Small-business owners at an ‘impasse’ over secure retirement planning

via The Globe and Mail | December 14, 2015

Dorothy and Lewis run a successful small business that earns gross revenue of about $200,000 a year. They pay themselves a salary and dividends, leaving the rest of the money in the corporation to serve as a pension fund. He is 47; she is 44. They have no children.

Dorothy has expressed concern about the security of their retirement plans.

“We are at an impasse and it surrounds how to retire one day,” Lewis writes in an e-mail. “Our accountant says just keep paying yourselves a small wage and high dividends and invest the tax savings in ‘something,’” Lewis adds. “We have been doing this for many years and managed to pay off the house and cars and develop a portfolio of stocks in our RRSPs.”

Dorothy thinks they should take higher wages and lower dividend payments so they will be entitled to larger Canada Pension Plan benefits. “She likes the security of the CPP program,” Lewis writes. “So what we are looking for is a way to balance savings in the company versus savings outside the company,” he says. They wonder how much they will have to save to maintain their lifestyle and how to invest the money in the meantime. They also want to renovate their kitchen and pay off their line of credit.

We asked Matthew Ardrey, vice-president of T.E. Wealth in Toronto, to look at Lewis and Dorothy’s situation.

What the expert says

To meet their spending and personal savings needs of about $86,900 a year, Lewis drew a salary of $47,500 a year and Dorothy $42,500. In addition, they took $19,000 each in dividends, for a total of $128,000. Mr. Ardrey assumes they continue to draw, spend and save at this level until they retire in 18 years. He assumes they live to the age of 90, earning 5 per cent a year on their investments, and that their expenses rise by 2 per cent a year.

Drawing a higher salary just to get larger CPP benefits would be a “costly measure” because they would have to pay more income tax, the planner says, but they could consider using part of their savings to buy an annuity at some point in the future to give them guaranteed income.

Dorothy and Lewis can save for retirement three ways. First, by contributing the maximum each year to their tax-free savings accounts.

Second is the $31,000 of savings left in the corporation each year. Because this is considered passive income, it will not be eligible for the small-business deduction, Mr. Ardrey says. He assumes this money is taxed at a blended rate of about 32 per cent (one-third interest income, one-third dividend income and one-third capital gains). The after-tax savings in the corporation would amount to $972,000 by the time Dorothy and Lewis retire. Of that, $72,000 would be in the capital dividend account. “This is the non-taxed half of the capital gains and can be taken out tax-free from the corporation.” That would leave $900,000 to be drawn down evenly until age 90. “This amounts to $48,500 per year pre-tax between them, plus $2,500 from the capital dividend account.”

Once the line of credit is paid off and the $15,000 kitchen renovation complete, they will have $15,000 a year to contribute to a joint, non-registered investment account starting in 2018, the planner says. This money will be taxed at a 19-per-cent rate. He assumes they will get two-thirds of the maximum CPP benefits and full Old Age Security benefits.

When they retire, Dorothy and Lewis want $55,000 a year after tax for living expenses, plus another $15,000 a year for travel until Lewis is the age of 85, Mr. Ardrey notes.

Based on his assumptions, the planner says Dorothy and Lewis will be able to meet their retirement goal comfortably. “In fact, if they chose to spend all of their investment assets, only leaving real estate and personal effects behind, they would be able to spend $67,200 a year in retirement instead of $55,000,” he adds. This number is over and above the $15,000 a year for travel.

A rough breakdown of their retirement income is Canada Pension Plan and Old Age Security benefits of $20,000 each at the age of 65, corporate dividends of $19,000 each after tax and capital dividends of $1,250 each, with the remainder coming from their non-registered investments and withdrawals from their registered retirement income fund.

It’s not all smooth sailing. Their retirement plan is based on an average rate of return of 5 per cent. If the corporation’s holdings are added to their personal portfolio, they are 77 per cent in cash and 23 per cent in Canadian equities – an asset mix not likely to produce a 5-per-cent return. Mr. Ardrey recommends a more diversified, growth-oriented asset mix of 25 per cent each in fixed income, Canadian equities, U.S. equities and international equities, using low-cost, broadly based products.


The people: Lewis, 47, and Dorothy, 44

The problem: How best to ensure a secure retirement

The plan: Continue with their existing arrangement, leaving money in the corporation. Take full advantage of TFSAs. In 2018, begin saving $15,000 a year in a non-registered account. Target a 5-per-cent return on investments with a more diversified, low-cost portfolio.

The payoff: A comfortable retirement

Monthly net income: $8,530 (variable)

Assets: Cash in bank $2,000; rainy-day fund $6,500; his TFSA $38,172; her TFSA $35,550; his RRSP $41,289; her RRSP $43,840; residence $400,000; savings in company $149,000. Total: $716,351

Monthly disbursements: Property tax $303; insurance $116; utilities $212; maintenance $100; transportation (paid by company); grocery store, clothing $850; line of credit $1,250; shareholder loan $437; gifts $20; vacation, travel $1,200; drinks, dining, entertainment $300; grooming $50; pets $20; sports, hobbies $150; other personal $55; doctors, dentists $416; drugstore $30; life, disability insurance $136; telecom (paid by company); TFSAs $1,600. Total: $7,245. Available for spending or saving: $1,285

Liabilities: line of credit $15,000; shareholder loan $42,000. Total: $57,000

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