Nancy Graham February 23, 2017 Business Wealth Personal Wealth Business Owners and Their RRSPs: Are You “Willing, Able and Ready” To Save? As a business owner myself, believe me, I know what it’s like to wear two hats, and be of two minds when it comes to spending money. There’s the professional “me,” who loves to plow every dollar back into the care and feeding of my business and saving for my retirement someday. Then there’s the personal “me,” who wants to enjoy at least some of the fruits of my labor along the way. Both of “us” may want to retire someday, or at least cut back to a six-day work week. That’s where funding a Registered Retirement Savings Plan, or RRSP can come in handy. What is an RRSP, and how do you make the most of it? There’s no sense reinventing the wheel here. I’m delighted to make best use of our time together by first pointing you to my colleague Susan Daley’s excellent video on this very subject. You’ll find it on her “Your Money, Your Choices” channel, and it already covers all the essentials any investor should know about funding an RRSP. But if you’re a busy business owner like me, you probably have additional questions like: When and how should you direct business profits into an RRSP account … or should you? How do you balance funding your retirement and reinvesting in your thriving enterprise? In this segment of “No Dumb Questions,” I’ll go over some of these specialized business-owner questions related to funding an RRSP. As a business owner, how much – and how – should you stash away funds for your ideal retirement?. Your best answers depend a lot on your personal and professional goals and circumstances … which means there is no one-size-fits-all answer. Instead, are you familiar with the expression, “ready, willing and able”? For retirement planning, you can apply a scrambled version of this catchphrase into thinking through whether you are “willing, able and ready” to fund and invest in an RRSP. First, are you willing to fund an RRSP? No matter how well your business is doing, there are always choices to make with your discretionary income. Should you keep building your business? Pay off your mortgage? Live a larger lifestyle? Save for retirement? There are always opportunity costs involved as you prioritize competing goals. So the first question to consider when you’re thinking about fully funding your RRSP is: What might you have to give up to do so – and are you willing to? Financial retirement planning for hardworking professionals often begins with hardworking questions, aimed at challenging your personal values and your professional goals. When I’m working with business owners on their retirement plans, we usually begin by listing and prioritizing their financial goals, to reveal where their retirements goals rank on their larger list. There also are practical considerations. For example, if you’re weighed down by an oversized mortgage, high-interest credit card payments or other burdensome debt, you may want to first lighten that load. In my experience, professionals who give a high priority to eliminating personal debt tend to be the most successful in the long run. And, as we’ll get to in a moment, you may be able to build up “room” in your RRSP in the meantime. Which brings me to my next point: Are you able to fund an RRSP? As Susan covered in her RRSP essentials video, the formula for how much money you’re allowed to contribute to a tax-sheltered RRSP is called your “contribution room.” How much room you have begins with how much earned income you’ve generated. But your contribution room is NOT a yearly “use it or lose it” deal. If you don’t contribute to your RRSP account in any given year, your earned income from that year carries forward, so your room can grow over time, until you do decide to use it. So far, so good. But if you’re a business owner, generating earned income may be trickier than for someone who is an employee. For example, if you own a business and you draw a dividend as income, the CRA does not consider this to be earned income, so it won’t count toward your contribution room. If you’ve never thought through how to generate earned income that will enable you to fund your RRSP, a conversation with your accountant may well be in order … Now before the time comes when you are in ready mode. So, are you ready to invest the funds in your RRSP? Eventually, you’ll reach the day when you are willing to set aside tax-sheltered retirement funds in an RRSP, and you’ve built up the room to be able to. To make the most of your RRSP assets, you now want to be ready to invest them as appropriate. Typically, any money that you don’t plan to spend for more than 5 years – including retirement funds – should be put to work earning long-term market returns. Otherwise inflation eats into your buying power. If you instead let the money sit in a savings account yielding next to nothing, that $10,000 you’ve set aside today may only buy you about $7,000 worth of ideal retirement living 20 years from now -in a 2% inflation environment. So how do you “ready” your retirement investments? Here’s an overview to get you started. First and foremost, you want to invest the funds in your RRSP according to your larger investment plan, based on your goals, time horizon and risk tolerances. You also want to work your RRSP investments into your larger tax planning strategies, by engaging in something called asset location. As the name suggests, you want to deliberately locate your kinds of investments in taxable or tax-sheltered accounts, with an eye toward minimizing eventual taxes owed. For example, you may be better off using your tax-sheltered RRSP for the bulk of your less-tax-efficient bond investing, and use your taxable accounts for more of your more-tax-efficient stock investments. How come? The tax break you receive when you contribute to your RRSP is a powerful incentive to help you save for retirement. But remember, moving forward in your non-registered, taxable accounts, you’ll incur tax on only up to half of any of the realized capital gains. In a tax-sheltered RRSP, the money grows tax-free while it’s in there. But when you take it out, it’s all taxed as ordinary income, whether the money came from principal or gains … or even Canadian stock dividends that normally would offer additional tax-favored treatments. If you’re following the bouncing ball, that means the less tax-efficient an investment is, the less it will matter that you’re paying ordinary income taxes on it later. So you want to bulk up on relatively tax-inefficient holdings in your RRSP, and locate your relatively tax-efficient holdings like Canadian stocks in your taxable accounts. There, the tax efficiencies can be used to maximum benefit. I know. That’s a lot to wrap your head around! It took me several professional credentials to get the hang of it myself. Once you reach this point, it can pay for itself – and then some – to invest in someone who has what it takes to help you organize and oversee your financial, investment and tax-planning best interests – for whatever business or personal hat you may be wearing. Let me know which hats you’d like help with for future episodes of No Dumb Questions. For now, I’ll leave you more willing, able and ready to fund your RRSP. 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