Tax Managed Strategy 11
If you are a business owner looking to pull money out of your company, there is a strategy available to you. Many business owners have built up significant retained earnings in their corporation and are looking for ways to pull those earnings out. There’s a simple strategy available that moves earnings out of the company and puts them to work generating investment returns – in a tax efficient way.
Retained earnings are a mixed blessing for business owners. On one hand, they represent the company’s success and profitability. On the other hand, it can be a challenge to take those earnings out of the business without incurring a large tax bill.
The strategy involves taking out an investment loan and using withdrawals from your corporation to pay the interest on the loan. The interest payments are generally tax deductible¹ and allow you to withdraw an equivalent amount from your company without any net tax consequence.²
At the same time, you now have the potential to significantly increase the value of your non-registered investment portfolio over the long term as you have a large lump sum amount invested that takes advantage of the benefits of compounding.
Furthermore, this strategy provides business owners with the potential to safeguard their portfolio from creditors, help protect their capital, potentially avoid estate fees and diversify their investments, by investing in a segregated fund contract.
Consider the tax consequences of having the corporation fund a $250,000 personal investment
Here's how it works, step-by-step
Take out an investment loan.
The amount of the loan is applied in a lump sum to purchase non-registered assets.
The corporation pays you an amount as salary or bonus equal to the interest on the leveraged loan. This amount is included in income.
You may be able to deduct the interest payments at your marginal tax rate.
The end result is that you use an investment loan to invest in a non-registered investment. Meanwhile, you use the payments from your company to fund the interest payments. The interest payments may be tax deductible and offset the amount brought into income allowing you to take money out of the corporation without paying any additional tax.
As you can see, it’s a simple strategy – and it can help make a big difference to your bottom line.
How far ahead could you be? – A case study
Jeremy, age 45, is a business owner. He takes out a $250,000 investment loan and invests the loan proceeds in a segregated fund contract.
What it looks like at year 10
After 10 years, assuming an average annual compound return of six per cent, the leveraged account has grown in value to $447,712. After repayment of the loan, after-tax net worth has increased by $160,641.
By using this leverage strategy, personal net worth can be enhanced without paying tax on the withdrawal of retained earnings from the company.
- Business owners who have built up significant retained earnings within their corporation that they would like to withdraw in a tax efficient manner and use to increase the value of their personal assets
- The amount of retained earnings you would like to pull out of the corporation
- Use payments from the company to fund tax-deductible interest expenses on an investment loan
Investment options with Manulife Investment Management
Mutual Funds can help meet your specific financial needs, throughout your life. Whether you are just starting out, accumulating wealth or are nearing/in retirement, mutual funds offered by Manulife is committed to providing quality investment products and services so you can enjoy life and worry less.
Manulife Segregated Fund Contracts combine the growth potential offered by a broad range of investment funds, with the unique wealth protection features of an insurance contract. Through Manulife segregated fund contracts, investors can help minimize their exposure to risk through income, death and maturity guarantees, potential creditor protection features, and estate planning benefits – all from a single product or insurance contract.
Manulife Bank Investment Loans allow investors to make a large initial investment contribution and benefit from the potential for compound growth and interest deductibility. These loans are available for a variety of Manulife Mutual Fund accounts and Segregated Fund contracts, and offer attractive options such as 100 per cent financing, no margin-calls on market fluctuations*, interest-only payments and a one-step application process.
1 Actual tax deductibility of loan interest depends on a number of factors with the Income Tax Act (Canada) providing the framework for determining deductibility. Individual tax situations and tax deductibility will vary. Results for Quebec residents may differ due to different deductibility rules. Tax laws are subject to change. Clients should consult their own tax and legal advisors with respect to their particular circumstance. 2 The funds withdrawn must be paid to the business owner as salary or bonus and not directly to the lending institution. The corporation should not guarantee the loan or provide security for the loan as this may have adverse tax consequences. Retained earnings can be paid out as dividends which have different tax implications that will affect the tax consequences and results of this strategy. Withholding tax on a withdrawal from the company can be reduced by filing form T1213 “Request to Reduce Tax Deductions at Source”.
*No margin-calls on 100% Loans and Multiplier Loans, however if Loan to Value (LTV) exceeds 125%, then interest only loans may be converted to a principal plus interest loan at the discretion of Manulife Bank. The no margin-call feature is not available on Custom Loans.
Borrowing to invest may be appropriate only for investors with a higher risk tolerance. You should be fully aware of the risks and benefits associated with investment loans since losses as well as gains may be magnified. Preferred candidates are those willing to invest for the long term and not averse to increased risk. The value of your investment will vary and is not guaranteed, however you must meet the loan and income tax obligations and repay the loan in full. Please ensure you read the terms of the loan agreement and the investment details for important information. Manulife Bank of Canada solely acts in the capacity of lender and loan administrator and does not provide investment advice of any nature to individuals or advisors. The dealer and advisor are responsible for determining the appropriateness of investments for their clients and informing them of the risks associated with borrowing to invest.
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