Financial Estate Planning
Considerations and
Tax strategies for
Executives and Business
Owners
Whitney Hammond CFP, CLU
Scott Sadler FSA, FCIA
Steve Shillington CA, CFP, TEP
Agenda
1.
2.
3.
4.
Comprehensive planning
Tax and estate planning strategies
Life insurance ‘tax shelter’
Questions
Total Planning
• Financial, estate, tax and business exit
strategy planning can’t be done in
isolation from personal goals and values
• Business exit strategy and succession
planning can’t be isolated from:
– Personal estate planning
– Personal financial planning
– Personal tax planning
Planning Pyramid
Financial Status
3
2
1
Financial Goals
Community
(Social
Capital Legacy)
Family
(Family Legacy)
Self
(Financial Independence)
Values,
Goals &
Objectives
Planning Pyramid – Business Owners
• Financial independence
– Create viable exit strategy for current owner
– Protect business from others
• Family legacy
– Preserve business as family heirloom (maybe)
– Provide opportunity for family members (maybe)
– Distribute estate ‘equitably’ amongst
successors/others
• Social capital legacy
“Exit Strategy”
• “Succession plan” too limiting
– 30% of family businesses make it to Gen 2
– 5%-10% make it to Gen 3
• Focus on controllable elements
– Reduce financial reliance on business
– Cover down side-role of savings and insurance
– Systematize mgt processes to facilitate
succession or maximize value on sale to 3rd party
– Let’s make sure you have options
Incorporation (professionals)
• Creditor protection (business creditors)
• Tax deferral if not spending all you earn
• Income splitting
– Salary to spouse and children (must support $$)
– Dividends
• With spouse (Where spouse allowed to own shares)
• With children age 18+ (to avoid ‘kiddie tax’)
$750,000 capital gains exemption
• Not realistic in some cases
– e.g. doctors can’t sell their ‘book’
• Not always available in many other cases
– Buyer generally doesn’t want to buy shares
– Passive assets exceed 10% of assets almost
immediately
• Strategies available to ‘purify’
– E.g. Sister company to hold investments
– Consider cost,complexity, likelihood of share sale
New Tax Rates: Change in Plans?
First $500,000
$500,000-$1,500,000 M&P
$500,000-$1,500,000 Other
Over $1,500,000 M&P
Over $1,500,000 Other
Investment income
2009
16.5%
34.3%
37.3%
31.0%
33.0%
48.7%
2013
15.5%
25.0%
25.0%
25.0%
25.0%
44.7%
‘Bonus Down’ Strategy
(Active business income > $500,000)
Corporate active business income
Bonus
Remaining income
Corporate tax (2012+)
Remaining in the company
Bonus
1,000.0
-1,000.0
0.0
-0.0
0.0
No Bonus
1,000.0
-0.0
1,000.0
-250.0
750.0
Salary
Personal tax (assuming highest rate)
After tax personally
1,000.0
-464.1
535.9
0.0
0.0
0.0
535.9
750.0
Money at work after tax
‘Bonus Down’ Strategy
(Active business income > $500,000)
Bonus
Money at work
535.9
‘Eligible’ dividend paid later
n/a
Remaining in hands of shareholder 535.9
Extra combined tax
No Bonus
750.0
-221.6
528.4
.65%
Leaving the income in the company gives the business owner a 21% tax
deferral on active business income over $500,000 and combined tax is
only slightly higher if and when this surplus is paid out as a dividend.
‘Bonus Down’ Strategy
• Consider not ‘bonusing down’ to $500,000
• Some of the other considerations
– Maximize CPP? (if not done with base salary)
– Maximize RRSP? (if not done with base salary)
– Creditor protection (bonus and loan back net if
no holding company)
– Maintain eligibility for $750K capital gains
exemption
Holding Company
• Holding company
Before
Owner
After
Owner
100%
Business
100%
Holding
Company
100%
Business
Holding Company
• Benefits
– Asset protection
• Tax-free dividend up to Holdco
• Loan back as secured note - maintain working capital
• Out of reach of general creditors of business
– Real estate and portfolio investments
• Sisterco to maintain Opco eligibility for $750K CGE
– Income splitting-dividends-shares to children(18+)
• Note: doesn’t help with 750K CGE purification
Estate Freeze
• Estate freeze
Before
Owner
100%
Business
$2,000,000
After
Trustee: Owner, Others
Owner 100% Preferred
Value today: $2,000,000
Family
Trust
100% common
Value today: zero
Business
$2,000,000
Beneficiaries:
Owner, spouse,
children
Estate Freeze
• Benefits of a freeze
– On future growth (above $2,000,000 in this case)
• Defer tax at death by one or more generations
• Multiply $750,000 capital gains exemption
– Sprinkle dividends to low income family members
• Benefits of discretionary family trust
– Defer decision on who gets shares (by 21 years)
– Ability to reverse freeze – distribute to parents
Personal strategies-Investments
• TFSA: re-contribution pitfall
• Spousal loan
• Gift of marketable securities
Will and Probate Planning
• Estate administration tax (EAT)
– Probate of a will:
• Establishes legitimacy of the ‘executor/administrator’
• Frees financial institutions to release assets
• A ‘probate’ judge certifies the will
– Probated will subject to EAT (‘probate tax’)
• $5/$1,000 on 1st $50,000, $15/$1,000 on excess
• Applicable to ALL assets that pass through that will
e.g. $2,000,000 estate attracts $30,000 of EAT
Strategies to Reduce EAT
• Dual wills – separate will for shares of and
debt receivable from private companies
• Spouses hold assets in joint tenancy
• Named beneficiaries on RRSPs, insurance
• Inter-vivos Trust
• Don’t let EAT planning drive bad decisions
– e.g. Insufficient assets to pay tax/final expenses
– e.g. Joint ownership with children -triggers capital gain
Testamentary Trusts
• Control and protection
– Creditor protection
– Protection from family law claims
• Spousal
– Assets must ‘vest indefeasibly’
• Children and grandchildren
– Allow beneficiary to become trustee
– Don’t force the trust to be wound up at certain age
• Tax savings
– Annual tax savings of up to $18,000/yr.
– Depends on size of trust and other income of beneficiary
Estate Gifts
• Will must name charity
• Will must specify dollar amount or % of
residual
• Donation can be used on final tax return of
deceased or by estate
Insured Gift of Private Corp. Shares
• Will amended to bequeath shares to charity
• Insurance equal to value of shares purchased
• At death
– Shares bequeathed to charity by Estate
– Company redeems shares using insurance proceeds
– Residual capital dividend account created by insurance
proceeds-used to distribute other surplus or future
earnings to the heirs as tax free capital dividends
Insured Gift of Private Corp. Shares
•
Example
–
–
•
$2,000,000 of shares
$1,000,000 of life insurance
Options
–
–
–
Do nothing
Estate gives $1,000,000 of shares to the Charity
Estate gives $1,000,000 of shares to the Charity and
the Company purchases $1,000,000 insurance to
redeem those shares at death
Insured Gift of Private Corp. Shares
Family
Charity
Tax
No
Donation
$ 1,536,000
$
0
$ 464,000
Donation of
$1,000,000
Shares
$ 1,000,000
$ 1,000,000
$
0
Insured
Donation
of Shares
$ 1,000,000
$ 1,000,000
$
CDA
$
$
$ 1,000,000
0
0
Additional win for life insurance if it’s less expensive
than alternatives for funding share redemption
Asset diversification
• Cash, fixed income, equities, real estate
• Private business
– Entrepreneurs comfortable with heavy focus on
one investment (the business)
– Foolish to suggest there are better investments
– However, viewing business in context of
investment asset allocation is legitimate
consideration
Net Worth Statement
Life insurance cash value
RRSP
Non-registered and RESP
Shares of holding company
Real estate
Financial assets
Home
Household effects (est.)
Total assets
Total liabilities
Net worth
Mr.
Mrs.
Total
20,000
0
20,000
95,000 18,000 113,000
3,000
2,000
5,000
4,775,000
0 4,775,000
315,000
0 315,000
5,208,000 20,000 5,228,000
0 380,000 380,000
40,000 40,000
80,000
5,248,000 440,000 5,688,000
0 33,000
33,000
5,248,000 407,000 5,655,000
88% of financial net worth is in equities *including the business) and real estate
Value of Holding Company
Value of operating company (subsidiary) 2,275,000
Real estate
1,500,000
Investibles-equities
500,000
Investibles-fixed income
500,000
FMV of shares of holding company
4,775,000
Life Insurance Strategies
•
•
•
•
•
•
Participating life insurance
a.k.a. ‘Investment grade’ permanent insurance
Return of profit mechanism (‘dividends’)
Values vest at each anniversary (can’t go down)
Stable patterns of cash and death benefit growth
Largely backed by fixed income
Insured Asset Transfer
• Reposition non-registered assets into
permanent life insurance
– Tax shelter fixed income
– Cash value growth is tax deferred
– Cash value growth is tax free to extent left
until death
• Can be done personally or inside
corporation
Corporate Insured Asset Transfer
an example
•
•
•
•
Clients are married couple
Both age 55
Standard medical rating, non-smokers
$1,000,000 coverage suggested to cover
tax at death
• Range of options considered:
– Minimum funded universal life
– Participating whole life with maximum funding
Corporate Insured Asset Transfer
an example
• Product: maximum funded whole life
– 10 annual deposits of $42,582
– Owned in holding company
• Compare to fixed income investments
– Earning 5% interest
– Taxed at 47.7% (passive income)
• Compare asset in company and net amount
paid to executor of estate
Estate and Cash Position
$3,000,000
$2,000,000
$1,000,000
$65
75
Age
85
95
Net Estate-Insurance
Corporate Asset-Insurance Cash Surrender Value
Corporate Asset-Investment
Net Estate-Investment
No values guaranteed-not valid without accompanying illustrations
of policy values including disclaimers and sensitivity analyses
Enhanced Retirement Income
Assumptions
• Male 42, standard, non-smoker
• Considering $5M cash value life
insurance policy to diversify portfolio
–Premiums are $170K x 5 years
• At age 65, assign insurance policy to a
bank as collateral for annual loan advance
–Annual draw is $130K to age 90
–Tax free under current Canadian tax law
Enhanced Retirement Income
• Deposits and loan advances occur at the
beginning of year, values at end of year
• Life insurance cash values based on
current dividend scale
• Collateral Loan based on 7.5% gross rate
• Loan interest is deductible
• Tax savings applied to reduce loan balance
Enhanced Retirement Income
Capital Efficiency Test
• Life Insurance
– Annual $130K loan advance (tax-free) to age 90
• Equities
– $169K pre-tax nets $130K @ 23.2% tax
• Fixed Income
– $242K pre-tax nets $130K @ 46.4% tax
• Dividends
– $189K pre-tax nets $130K @ 31.3% tax
Capital Efficiency Test
To Provide an Equivalent After-tax Income
Why Life Insurance?
•
•
•
•
•
One tool in your financial planning toolkit
Tax sheltered growth, no CRA deposit limit
Creditor protected
Free from probate if properly structured
A private tool for wealth transfer to future
generations
• An efficient use of fixed income assets
Questions
Thank you for participating in our
presentation today.
Whitney Hammond and team can be
reached at:
905-637-3500
627 Guelph Line, Burlington, L7R 3M7
www.sovereignwealth.ca