Tax Effective Way To Get Money Out Of a Holding Company

Business owners who are banking on the build up of capital in an operating company to help finance retirement are paying much higher taxes than they need to. It is possible to enjoy a tax-free retirement income by setting up a holding company that tax-shelters dividends from the operating company inside a Universal Life policy.  Upon retirement, that policy is used as collateral for annual loans that provide a tax-free income.

Building up retirement savings inside a Canadian controlled private operating company exposes the company to higher taxes in two ways. To begin with, all companies pay tax of about 23% on their first $200-thousand of annual profit. But if the company’s non-active business assets, such as GIC’s and other investment, ever total more than 10% of total business assets, the company loses that low tax rate and pays about 45% instead. Secondly, if non-active business income, such as the interest earned on investment, exceed 10% of business income in any year, the company will again lose the lower tax on its first $200-thousand of profit.

Those non-active business assets were dividened up to a holding company and invested in a UL policy, retirement saving could grow tax-sheltered and no longer expose the operating company to additional taxes.

Companies typically bonus out profit in excess of $200-thousand to shareholders rather than pay 45% tax on it. The shareholder then pays a personal tax rate on the bonus. But if the company were to dividend that money up to a holding company that placed it inside a UL policy, no tax would have to be paid.

Here is how the holding company scenario works. The holding company is formed to own the shares of the operating company. Individual shareholders can sell shares to the holding company without triggering capital gains. The holding company buys a Universal Life policy to shelter its assets from tax and names itself as the beneficiary. Of course, the shareholder who used to own shares in the operating company, now owns the shares of the holding company.

Until the shareholder is ready to retire, he or she grows a retirement nest egg inside the life policy dividends paid by the operating company. As a private Canadian corporation, the holding company can use business assets as security for a personal loan to a shareholder. So when the shareholder retires, the holding company uses the cash value of the UL policy as collateral for annual bank loans to the shareholder, and you don’t pay tax on a bank loan, so it becomes an effective tax-free income.

Rather than demand regular payments be made, the bank will agree to capitalize the interest on the loan and wait to be paid until the shareholder and spouse die. The bank would be prepared to do this because the cash value inside the policy would continue to grow tax-sheltered to offset the increasing bank loan.

We recommend the UL policy be a joint last-to-die policy on the shareholder and spouse so that upon one of their deaths, the policy would continue in force, maintaining the tax shelter and the surviving spouse would continue receiving the bank loans as tax-free income.

When the last spouse dies, the holding company, which is the owner and the beneficiary of the policy, would receive the death benefit tax-free from the insurance company. That money would be paid out as a special capital dividend to the shareholder’s estate which would then pay the bank loan. There would also be money left over for estate taxes and possibly for inheritances.