Retirement Income Planning Challenge

Case Analysis: Canadian Controlled Private Corporation (CCPC) - J.W. Dental Inc.

Introduction:

Below is a case study of a fictional dental practitioner named Jane. She represents a typical business owner in the professional services field who is in the wealth building stage of her financial life: A high income earner building a practice and saving for the future. This case study will allow you the opportunity to use financial calculations for the purpose of helping Jane formulate a retirement income plan with respect to drawing a retirement income from a corporate savings account. Begin by reading her background and start making note of Jane's goals and concerns.

Background:

Name: Jane Wilson

Sex: Female

Age: 45

Employment: Incorporated General Dental Practitioner

Financial Situation:

Jane has spent most of her working years focusing on running her successful dental practice and being fiscally responsible with the healthy income she earns. She considers herself a "do-it-yourself" investor and has managed her money at local banks and TD Direct Investing online. Her only financial relationship is with their independent insurance agent who is also her neighbour.

Jane is a general dental practitioner in London, Ontario. She started the practice, J.W. Dental, upon graduating from the School of Dentistry at Western University. She's a single mother of two children, Sam (13) and Judith (9).

When Jane first started out, finances were very tight. At one point she even needed to loan the corporation $50,000 to keep it afloat. Eventually, her strict work ethic and savvy business acumen brought her financial success. It's at this point that she began to enjoy the finer things in life. This involved a great deal of world travel and significant leisure time with her children. Now, as she is entering her mid-forties with a six-figure income, very good health and a corporate savings account approaching half a million dollars, she is beginning to ask herself what kind of income she can expect when she decides to retire at age 65.

Jane's dental practice currently has an average annual revenue of approximately $900,000. Her net earnings after operating expenses and taxes has been approximately $300,000 to date. A detailed projection of future earnings is provided under the "Corporate Earnings Projection" heading below. She pays a portion of these earnings to herself as dividends each year and leaves the remainder to accumulate inside the corporation. She currently has $450,000 saved inside the corporate account, which she manages herself through TD's Direct Investing website. Without the help of any financial advisor, she's been able to achieve an average compound annual return of 5% on this account.

Jane is 45 this year. She would like to work until age 65 and retire when she turns 66. It's at this point where she's lost planning-wise. Accumulating the money seems easy for her. Given her risk tolerance and time frame, she simply saves annually and rebalances to her moderate investment allocation (40% equity, 60% fixed income) once a year.

When it comes to retirement income, she hasn't a clue where to start. At the very least, she knows she should invest more conservatively. She plans to adjust her asset allocations at age 65 to a 30% equity / 70% fixed income mix and use 4% annual return for her retirement income projections. She knows very little about the taxation of corporate withdrawals and wonders what would happen to the corporate accounts if she were to pass away in retirement with funds still left inside.

Jane was introduced to you by a friend of hers, a current client of yours, who invited her to your retirement seminar that you hosted. After agreeing to a face-to-face meeting at your office, she prepared the following summary of her financial data and returned it to you.

J.W. Dental - Corporate Investments:

Current Market Value: $450,000

Starting Adjusted Cost Base (ACB): $400,000

Current Non-eligible RDTOH Balance: $50,000

Current CDA Balance: $0

All income earned thus far has been taxed at the lower rate so you may assume a GRIP balance of $0

Accumulation Phase (Age 45-65) Annual Return:

Interest: 2.0%

Eligible Dividends: 1.0%

Foreign Dividends 0.5%

Realized Capital Gains: 0.5%

Unrealized Capital Gains: 1.0%

Total 5.0%

Retirement Phase (Age 66-85) Annual Return:

Interest: 1.5%

Eligible Dividends: 1.0%

Foreign Dividends 0.5%

Realized Capital Gains: 0.5%

Unrealized Capital Gains: 0.5%

Total 4.0%

Corporate Earnings Projection:

Age

Year

Corporate Earnings After Tax*

Dividend Paid to Jane

Retained in Corporation

45

2020

$300,000

$145,000

$155,000

46

2021

$310,000

$150,000

$160,000

47

2022

$320,000

$155,000

$165,000

48

2023

$330,000

$160,000

$170,000

49

2024

$345,000

$165,000

$180,000

50

2025

$355,000

$170,000

$185,000

51

2026

$370,000

$180,000

$190,000

52

2027

$380,000

$185,000

$195,000

53

2028

$395,000

$190,000

$205,000

54

2029

$410,000

$200,000

$210,000

55

2030

$425,000

$205,000

$220,000

56

2031

$440,000

$210,000

$230,000

57

2032

$455,000

$220,000

$235,000

58

2033

$470,000

$225,000

$245,000

59

2034

$485,000

$235,000

$250,000

60

2035

$500,000

$240,000

$260,000

61

2036

$520,000

$250,000

$270,000

62

2037

$535,000

$260,000

$275,000

63

2038

$555,000

$270,000

$285,000

64

2039

$575,000

$280,000

$295,000

65

2040

$600,000

$290,000

$310,000

* These are corporate earnings after Part I and IV tax have been paid

The Challenge:

Build a complete calculation model of CCPC taxation showing two scenarios:

1. Build the corporate savings account according to the assumptions provided. Jane will begin her retirement and start taking withdrawals from her corporate savings on her 66th birthday. Solve for the annual level withdrawal amount that will deplete the corporate savings account at the end of Jane's age 85.

2. Build the corporate savings account according to the assumptions provided. Jane will begin her retirement and start taking withdrawals from her corporate savings on her 66th birthday. Solve for the annual level withdrawal amount that will leave $5,000,000 in the corporate savings account at the end of Jane's age 85.

The focus of these calculations will be on passive income that is earned by corporate-owned investments.

The model should be built in Excel or another computation platform. An additional write-up in Word (or other word processor) should be included to address the solutions to the two scenarios above and what assumptions were made in obtaining those solutions.

The model should show year-by-year corporate tax calculations and should last until Jane's age 100.

The CCPC taxation model must include the following:

o Tracking of net operating revenue into the corporate account.

o Account for corporate investment returns in the proportions provided including interest, eligible Canadian dividends, foreign dividends, realized capital gains, and unrealized capital gains.

o Track the adjusted cost base of the corporate investment account and account for capital gains tax realized in relation to withdrawals from the corporate investment account.

o Tracking of notional accounts such as LRIP vs GRIP, Refundable Dividend Tax on Hand (RDTOH), and Capital Dividend Account (CDA).

o Account for withdrawals from the corporation with customizable priorities between RDTOH, CDA, eligible & non-eligible dividends.

When investments are sold and capital gains are realized, you should assume the capital gain realized is proportional to the total amount of the investments sold.

o As an example, suppose in one year the corporate investments had a market value of $100,000 with ACB of $80,000 and $10,000 of those investments are to be sold to issue a dividend. Since 10% of the total investments are being sold, we would assume 10% of the previously unrealized capital gain is being realized with that sale so the sale would trigger a capital gain of $2,000 [= ($100,000 - $80,000) * 10%]. Immediately after the sale, the market value of the investment would then be $90,000 [= $100,000 - $10,000] and the ACB would be $72,000 [= $80,000 + $2,000 - $10,000], Jane would receive a $10,000 dividend, and the corporation would include an additional $2,000 of capital gain in determining their taxes that year.

Additional functionality that is desired but not required includes:

Corporate-owned life insurance - Illustrating the expense of a life insurance premium being deducted from corporate savings and tracking the cash surrender values and sum insured.

Add functionality to account for a capital loss and allow it to be carried forward to offset future capital gains.

Allowing for a shareholder loan to be included and subsequently withdrawn