In Ontario, the small business tax rate is 12.2%, so on $110,000, your company will only pay tax of $13,420, leaving you with $96,580 to invest.
Bottom line: You will pay $41,167 less tax by splitting your income between your personal income and your holding company. Sure, you’ll have to pay some tax when you eventually draw dividends from your corporation, unless, of course, the accumulation of your $41,167 tax savings leaves your corporation as a tax-free dividend created by a tax-free life insurance death benefit.
Investing in your holding company
If you continue working for the next 10 years at your current income, $96,580 per year will be available to invest within your holding company. You can invest all of this money or you can divide it between an investment portfolio and a life insurance policy.
The challenge that comes with investing within a corporation is that your investment earnings are taxed at the highest marginal tax rate. In Ontario, that means interest is taxed a 53.53%, eligible dividends at 39.34% and capital gains at 26.76%. So, if you have a $100,000 GIC earning 2.2%, you will earn $2,200 minus 53.53% for tax = $1,023. The after-tax return on that GIC is 1%. (Ouch!) That is why it makes sense to avoid, as much as possible, investments with some form of distribution.
One solution is to purchase an insurance policy that allows you to accumulate funds (cash value) within the policy. Once the money is in the policy the cash values grow tax-deferred and upon death, the insurance proceeds pay out tax-free, and in most cases can be paid tax-free out of your corporation.
Does the plan really work?
This all sounds good on paper, but does it really work? To simplify things and help you make a good decision, I have modelled your situation and run a few different comparisons. You can view the outcome in this video.
To model this out I have made the following assumptions:
- You have an investment portfolio made up of 60% stocks and 40% bonds, earning a total return of 4.1% after fees.
- You purchase a whole life insurance policy from which the death benefit pays out when you have both passed away. The premiums are set at $40,000 a year for 10 years, and then you will stop making premium payments. The death benefit will start at $477,000 and grow over time.
- In year 11 you will borrow $23,167 against the insurance cash value and pay yourself a dividend of $23,167 each until you both pass away at age 90. The interest rate on the loan is 5%, which will be paid off with the life insurance death benefit.
- If you are an aggressive investor, I’ve included a solution with an investment portfolio made up only of stocks, with some dividend and capital gains income, earning 5.58% after fees.
- Finally, I thought that if the insurance is going to take the place of your bond portfolio, then maybe the remaining money could all be invested in a stock portfolio, so I also ran this solution.
The table below summarizes the results for the year 2054, when your wealth has transferred to your children. All of your personal assets have been taxed but I have not calculated the after-tax value of the investments in the corporation. This is because the corporate investments will not be taxed until your children decide when and how they would like to draw the money.
My Husband and I we have 20 years Term life insurance for 15 years now. We are contemplating to use the collateral option to pay for our mortgage and buy a cottage etc. We are 65 and 63 but we are afraid to do so not knowing how would that work for our children . Please advise, thank you.