Make sure the money from your small business will be there for you when you retire, experts caution
BY TERRENCE BELFORD
It has been so long since Jim Smith made an RRSP contribution he can’t remember exactly when or how much. Nancy Wallace says the same. Yet neither are particularly concerned about having enough money tucked away to fund their retirement years.
“I now have it set up so I can walk away any time I want,” says Mr. Smith.
What sets these two Halifax residents apart from many Canadians is that they are small business owners. Mr. Smith, 54, runs a quartet of automotive-related businesses in the city; Ms. Wallace, 53, owns a private school, day care and nursery school. And unlike many other small business owners, they have successfully integrated tax planning with financial planning to prepare for retirement.
The need to connect both is crucial when it comes to creating and sustaining wealth, say financial planners.
“The biggest challenge is always getting small business owners to separate personal wealth from the money that is in the business,” says Chris Butler, a Halifax-based financial adviser with the Royal Bank of Canada. Both Mr. Smith and Ms. Wallace are his clients.
“Their focus is almost always on the shorter term; they do their tax planning but neglect to connect it with the much longer term goals of preserving the money they are making,” Mr. Butler says.
The upside of running your own business is that you have considerably more options when it comes to retirement savings than do salaried employees, points out Catherine Swift, president of the 105,000-member Federation of Canadian Business.
The downside, however, is that too few small business owners take advantage of them.
“There is a pressing need right now to address that situation,” she says. “Simple demographics show us that small business owners are aging and approaching retirement. Unless they begin to plan for those years, we may face a serious problem.”
“The basic principle all small business owners should follow is to take care of themselves as well as their business,” says Valerie Chatain-White, of VCW Financial in Winnipeg and a director-at-large of the Financial Advisors Association of Canada.
“One of the biggest challenges almost all of them face is managing the cash flow they generate,” Ms. Chatain-White says.
“Leaving cash in the business may, in fact, create problems.”
That was the situation Mr. Smith found himself in three years ago. He owns four Halifax businesses: Cheapy Tire, Rent-A-Wreck, Wilson’s Fuel and Crown Rust Control, and had been in business 15 years.
“The problem was that all I thought about was making money and so I just focused on that. I thought I was doing well because I had all this money in the business.”
Like many small business owners, Mr. Smith saw the eventual sale of his business as generating enough money to let him live a comfortable retirement.
The problem is that cash-rich operations can actually reduce the gains realized from the sale of the business, says Tracy Broeze, financial adviser with Cumming & Cumming Wealth Management in Oakville, Ont.
“The government recently raised the lifetime capital exemption to $750,000 from $500,000,” she notes, “but that is only available to qualified businesses and many people fail to read the fine print.”
That fine print says that 90 per cent of a business’s assets must be in active use by the business for two years previous to the sale. Only 10 per cent of those assets can be in cash or savings accounts.
At his accountant’s urging, Mr. Smith brought in RBC’s Mr. Butler, who helped him reorganize into three companies: An operating company to conduct the businesses, a holding company into which surplus cash would be paid as dividends, and a second holding company, which would own the building from which he runs his businesses.
The holding company invests the dividends and if he were to sell the operating company, the buyer can rent the premises from Mr. Smith’s company, thereby providing him another stream of retirement cash.
“It cost me $16,000 to do it but it was well worthwhile,” Mr. Smith says. “I can walk away from the business any time I want and know I have enough to last me the rest of my life.”
Ms. Wallace, who operates the Bedford Academy, Mary Poppins Early Learning Academy and Mary Poppins Day Care tells a similar story.
“I used to put money in RRSPs but haven’t made a contribution in years,” she says. “My accountant pointed out that I might be reducing taxes now but when I retired, the government would just tax that money as income anyway.”
With the help of Mr. Butler and her accountant, she mortgaged her home and built her own school, a three-storey building she estimates is now worth $4-million. She also has a 2,400-square-foot day care centre plus her 5,000-square-foot home, which doubles as the site for the early learning academy.
Again with the help of her advisers, Ms. Wallace crafted a succession plan whereby her daughter, Megan, assistant director of the school, could take over all of the businesses when Ms. Wallace chooses to retire.
Mr. Smith and Ms. Wallace each found routes that suited their particular situation, but financial advisers point out that preparing for retirement is not a one-size-fits-all proposition.
The challenge that small business owners present is that no two are exactly alike, points out Jack Courtney, assistant vice-president advanced financial planning at Investors Group in Winnipeg.
“For some, RRSPs will make sense; for others, keeping cash in the business may be best because small business tax rates vary from 13.5 per cent to 18.5 per cent, depending on where you live in Canada.
“Businesses are often high risk, while RRSPs present much lower risk. Yet at the same time RRSPs are not creditor-proof unless the money is in insurance-related segregated funds,” Mr. Courtney notes.
The biggest challenge is most often simply persuading small business owners to devote the time and money to make that necessary connection between tax planning and financial planning, says Mr. Butler.
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“I now have it set up so I can walk away any time I want,” says Mr. Smith.