Tax Managed
Strategy
11
PUT YOUR RETAINED EARNINGS
to work
LOUISE GUTHRIE
B. Math, FLMI, ACS, CAM, CFP, EPC, FDS
Assistant Vice-President
Tax and Regulatory Services
Manulife Investments
Many business owners have built up significant retained earnings in their corporation
and are looking for ways to pull that money out. There's a simple strategy available
that moves retained 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
amount from your retained earnings without any net
owners. On one hand, they represent the company's
tax consequence1.
success and profitability. On the other hand, it can be
At the same time you now have the potential to
a challenge to take retained earnings out of the
significantly increase the value of your non-registered
business without incurring a large tax bill.
investment portfolio over the long term as you have a
If you are a business owner looking to pull money out
large lump sum amount invested that takes
of your retained earnings there is a strategy available
advantage of the benefits of compounding.
to you.
Furthermore, this strategy provides business owners
The strategy involves taking out an investment loan
with the potential to safeguard their portfolios from
and using your retained earnings to pay the interest
creditors, help protect their capital, ability to avoid
on the loan. The interest payments are generally tax
estate fees and diversify their investments, by
deductible and allow you to withdraw an equivalent
investing in a segregated fund contract.
Comparing the tax consequences of having the corporation fund a $250,000
personal investment
T R A D I T I O N A L M E T H O D O F TA K I N G
MONEY FROM A BUSINESS
L O O K I N G AT A L E V E R A G E
S T R AT E G Y
Pre-tax withdrawal required
from retained earnings1
Net assets available for investment
$250,000
$462,963
Interest on Loan*
7.5%
Tax payable @ 46%
$212,963
Annual withdrawal from retained
earnings to service interest only loans1
$18,750
Net assets available for investment
$250,000
Interest deduction
$18,750
Tax Paid
$212,963
Tax Paid
$0
Here’s how it works step-by-step
STEP #1
STEP #4
Take out an investment loan.
You may be able to deduct the interest payments at your
marginal tax rate.
STEP #2
The end result is that you use an investment loan to invest
in a segregated fund contract. Meanwhile, you use the
payments from your retained earnings to fund the interest
payments. The interest payments may be tax deductible
and offset the retained earnings brought into income
allowing you to take money out of the corporation without
paying any additional tax.
The amount of the loan is applied in a lump sum to
purchase non-registered assets.
STEP #3
The corporation pays you an amount equal to the interest on
the leveraged loan from retained earnings2. This amount is
included in income.
As you can see, it's a simple strategy - and it can make a
big difference to your bottom line.
H O W FA R A H E A D C O U L D Y O U B E ? - A C A S E S T U D Y
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.
ASSUMPTIONS
Total loan amount
$250,000
Annual investment fund rate of return
8.00%*
Loan interest rate
7.5%*
Annual taxable portion of fund return
25.00%
Marginal tax rate
46.00%
Tax rate on income allocations
30.00%
* Rates are for illustration purposes only.
WHAT IT LOOKS LIKE AT YEAR 10 3
After 10 years, assuming an average annual
compounded return of 8%**, the leveraged account
has more than doubled, growing in value to
$539,731. After repayment of the loan, Jeremy's net
worth after-tax has increased by $239,7534.
By using this leverage strategy Jeremy has enhanced
his personal net worth without paying tax on the
withdrawal from retained earnings (assuming a 46%
marginal tax rate).
I D E A L C A N D I D AT E
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
TA K E A C T I O N
Consider:
The amount of retained earnings you would like to
pull out of the corporation
Using payments from retained earnings to fund
tax-deductible interest expenses on an investment loan
INVESTMENT OPTIONS
AVA I L A B L E T H R O U G H
MANULIFE INVESTMENTS
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 limit their
exposure to risk through death and maturity guarantees,
potential creditor protection features, and the estate
planning benefits - all from a single investment.
For conservative investors looking to help grow their
wealth but who are also concerned about minimizing
risk, Manulife Segregated Fund Contracts can provide
an ideal solution.
FIND OUT MORE
With 30 years of experience in retirement planning and
wealth accumulation strategies, Louise Guthrie leads the
Manulife Investments Tax and Regulatory Services (TRS)
team – a group of accountants, lawyers and other
specialists skilled in proactively identifying opportunities
for clients based on changing regulatory environments
and the market.
Manulife Mutual Funds For those looking to help build
wealth, Manulife Mutual Funds can provide an ideal
solution. Our funds offer you the growth potential of a
diversified pool of mutual funds, managed by some of
the world's most respected money managers from North
America and around the world.
GIF Select featuring IncomePlus – the first
Guaranteed Minimum Withdrawal Benefit available in
Canada. IncomePlus can provide predictable,
sustainable and potentially increasing income to help
investors achieve the retirement lifestyle they want.
The 75 Series available within GIF Select can provide
younger investors with a low cost option to help grow
their wealth. In addition to low MERs, the 75 Series
offers potential protection from creditors as well as
estate planning benefits.
As investors move closer to retirement, they have the
ability to switch from the 75 Series into the
IncomePlus Series.
INVESTMENT LOAN OPTIONS
WITH MANULIFE BANK
Manulife Bank Investment Loans allow your clients
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% financing, no margin-calls, interest-only
payments and a one-step application process.
1 It is assumed that the retained earnings are paid as a salary or bonus. Retained earnings can be paid out as dividends which have different tax implications that will affect the tax consequences and results of this strategy.
2 The retained earnings must be paid to the business owner and not directly to the lending institution and the corporation should not guarantee the loan or provide security for the loan as this may have adverse tax consequences.
3 This illustration assumes that a specific percentage of loan interest is tax deductible. However, actual tax deductibility of loan interest depends upon a number of factors, with the Income Tax Act providing the framework for
determining deductibility. Tax laws are subject to change and, therefore, tax treatment of illustrated figures cannot be guaranteed. Results for Quebec residents may differ due to the interest deductibility rules introduced in the
2004 – 2005 Budget. Readers should consult their own tax and legal advisors with respect to their particular circumstances.
4 The $239,753 represents a gain of $289,731 less $49,979 in taxes. The value of the taxes paid on the leveraged investment. Assumptions used are for illustration purposes only and are not indicative of future performance.
For more information please contact your
advisor or our Client Services Teams:
MANULIFE MUTUAL FUNDS 1 888 588 7999
MANULIFE SEGREGATED FUNDS 1 888 626 8543
GIC AND ANNUITY 1 888 626 8543
www.manulife.ca/trs
Borrowing to invest may be appropriate only for investors with 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. The value of your
investment will vary and is not guaranteed, however, you must meet your loan and
income tax obligations and repay your loan in full. Manulife Bank of Canada solely
acts in the capacity of lender and loan administrator and does not provide
investment advise of any nature to individuals or Advisors. Read the terms of your
loan agreement and the investment details for important information and discuss
with your financial advisor before deciding whether to borrow to invest.
Investment loans are offered by Manulife Bank of Canada.
The Manufacturers Life Insurance Company (Manulife Financial) is the issuer and
guarantor of Manulife Segregated Fund Contracts.
Commissions, trailing commissions, management fees and expenses all may be
associated with mutual fund and segregated fund investments. Please read the
Prospectus or Information Folder before investing. Investment returns are not
guaranteed, their values change frequently and past performance may not be
repeated.
Manulife Investments is the brand name identifying the personal wealth
management lines of business offered by Manulife Financial and its subsidiaries in
Canada. As one of Canada's largest integrated financial services providers,
Manulife Investments offers a variety of products and services including:
segregated funds, mutual funds, principal protected notes, annuities and
guaranteed interest contracts.
The commentary in this publication is for general information only and should not
be considered investment or tax advice to any party. Individuals should seek the
advice of professionals to ensure that any action taken with respect to this
information is appropriate to their specific situation.
GIF Select, Manulife, and the block design are registered service marks and trademarks
of The Manufacturers Life Insurance Company and are used by it and its affiliates
including Manulife Financial Corporation and Manulife Bank of Canada.
MK1700E (03/2007)