Saturday, July 23, 2011

Small Business Owners and RRSP's

I was in Ottawa last week sitting on a shady patio looking at Parliament Hill. I overheard a conversation that got me thinking about RRSP’s. For those individuals who are unconventional thinkers (i.e. most entrepreneurs), I believe I have some food for thought. I have actually considered RRSP's, thought the concept through to completion, and discarded the notion. We have a few dollars left in a relic spousal RRSP from my days as an employee when I was getting my first part time businesses off the ground. I have since liquidated all my other assets in my RRSP's. They are much more useful to me for investments outside the RRSP, specifically to procure income generating assets such as new business opportunities or expansion of my existing businesses.

An RRSP is designed for the conventional thinkers (i.e. employees) who don't have any other significant tax deferral tool.

The first principle of an RRSP is that you will be in a lower tax bracket on retirement than during your working life. I find that is just a different way of saying you want (or should expect) less income in retirement than you do during working years.

Of course, it is true… the statistics that support that idea are derived from the conventional thinkers who make up 95% of the statistical sample.

Median Household Income according to Statistics Canada in 2009 was $68,410

This article from Statistics Canada using 2005 data indicates a median value of an RRSP was only $55,000 for people aged over 55 years (i.e. approaching retirement). That is not even one year`s worth of their current revenue. Naturally government programs and private pensions are income generating assets and will add about $20,000 of revenue annually. They are designed to bring you to about 35% of the median Canadain Household Income.

The conventional thinking says you should get an education, spend your life working for an employer, enjoy your existence, drift off into retirement and die. Conventional thinking does not encourage you to acquire viable income generating assets to support yourself permanently going forward (including retirement). And the statistics above support that... IMHO, that is not sufficient capital to provide any meaningful income. I don’t know about you but I have aspirations higher than that for my golden years. I am offended by that idea.

Personally I want more revenue & earnings in my retirement days than during my working life. I want to actually enjoy that time with travel & luxuries. Naturally, I also have to pay the health care costs to maintain all my bodily components that I've already "over-enjoyed". My intention is to make my last day on the planet my highest revenue day ever!

Here are three points that I would encourage conventional thinkers to consider:

i)With an RRSP you're making a contract with the devil and he can change the rules unilaterally without your consent... not a smart business contract!
ii) An RRSP strips away any benefits of investment management... all payouts from an RRSP are taxed as earned income (the highest)... there is no benefit of capital gains deductions or dividend tax credits or other strategies
iii) With a few exceptions, you can't use RRSP money for other purposes to greater effect within your business in the interim. An RRSP withdrawal incurs an immediate tax hit in the year it occurs.

Leave the RRSP’s for the employees and instead consider how you could deploy this capital to generate more perpetual business revenue instead.

Saturday, July 16, 2011

Income Splitting, My Kids Tuition and RESP’s

One of the beauties of running your business under a corporation is you get to issue dividends to yourself and your family members. It is the foundation of income splitting. Minor children can be shareholders of companies, but can not be named as directors until they reach the age of majority. There is no tax benefit in issuing them dividend cheques until they are adults because the tax will be attributed back to you in any event. However, they should be set up as shareholders at the outset to prepare for the day when they become adults.

The big benefit though is, as each of my two daughters turned 18, I began making payments to them that would be designated as their dividends by my accountant. I wonder if it is coincidental that as soon as your children turn 18 and you can pay them legally that they go off to university at the other end of the country and the Bank of Dad is no further ahead!

Back to the story; with the personal exemption tax deduction now over $10,000 for everyone in Canada that meant I was able to pay them more than enough to cover their university tuition and living expenses. On which they paid no tax! Personally I view it as a parent’s responsibility to provide your child’s education, including university. I don’t think student debt is ethical! So since I was going to be paying that money anyways it was good to make it tax deductible. Of course, the dividends were always well under the personal exemption so that they were still able to transfer the Tuition Deduction back to apply my wife’s earned income for even more tax benefits the following year.

I should also comment that an RESP is a good vehicle and back in the days when I was an employee I tried to deposit the maximum each year. However, it was a challenge on an employee salary. I’m glad I started my businesses because my kids would be carrying serious student loan debt today if I hadn’t. An RESP is basically a smart idea because you are getting the 20% Canadian Education Savings Grant (CESG) federal grant contribution to the fund. I don’t feel the same about RRSP’s but that is another story.

The one experience of regret for me was my investment management. I was using a self directed plan with mutual funds. That isn’t necessarily a bad thing in itself. However, when I was young I believed I was a self-styled investment guru and I was chasing the big returns. It was me against the world; John Wayne & Rambo-style. Only unconventional wisdom teaches you that is not the smart approach! Over the life of the plan my overall return was probably just above zero. If I had to do it over again I would just buy some big bank shares in the RESP and add to them every year. Don’t chase the return; just keep adding to the fund in a boring dividend paying stock. Regardless I still think the RESP was a great plan because it was forced savings. We saved about $45K in it. Unfortunately that wasn’t enough to pay for two 4-year degrees at a non-local university. So my businesses came to the rescue.

One little interesting tidbit I discovered is that once the first child heads off to university you are able to start withdrawing from the fund. I used those withdrawn funds to make additional contributions back into the fund for even more CESG in the name of the second child. It seemed like double dipping but when I asked CRA it is legitimate.

Monday, July 11, 2011

Paying Yourself with Dividends

Do you take out all dividends out of your small business to pay yourself?

I keep getting asked this question a lot. As a general rule "Yes", I use all dividends. I've had two accountants for my IT consulting business and both are fans of dividends so I guess I just "go with the flow". However, your accountant may want you to do payroll and it is important to be on the same wavelength as your accountant.

From a “no-lose” perspective, you should at least set up the share structure in your corporation to accommodate the payment of dividends to all of your family members if you ever change accountants. I’ll cover those details in another posting. I talk about this in great deal on my consultant mentoring website; Brock Consultants.

Basically the cash flow works like this. I just merrily spend money out of my own pocket all year; including cash, personal credit cards, and personal cheques. Of course, as any seasoned business person will tell you, it is necessary to ask for receipts for everything you purchase. I don't have any concept of getting "paid" on a regular schedule. Whenever I need money for any reason, I just write a business cheque for the desired amount. It is recorded by my bookkeeper as a draw, and detailed as an advance on expenses. I simply deposit it in our personal account (joint with my wife) to replenish my personal money.

At the end of the week or the month, I sort my receipts into two piles; business and personal. Naturally, I try to have the business pay for as much as possible, so that pile gets anything even remotely business related. After all that is the purpose of operating your own business… to generate funds to support your lifestyle! The personal expenses of course are a dead loss from a tax perspective.

I give all my collected business receipts to my bookkeeper who dutifully records them as expenses. Sometimes she throws them back if I’m trying claim something ineligible. At the end of the year the eligible expense receipts are totalled up as one giant expense claim for the business. My accountant then handles them from a tax perspective on the annual T2 return. Ultimately he decides what is deductible.

Of course, I have my finger on the pulse of my business revenue, earnings and cash flow on a daily basis, so my businesses aren’t just an endless supply of cash like a golden goose. The business obviously has to have the earnings on hand to pay me; I’m just explaining the process. Sometimes, we have cash flow squeezes and I need to remind myself it is my responsibility to grow the business to pay for that lifestyle.

You also need to make sure you leave enough in the business account to be able to pay yourself this way and still meet your taxes and other commitments. I also like to leave about 20% of revenue in there for contingency.

By the way, all these business cheques are made out to both my wife and me. That is so my accountant can decide at the end of the year how much of the cheques were recorded as paid to me and how much to my wife. It is just an accounting entry in his books at the end of the year.

Saturday, July 2, 2011

About 1 in 10 for Unconventional Health Benefits

About 1 in 10 small business owners know about Private Health Services Plans (PHSP).

I should let you know I have some blatant self interest in this post. Brock Health Administration Ltd is a major low cost provider of PHSP’s across Canada. I happen to own it, so I have some expertise on the topic.

In September 2010, Tom McFeat of the CBC contacted me about an interview on Private Health Services Plans. I was naturally flattered and excited… who doesn’t like quality exposure. You can read Tom’s article at this link on cbc.ca. I won’t go into details about the interview, the article or the functioning of a PHSP, but I will relate it to unconventional wisdom.

A Private Health Services Plan (PHSP) is for small and medium sized businesses to provide health benefits to themselves, their families and their employees while enjoying 100% tax deductibility. A PHSP is a low cost alternative to Insured Plans.

The average healthy family of four in Canada spends about $2,000 on unavoidable health expenses every year. You’re going to spend that money whether you like it of not. A PHSP will simply make it tax deductible. What amazes me is that only the 1 in 10 small business owners arrange their affairs so they don’t pay tax on it. The other 9 conventional small business folks simply hand over $500 or so in extra tax. I’m sure you can imagine the savings if you have a large health expense of $10,000 or $15,000 in a year.

These plans have been around for over 20 years. They aren’t promoted heavily by the large insurance companies because they don’t make much profit on them. That should be a clue why you might want one.

Small family businesses whether incorporated or not should open a PHSP as soon as your business is established and stable. While you can open one immediately, there are often other more pressing expenses in those early start-up years. Those start-up expenses are usually enough to offset any taxable earnings. But once you are generating stable revenue, a good businessperson is always looking for ways to minimize tax. At that point a PHSP makes sense for every business.