Advanced Financial Planning

Markus Muhs - Nov 26, 2019
November is financial planning month. I've written plenty of times before about some basic financial planning, so I wanted to take a bit of a detour this month into the realm of “Advanced Financial Planning”.

My colleague, Jeff Haggerty, is a Certified Financial Planning Professional (CFP®) and Chartered Life Underwriter (CLU®) with almost 20 years of experience in wealth and estate planning at a major insurance company, the investment dealing arm of a major bank, and now at Canaccord Genuity. Most of this time he spent helping other advisors, like me, think “outside the box” for clients in more complex situations—such as professionals (doctors, lawyers, etc), business owners, and farmers—in helping them find tax-efficient solutions to retirement, succession planning, and other life goals.

For this blog post I asked Jeff to provide me with a case study of typical clients he sees and the solutions he discusses. The below example is entirely fictional, so any similarities to actual people are unintended and entirely coincidental (even the family’s names are simply A-B-C-D). As always, before implementing any specific tax or legal advice you should consult accountants and lawyers specializing in those areas, as we do in collaboration with our clients.

 

Engineering an Exit

 

Andrew and Beth are a couple in their late-40s with two sons, Chris & David, both attending university. Andrew co-founded a civil engineering firm in 2010, which has now grown to 20 employees, and after consecutive successful years Andrew and his partner have accumulated substantial retained earnings.

Andrew is looking for retirement planning with some tax and estate advice. His older son, Chris, is studying civil engineering and may take over the company when he plans to retire. Andrew's business partner, who owns 50% of the company, is in his late-50s. This partner eventually wants to be bought out.

His goals are:

  • Successfully transfer the business to his son by the time he is 60. He wants to know what it would take to be able to retire with $10,000 per month, inflation adjusted.

  • Help pay for his kids’ education.

  • Ensure that the business would continue even if he was to die prematurely, and ensure his family is protected in the event of death or disability.

  • Ensure his estate plan is in place.

  • Look at general tax planning strategies.

 

Through the financial planning process Jeff identified several gaps and solutions:

  • One issue pertained to the new tax rules around passive income. The business has been accumulating and investing its retained earnings and was at risk of eliminating the small business deduction for corporate earnings less then $500,000. We had to identify strategies to either reduce this passive income or shift wealth out of the corporation.

  • He was accumulating personal investment assets in his name and the income from the portfolio was all taxable to him. Due to his high income, he is taxed at a marginal rate of 48% on investment income. He was not implementing any income splitting strategies.

  • We had to identify ways to help pay for the rising costs of tuition for the kids. He wanted to use some of the funds in his business for this purpose.

  • The couple’s Wills were very general and did not elaborate on what would happen to the business if Andrew were to pass away prematurely.

  • There was no succession plan for Chris to take over the business.

 

Strategies identified and implemented:

  • To get money out of the company we recommended setting up Individual Pension Plans (IPPs) for both Andrew and his partner. This allowed a Past Service Funding deduction of $200,000 for Andrew and an advantage over conventional RRSPs by allowing much larger annual contributions. It also allowed his management fees to be deductible to the corporation and allow additional tax-deductible funding when there was poor market performance. We also considered a Retirement Compensation Arrangements (RCAs) to get more funds extracted from the company.

  • We looked at a Corporate Insured Retirement Strategy using permanent insurance with cash values to shelter some of the capital inside the company. This prevented annual taxation of the investment capital, provided cash for the estate for his final tax liability which was estimated to be over $1 million. He could also access the cash value through annual loans (tax-free) at a low interest cost if he needed more funds for his retirement.

  • Set up a Spousal loan, where Andrew lends cash to Beth at the prescribed rate of interest. Andrew has to pay tax on the small amount of interest revenue, but when Beth invests this money the income and gains, net of interest costs, are taxed solely in her hands, reducing taxation on this money from 48% to 0-15% (Beth has no other income) versus if Andrew invested it himself (or if it were held jointly, in which case Andrew as the originator of this money would still be 100% liable for taxation).

  • Had the corporation lend money to the kids for their education. This allowed the loan to be reported under the kid’s names and the taxes payable on the loan were reduced as they utilized their tuition tax credits. This ended up being more tax-efficient then paying out a higher salary or dividend to Andrew to cover these education costs.

  • Recommended an estate freeze utilizing a family trust. This allows some of the future growth of the company to accrue to the rest of the family. Upon a future sale, if applicable, it would allow a multiplication of the lifetime capital gains exemption, allowing for more tax savings. It also caps the tax liability on Andrew’s death, and starts transitioning the future growth of the company to Chris once he’s ready to take over. Once Andrew retires, his “frozen” preferred shares could be redeemed over time to provide for his retirement income.

  • Looked at drafting a buy-sell agreement with Andrew’s business partner, funding it with life insurance, to protect each other’s interests including the future shares going to Chris.

  • Discussed detailed estate planning, looked at ways to be fair to David in lieu of Chris inheriting the business. Andrew and Beth were referred to a lawyer specializing in wills and estates to have their Wills redrafted, along with Enduring Powers of Attorney and Personal Directives.

  • Presented a retirement savings strategy on how much to contribute to the IPP, both TFSAs, the Corporate Insured Retirement plan, the non-registered portfolio, etc. Reviewed what assets to invest in and where to provide the most tax savings.

  • Through a comprehensive financial plan we illustrated a road map of how it would all look upon his retirement at age 60. Where and how to draw retirement income in the most tax-efficient manner, how much to expect, when to use pension income splitting, etc.

 

Finally, and only once the financial plan was in place and agreed upon by all parties, would I outline and implement an evidence-based investment strategy for each of the investment accounts, keeping with the time horizons, risk levels, and tax strategy of the overall financial plan.

My own financial planning experience over the past decade+ has focused more on getting the mass affluent—generally individual non-business-owners—to and through retirement, while saving for their kids education and other life goals. When Jeff Haggerty joined Canaccord Genuity’s Edmonton team in 2016 he opened up a whole new world of wealth advice that I think many in my field (myself included) often overlooked.

Having another CFP Professional to partner with in tackling my clients’ challenges is what led to the birth of “Muhs Wealth Partners” more than three years ago.

Whether your financial goals are simple or complex, I’m confident we have an unbiased an cost-effective solution. Contact us now for a complimentary review of your situation.

 

Markus Muhs, CFP, CIM

 

 

The above was co-authored by Jeff Haggerty, CFP, CLU, FMA and pertains to a fictional case study of a typical client scenario. Any similarities with actual persons is entirely coincidental and unintended. The aforementioned was provided for information purposes only and does not constitute any type of advice. Please consult with a tax or legal professional before enacting any tax or legal strategies. Insurance and estate planning services are provided by Jeff via Canaccord Genuity Wealth & Estate Planning Services Ltd.