NOTE: The case studies illustrate Black Spruce Financial’s Three-step Process of Life Planning. Although the individuals portrayed are fictitious, the scenarios are based on common cases we encounter. In these cases, all individuals are assumed to be Canadian tax paying residents (Canadian Citizens, Permanent Residents or Landed Immigrants).
Explore – Business Retirement
Paul is the happy, sole owner of Ironclad Protection Co., a personal and corporate security business, but he hopes to retire from his business in 15 years. The company currently has retained earnings (profits that have built up over the years) of nearly $250,000. Annual company profits, currently averaging $35,000, will be added to this amount over the coming years. The company usually has inventory of approximately $50,000 on hand. The fair market business valuation has not been determined.
Paul is married, and has four children under the age of seventeen. His wife, Pauline, is a home-maker, and their children will all be adults by the time Paul retires. He has registered investments, all in equities, held with a brokerage firm that he has dealt with for some time. Two stock market down-turns somewhat diminished his savings, and Paul has been reluctant to follow his investment broker’s suggestion to open a corporately held investment account in order to invest the retained earnings held within the company. Paul has decided to look for other options.
Paul and his wife purchased a personally owned, joint universal life insurance policy over a decade ago, with a face value of $500,000 and cash value of $15,000. Neither Paul nor Pauline has any supplemental medical benefits, long-term disability, or critical-illness policies in place.
Paul’s aspirations are threefold: first, he would like to have sufficient money set aside to retire in 15 years; second, he must be able to sell the business; and third, he wants to ensure his children will equally inherit the estate assets when he and Pauline pass way.
Sculpting a Business Retirement Plan
After Paul and Pauline complete the discovery process and hold a series of fact-finding meetings with us, their data is entered into the Black Spruce Life Planning software. The software helps to bring forward several different approaches to meeting their goals. The most practical options are reviewed and discussed, and they agree on a plan that they believe will meet their needs and objectives.
The Life Plan they decide to follow allows for Paul’s registered investments to be moved to a portfolio management firm suggested by Black Spruce Financial. The KYC (Know Your Client) questionnaire Paul completed placed his risk tolerance at ‘medium’, leading to a mix of assets including fixed investments, income producing investments, as well as equities. Their life insurance policy was valuated and ‘sold’ to the business for $90,000, paid to them tax-free from the company’s retained earnings. Now the corporation is the sole owner of the life insurance policy. The proceeds of this ‘sale’ can now also be invested within TFSAs in both Paul and Pauline’s names. Any remaining amounts can be placed in non-registered investments at the new investment firm. The benefit of this sale is to gain tax free access to company retained earnings while creating a tax-sheltered asset fund within the corporation that can be accessed in a tax-advantaged manner at a later time.
Ironclad Protection Co was given a current ‘ball park’ business valuation figure that may change over the next 15 years. However, at least Paul knows where the company valuation stands now. Also, Paul is relieved that the lifetime capital gains exemption rule in Canada makes him eligible for sufficient tax-exemptions to offset any proceeds from selling the business.
As our system determined that Paul did not have sufficient life insurance in place to offset his tax bill upon death, a whole life participating policy was put in place, again, owned by the corporation with premiums funded by the retained earnings. The new life policy has a tax-sheltered cash value component, which will be the main investment vehicle for Paul’s retirement from business. To ensure that the life policies remain in the hands of Paul and Pauline, and not sold with the operating company, Ironclad, they will be setting up a holding company and transferring both policies into this new corporation well before the time that Ironclad is sold to another party.
Paul and Pauline’s wills were also updated to reflect all the changes made, including who would inherit the company shares should Paul pass away before selling the business. They also implemented a group benefits plan for the company to cover disability and medical, optical, drug and dental costs.
The Outcome – Business Retirement
Fifteen years later, Paul has retired from his business and his children are adults, all of whom have begun their own careers, outside of their father’s security business. Darcy and Donna’s Life Plan has provided them with the structure needed to reach their goals. It has changed somewhat over the years, but not dramatically.
For instance, Paul had to take a year off of work due to a back injury while on a job site. His disability insurance covered some of the family’s income needs offsetting the household expenses. During this time off, Paul managed to contract out excess projects that Ironclad could not handle to a reputable firm with which he had built up a relationship over the years. Ironclad was able to make a smaller profit from these projects.
The holding company they set up now owns both the existing and new life policies. Paul sells his business to this other security and protection firm for $200,000. This amount falls well below the lifetime capital gains exemption maximum for the sale of the shares to a privately owned corporation.
The Life Plan created a combination of income for Paul and Pauline – cash flowing from Paul’s RRSP’s, their TFSA accounts, the proceeds of the cash values from the corporately-owned life policies, and the sale of Ironclad. These steps provide them with more than sufficient after-tax funds needed to have a comfortable retirement. In addition, their insurance policies and updated wills will protect their children’s interests, and even their grandchildren’s, once they pass away.
To find out how the Life Planning process may be able to help you with your future plans, please contact us.