there anything more efficient than corporate class until you can get into another business?  I mean aside from having a minority stake in another corporation that you are able to continually buy more and more stake in at will, that actually generates an active income for your corporation.  the trouble I get into is that I can barely keep myself employed full time at this time (and that's fine by me).  I can't justify taking on a salaried employee, because my payment standards are terrible.  growing my existing core business is difficult in that regard, and the retained earnings should be doing something aside from eroding due to inflation.  CCETFs (https://www.purposeinvest.com/) are really the only "sure bet", in that my personal investments are tied up in ETFs as well.  trying to get away from the capital gains is a good problem to have, and if you can't avoid the capital gains then you just need to smile because at least you made money right?  no way to roll those CCETFs into a different active investment right?


totoro

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Re: Any Canadians using corporate retained earnings as a retirement plan?
« Reply #10 on: January 08, 2016, 05:06:11 PM »
No problem.  I'm in BC not Ontario so there will be some differences.

You might want to read this: http://www.taxplanningguide.ca/tax-planning-guide/section-1-businesses/salary-vs-dividends/

I don't have time to answer all the questions right now but many can be answered via google or might try here - lots of good topics and he answers questions and is located in Ontario.

http://www.thebluntbeancounter.com/2011/12/should-your-investment-income-be-earned.html

thorin_ii

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Re: Any Canadians using corporate retained earnings as a retirement plan?
« Reply #11 on: January 11, 2016, 11:41:55 AM »
thanks for those links..

I've read both of them, in fact the BBC page you linked is the best discussion of CC funds I've seen in one place (seeing as a couple people mention their specific scenarios). 

with either of those in mind, I'm still left in the position of discussing future growth plans.

I understand that a "hobby farm" or "rental property" is looked at unfavourably in that they are both passive income sources unless you have more than 5 full time employees (I still need to read on the definition of commercial farming but I assume it's similar to rental ownership from the capital standpoint).  It occurred to me today that an "agri-tourismo" or B&B would be viewed as a more active business without being an overly large commitment (again, the 5 employee test).  I'll have to look into this further but that's my latest update on the idea of spinning an active corporate entity into a mustachian business venture. 

out of curiosity, what's the nature of your business?

totoro

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Re: Any Canadians using corporate retained earnings as a retirement plan?
« Reply #12 on: January 11, 2016, 01:54:40 PM »
I own a small law firm.  I don't know about farms or B&Bs.  A business venture that you can later sell shares in and use capital gains exemption for seems the easiest if you are so inclined.