A Tax-Sheltered Holding Company: The Optimum Solution for Most Business Owners
Submitted by Stephen Southern, Ogilvie Daugherty Business Profit Solutions
We at Ogilvie Daugherty Business Profit Solutions (ODBPS) talk a lot about tax-sheltered holding companies. It continues to amaze us that most business owners have never considered this powerful financial structure. For most successful business owners a tax-sheltered holding company forms the foundation of their ideal wealth-accumulation strategy. Indeed, such holding companies are, we believe, the only tax-sheltered option available to business owners. And yet they remain largely unknown and misunderstood.
Most entrepreneurs continue to save for retirement inside a fully taxable structure such as a Registered Retirement Savings Plan (RRSP) or an Individual Pension Plan (IPP). These structures offer many benefits including tax deferment. And yes, tax deferment is powerful. But tax deferment and tax sheltering are two very different beasts.
RRSPs and IPPs defer income tax until at latest age 71. At that milestone, as a birthday present, the Canada Revenue Agency (CRA) will evaluate your RRSP or IPP and issue a schedule of minimum annual withdrawals. Your RRSP or IPP will be converted to a Registered Retirement Income Fund (RRIF) or Life Income Fund (LIF) respectively, and you will be told the minimum amount that you must withdraw from your RRIF/LIF each year from age 71 onwards. The minimum amounts are non-negotiable (e.g. at age 71, 7.38 percent must be withdrawn). The amounts must be withdrawn each year regardless of your other income, your income needs, etc.
And all withdrawals from your RRIF/LIF will be subject to income tax. If you have accumulated any significant wealth in your RRSP or IPP – which is then converted to a RRIF/LIF – your minimum annual withdrawals from your RRIF/LIF, as dictated by CRA, will land you in the top income tax bracket.
Just shy of half of your RRIF/LIF will flow to CRA in the form of income tax.
Alternatively, you could consider a tax-sheltered holding company and grow your retirement, estate and legacy wealth sheltered from income tax.
A tax-sheltered holding company is simply a standard holding company with one additional inclusion. The holding company includes a permanent life insurance contract. The life insured will generally be one of the owners of the holding company, although other scenarios do come up.
The insurance contract consists of two distinct structures. The first, and most obvious, is the life insurance. There is a cost to the life insurance and there is also a death benefit. The other structure within the insurance contract is the investment account. The investment account is debited monthly to fund the cost of the insurance.
But here’s the rub; the investment account is sheltered from income tax. This investment account offers, we believe, the most strategic tax-sheltered wealth accumulation structure available to successful business owners.
If you continue to look at the insurance contract as an expense item, used simply to pass money on to your estate and heirs to possibly cover outstanding capital gains taxes upon your death, then you will not see the elegance of this tax planning strategy.
If, on the other hand, you can see the insurance contract as having an investment structure/tool, you will be well-positioned to consider this approach.
Your operating company will pay income tax and then dividend profits up into your holding company. A portion of that dividend that is designated for long-term wealth accumulation (for retirement, estate and legacy) can then be invested in the investment account inside the insurance account. Neither dividend tax nor income tax is paid during this journey. Every dollar that left your operating company (after the income tax paid there) has arrived intact inside the investment account within the insurance contract.
In this environment, inside the investment account within the insurance contract, your investments grow tax-sheltered.
Now you may be wondering how you would access these funds if and when desired. The answer is leverage. Assuming you have worked with an expert to establish these structures, you can establish a line of credit against the insurance contract and access this credit as needed. Of note, drawing down from a line of credit is a non-taxable event. There are details here that go beyond the scope of this article, but again, a highly-skilled professional can assist with these details.
So if you decide to access funds inside the insurance contract to expand your operating company, you draw down the line of credit and lend the money to your company. You would do the same thing to buy another operating company.
During retirement, you live off of the line of credit, which is again fully backed by your ever growing, tax-sheltered holdings inside the insurance contract.
Lastly, upon your death, or more specifically the death of the life insured, the death benefit (comprised of the insurance component, the deposits and the growth) flows mostly tax-free through the Capital Dividend Account (CDA) of your holding company to your estate, your heirs and your legacy. Again there are some details here, hence the word “mostly” in the previous sentence. Once again, ensure you deal with a very reputable and highly-skilled financial planner that has implemented this same strategy for many previous clients.
This very simple illustration clearly does not constitute nor should it be considered investment or financial planning advice. I have skirted many details based upon both a desire for brevity and the relevance of said details. The details passed over do not materially affect the desired outcomes. Further, said details will come out as you work with your skilled financial planner to evaluate and ultimately establish this strategy and these structures.
The content of this article does not constitute legal, financial or commercial advice, or a recommendation of any services or products. You should consider obtaining independent advice before making any investment, financial or legal decision.
For more information please contact Steve Southern directly via 519-588-5251 or firstname.lastname@example.org.