As a business owner, your financial planning needs to go way beyond RRSP contributions: you’re responsible for paying yourself, providing for your family and making sure there’s enough left for your sunset years, all the while sitting on top of a high-risk investment that ebbs, flows and might one day go bust. That makes you a rare breed in need of special care and attention. Because such financial expertise is hard to find, PROFIT asked experts from across the country to answer five of the most popular questions concerning wealth management for entrepreneurs.
How much should I pay myself?There is no one easy answer to determining CEO compensation, says Terry Greene, senior financial planner with MSC Financial Services Ltd. in Vancouver. You’ll need to consider a number of variables, including your firm’s profitability, which stage of the the life cycle your business is in and your goals for the company.
As a startup, you probably won’t have too much room to manoeuvre your salary. The cash needs of a new business mean either forgoing a salary entirely or paying yourself a minimum wage in order to plough most of the profits back into the company.
Although paying yourself frugally may be necessary in the short term, says Greene, “Long term, the business is unlikely to succeed unless the owner receives fair compensation for his efforts.” And your firm’s sustainability is of primary interest not only to you, but to the outside investors you may count on to help grow your firm.
What’s fair? Determine the market value for your position and industry. Gather information from as many different sources as you can on what owners of companies like yours pay themselves. Ask other entrepreneurs, your banker and accountant. Even then, you may adjust the figure up or down, depending on your firm’s revenue, profitability, age, your skill set and the time you’ve put into the company.
Other avenues to pursue include consulting compensation surveys. Many trade associations and compensation specialists publish annual salary surveys of CEOs. Yet another option might be to ask your board of advisors for help in determining a fair wage.
Whatever figure you settle on, remember to revisit it each year.
IPP or RCA: what’s right for me?Independent pension plans and retirement compensation arrangements are two specialized vehicles busy entrepreneurs can use to catch up on their retirement savings. Set up by your company, both let you quickly sock away large chunks of cash. The one you choose depends on your age and circumstances and whether you want access to the money before you retire.
To qualify for an IPP, you must be 50 or older, with an annual T4 income of more than $86,111. Annual contributions are based on your age, length of service to the company and past salary. IPPs are tax-deductible and investments compound tax-free. As a defined-benefit plan, you must make annual contributions and your plan must grow at a rate prescribed by the Canada Revenue Agency, currently 7.5%. Any shortfall in the investments must be made up by your company. While the funds are creditor-proof, you should also consider that you can’t touch the money until you turn 55. Then you can withdraw up to $70,000 per year, less taxes.
RCAs, on the other hand, are flexible vehicles that can be set up at any age with contributions of any size — potentially millions. Unlike IPPs, which must avoid high-risk investments, RCAs allow you to invest in anything. They’re also tax-deductible to the business, and you don’t pay personal taxes until you withdraw the funds. Still, bear in mind that half your contributions and any investment growth must go into a refundable Canada Revenue Agency account, which is non-interest-bearing. In other words, half of your RCA won’t make you any money.
Still, RCAs can be particularly useful for younger entrepreneurs looking to fund future business growth, says Paul Way, vice-president with TD Waterhouse Private Client Services in Winnipeg. That’s because banks will typically lend against up to 90% of the value of an RCA.
I want to ensure my family is provided for adequately in the event of my death. What are my options?When it comes to your assets, there are many ways to keep them in the family. Typically, you’ll use a combination of vehicles to ensure you achieve your goals.
Start by creating a personal net-worth statement, excluding your business, followed by a business valuation to get a better understanding of your holdings and how best to distribute them.
“Gifting assets to adult children is often the simplest solution,” says Greene. The biggest danger is that you might miscalculate and shortchange yourself. Consider what to gift. From a tax perspective, giving away cash is easy, but gifting other assets — company shares, for example — is more complex under attribution rules.
Life insurance is another option; benefits to a named beneficiary are tax-free, avoid probate and are out of reach of any creditors of the estate.
You also might consider creating a trust, a flexible and tax-efficient way to hold assets for your family’s benefit. There are two types: an inter vivos trust is a living trust; a testamentary trust is created upon your death. You can hold almost any asset in a trust, including cash, property, personal items or even your business. “Putting assets aside under the administration of a trustee provides segregation, along with a third-party perspective,” says Anthony Canale, a tax partner with KPMG in Toronto. And if your child or spouse gets into financial or marital difficulty, he says, the money is safe: “No one can meddle with how it’s distributed.”
If you plan to transfer ownership of your business to your children, consider an estate freeze. The tax liability is limited to the present value of the business, and future capital gains are taxed to the new owners — but only when they sell or transfer ownership.
What’s the best way to fund a buy-sell agreement?You have several options: you can set aside money on an ongoing basis, borrow cash from your company or a third party, or liquidate corporate assets. But, according to experts interviewed by PROFIT, your best bet is life insurance. “Permanent exempt” life insurance, such as universal life or whole life, for example, is one cost-efficient, low-risk tool that gives you coverage for life and generates cash, which may help fund a buyout in the event of a dispute, retirement or death.
Universal life is a popular choice since it combines lifelong insurance coverage and a tax-deferred investment plan to build capital — and offers valuable protection from creditors. When you purchase a universal life policy, you pay more than the cost of the insurance. Once the premium and management fees are deducted, the remainder goes into a tax-sheltered investment fund of your choice. So, two shareholders with a million-dollar business would insure each other with two policies worth $500,000 each. When one dies, the other partner (i.e. the beneficiary) receives the insurance payout and the investment account tax-free, which can be used to buy the deceased partner’s shares. Alternatively, the insurance could be held at the corporate level.
You can also withdraw funds prematurely in the event of a partnership dispute or other business emergency.
How do I find an investment advisor who meets my needs?It’s critical you find an advisor who works primarily with entrepreneurial clients and is experienced in financial tools that can best meet their needs. Start by asking for referrals from other business owners, your banker or lawyer. “As with any other professional in your life,” says Canale, “look for referrals from people you respect.” If your initial search doesn’t bear fruit, then think about attending financial seminars or checking newspaper or magazine ads for appropriate individuals.
Before you meet with any advisor, consider what it is you want from one and how much participation you want to have in managing your investments. Meet with at least three candidates to ensure you find someone you jell with. Ask about their experience and qualifications, and determine whether their investment style and philosophy matches your own. (For instance, are you growth-oriented or value-oriented?)
You’ll also want to find out the fees you’ll be charged: from commissions to percentage of assets, what is motivating the advisor to perform? If the advisor gets paid a commission, ask how much he or she will make from your account. This will allow you to determine whether or not you are receiving value for the money you are paying. After all, you’re worth it.
© 2005 Caroline Cakebread