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Family Business Planning Strategies

67% are at Risk of Succession Failure

If you are an owner in a family enterprise, the likelihood of your business successfully transitioning to the next generations is not very good.  This has not changed over the years. Statistics show a failure rate of:

  • 67% of businesses fail to succeed into the second generation
  • 90% fail by the third generation

With 80% to 90% of all enterprises in North America being family owned, it is important to address the reasons why transition is difficult.

Why does this happen and what can you do to prevent it?

Communicate

Family enterprises are often put at risk by family dynamics.  This can be especially true if the family has not had any meaningful dialogue on the succession of the business. And, while we are throwing around statistics, it has been estimated that 65% of families have not had any meaningful discussion about business succession.

  • Family issues can often hijack or delay the planning process. Sibling rivalries, family disputes, health issues and other concerns certainly present challenges that need to be dealt with in order for the succession plan to move forward.
  • Many times a founder of a family business looks to rely on the business to provide him or her with a comfortable retirement while the children view the shares of the company as their inheritance.
  • Sometimes an appropriate family successor is not readily identifiable or not available at all.

Decide

  • In these times a decision needs to be made as to whether or not ownership needs to be separated from management, at least until the second generation is willing or capable to assume the reigns of management.
  • If the founder needs to receive value or future income from the business a proper decision as to who is running the company is vital. If this is not forthcoming, then there may be no other alternative but to sell the company.

Plan

Tax Planning

When planning for the succession of the business an important objective is to reduce income tax on the disposition (sale or inheritance). One of the methods is to implement an estate freeze which transfers the future taxable growth to the next generation.  The corporate and trust structure utilized in this strategy may also create multiple Small Business Gains Exemptions which can reduce or eliminate the income tax on capital gains.

Just as it is important for a business owner to plan to reduce taxes during his or her lifetime, it is also important to maximize the value of the estate by planning to reduce taxes at death.

Minimize Management and Shareholder Disputes

This can be accomplished with the implementation of a Shareholders’ Agreement.   Often there are multiple parties that should be subject to the terms of the agreement, including any Holding Companies or Trusts that may be created to deal with the tax planning issues.  The Shareholders’ Agreement will include the procedures to deal with any shareholder disputes as well as confer rights and restrictions on the shareholders.

The agreement should also define the exit strategy that the business owners may wish to employ.

Estate Equalization

Often the family business represents the bulk of the family fortune.  There are times that one or more children may be involved in the company while the other siblings are not.  Proper planning is necessary to ensure that the children are treated fairly in the succession plan for the business when the founder dies.

One method often employed in this regard is for the children active in the business to receive the shares as per the will or shareholders’ agreement while the non-business children receive other assets or the proceeds of a life insurance policy.

Founder’s Retirement Plan

It is problematic that often a business owner’s wealth may be represented by up to 80% of his or her company’s worth.  It is important that the founder develop a retirement plan independent of the business so that his or retirement is not unduly affected by any business setback.

Protecting the Company’s Share Value

Risk management should be employed to provide for any unforeseen circumstances that would have the effect of reducing share value.  As previously mentioned, if the bulk of a family’s wealth is represented by the shares the family holds in the business, a significant reduction in that share value could prove catastrophic to the family.  These unforeseen circumstances include the death, disability or serious health issues of those vital to the success of the business, especially the founder.  Proper risk management will help to ensure that the business will survive for the benefit of future generations and continue to provide for the security of the founder and/or his or her spouse.

Act

Since the dynamics of family businesses differ from non-family firms, particular attention is required in the planning for the management and succession of these enterprises.  This planning should not be left until it is too late – it is never too soon to begin.

Please feel free to use the social sharing buttons below to forward this article to someone that you think might find it of interest.

 

Ease Your Retirement Worries with Immediate Annuities

The majority of Canadians work hard to accumulate a retirement fund and many are averse to exposing savings to unnecessary market risk after they retire.

In today’s prolonged low interest rate environment, immediate annuities are often dismissed or overlooked as a viable vehicle for providing retirement income. Perhaps they shouldn’t be.

An annuity is an investment that provides a guaranteed income stream for a set period of time or for the lifetime of the annuitant. While annuities may not be for everyone, for those trying to find a way to guarantee income in retirement Immediate Annuities may be the answer.

3 Retirement Risks to Avoid

Outliving Your Savings

No one wants to outlive their retirement fund or leave their surviving spouse without resources. An immediate life annuity either on a single life or a joint life basis could be the answer for those looking to ensure that their monthly living expenses are taken care of for the rest of their lives.

If you are a member of a company or government pension plan, you will have the option of structuring a regular pension income for this purpose and to select survivor options for your spouse.

If your retirement savings are in the form of a Registered Retirement Savings Plan, you have the option of converting your RRSP into a RRIF (Registered Retirement Income Fund) or purchasing an immediate life annuity.  This must be done no later than age 71.

Market Risk and Volatility

While you are drawing income from your RRIF you remain invested for the undrawn balance. Seeking higher yields involves a measure of risk. A downturn in the market, such as what happened in 2008, could prove disastrous to a retirement plan. An immediate annuity is not subject to this market risk.

High Rates of Income Tax

The income you receive from a registered source (i.e. RRIF’s, pension, or registered immediate annuities) is all taxable.

You can use your non-registered savings (such as TFSA’s) to purchase a prescribed immediate annuity which will be taxed at a much lower rate than traditional income producing investments (such as GIC’s, bonds etc.).

There are a number of conditions to be met for an annuity to be prescribed, the main ones being:

  • The owner of the annuity must be the annuitant;
  • The owner is an individual, testamentary trust or spouse, alter ego or joint partner trust;
  • The purchase of the annuity is made with non-registered funds.

Annuity income from a prescribed annuity is a blending of interest and return of capital.  This results in less tax payable.

Changes are coming

Unfortunately, the advantage of prescribed annuities will be greatly reduced after January 1, 2017 as the government is changing the factors in determining the taxable portion of prescribed annuity income.  Existing arrangements will be grandfathered meaning only new annuity purchases will be affected after this date.

Also, as of January 1, 2016,  the only Testamentary Trusts that will be allowed to purchase a prescribed annuity are testamentary spouse or common-law partner trusts, or a Qualified Disability Trust.

Retirement Scenario A

Protecting Against Market Risk – Certainty of Income

Consider the circumstances of John and Mary who are aged 73 and 72 respectively.  They have done well for themselves in accumulating wealth for retirement but, after living through a number of bear markets, they realize that they must stay conservative in their investment approach in order to protect their future income.

They have determined that they require a guaranteed monthly income of $1,800 pretax in order to meet their day to day living expenses.  To give them peace of mind, they purchase an immediate joint life annuity that will pay them $1,800 per month for as long as they live.

John and Mary transfer $344,947 * from their RRIF to pay for a registered immediate annuity providing $1,800 monthly income. This will provide them with a predictable and sustainable income for the rest of their lives. The guarantee income period is 10 years which means if they should both die within this time the balance of the 120 guaranteed payments would go to their beneficiaries.

Retirement Scenario B

Reducing Taxable Income with Prescribed Annuities

Roger is a 74 year old widower who has non-registered funds invested to produce income.  He has GIC’s and bonds totaling $250,000 which provide him with an average return of 3%.  This results in $7,500 per year annual income which after tax gives him $ 4,875 spendable income (assuming a tax rate of 35%).

If he were to use the $250,000 to purchase a prescribed immediate life annuity he would receive an annual income of $19,915.* Of this, only $1,255 per year would be taxable.  His after tax spendable income would be $ 18,660 per year.  The income from the annuity would be paid for the rest of his life but should he die within 10 years his beneficiary would receive the balance of 120 guaranteed payments.

By providing lower reportable income, prescribed annuities can also be effective in reducing the chances of a clawback of OAS and Guaranteed Supplement Income payments from the federal government.

8 Key Facts to Know About Immediate Annuities

  1. An annuity can be an important component of a balanced financial plan;
  2. It can provide predictable and sustainable income for the life of the annuitant(s), regardless of market conditions or interest rate fluctuations;
  3. The rate of income provided by an annuity is generally higher than other guaranteed income vehicles;
  4. Annuitants can chose the frequency of their payments and also include indexing to help keep pace with inflation;
  5. Annuities are backed with assets to match the duration of the payments. This means that when interest rates are low, it is possible to lock in higher long-term interest rates with an annuity;
  6. Choosing a guarantee payment for the annuity income means that if the annuitant dies prior to the balance of the guarantee period, the beneficiaries will receive the balance. Otherwise the annuitant receives the income for life;
  7. For those over the age of 65, taxable income from an annuity will generally qualify for the pension income credit;
  8. For prescribed annuities, after January 1, 2017 the government changes in how the non-taxable portion is calculated come into effect and after that date will not provide the significant advantage that they do now.

If you or someone you know shares the concerns of protecting income throughout the retirement years, an immediate annuity might provide a solution to some of those concerns.  Please feel free to share this information with your friends and family.

*Annuity rates shown are those of BMO Life current as of August 14, 2015;

** For prescribed annuities purchased prior to January 1, 2017.

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1 in 3 Canadians Will Become Disabled Before the Age of 65

What you need to know about your Group Long Term Disability

Having a source to replace your earned income in the event of an illness or accident is vital considering that on average, 1 in 3 Canadians will become disabled for a period of more than 90 days at least once before the age of 65.  For those that are disabled for more than 90 days the average length of that disability is 2.9 years.

If you are one of the approximately 10 million Canadians covered under a group Long Term Disability plan (LTD) it’s important to understand what your coverage provides. Don’t wait until after you’re disabled to read the employee handbook, because you could have a few surprises!

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