Financial planning for clients with corporations: the art of asset location

MD Financial director of financial planning breaks down what advisors can do when their clients have a professional corporation

Financial planning for clients with corporations: the art of asset location

For professionals and business owners, incorporating can open the door to a wide array of financial planning options. It can offer tax efficient outcomes, vehicles for retirement savings, and flexibility that many clients need when planning for their families or their legacies. But while many professional and business owner clients see incorporating as the be-all and end-all of their financial planning, their advisors need to remain clear about how the corporation fits into their wider personal financial picture.

Professional corporations are a hallmark of medical professionals’ financial plans. Given the preponderance of incorporated clients in the medical field, WP spoke with Stephen Hunt, director of financial planning at MD Management Limited. He outlined some of the options that advisors have when working with an incorporated client, and detailed some of the areas they often miss or struggle with as they seek to use the corporation to their clients’ advantage.

“The key benefit of a corporation is as another vehicle that you can use within your client’s personal financial planning,” Hunt says. “All Canadians have access to the non-registered account, and most have access to the RRSP and the TFSA, but for professionals the corporation gives them access to another vehicle with different traits…The key is understanding the intent of the corporation in the first place.”

Hunt emphasizes that there’s a big difference between incorporating to run and manage a business like a restaurant — with large amounts of money flowing in and out, with little opportunity for retained earnings — and a professional corporation. When the corporation has day to day requirements for the running of a business, advisors and their clients are more limited with how they can use the corporation for financial planning — though they do still have some options. Professional corporations, while still running a business, can offer a much wider array of options with the retained earnings, if used correctly.

Advisors need to think of professional corporations as a tool for asset location, rather than allocation. That means selecting which assets in your client’s overall portfolio work best inside a corporate account, as opposed to an RRSP, a TFSA, or a non-registered account. Registered accounts like RRSPs and TFSAs have tax sheltering advantages, which makes   holding interest paying investments like bonds or GICs desirable. Corporate accounts don’t have the same tax sheltering, but they can be used to hold securities eligible for the Canadian dividend tax credit — such as Canadian equities, and securities you expect your client may need to pay capital gains on.

Not only are the tax rates lower on income from these securities, or eligible for tax credits, but the corporation can add efficiency to passive income strategies involving capital gains. That’s because of something called a capital dividend account (CDA) within a corporation. If your client earns $100 of capital gains in their corporate account, for example, only $50 of that is taxed. The other $50 that is tax free, remains in the corporation and credited to the  CDA. From there it can be paid out at a later point in time, tax free, say when your client is retired or any time where additional taxable income is not desirable.

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While artful use of asset location can be a huge benefit for advisors and their clients, Hunt says the most common mistake advisors make with these clients occur when they focus almost exclusively on the corporation. Holding those less-efficient securities inside a corporate account can have negative tax consequences for clients, for example.

As for client mistakes, Hunt will frequently see cash accruing inside corporate accounts without any allocation. Whether because they’re too busy, or risk-averse, clients may leave huge sums of money in their corporate accounts earning little more than a low rate of interest. That work of asset location and allocation can best be done by their advisor.

Hunt believes that advisors who want to work with more incorporated clients can improve their services by learning more about tax planning. While sometimes tax planning is confused with what a client’s accountant takes care of, Hunt stresses that of the core competencies in financial planning, tax planning is one of the areas where advisors can make the greatest difference for their clients, especially those with professional corporations.

“The key word is planning,” Hunt says. “Right now, the average accountant is looking at your clients’ slips and accounts to put together the 2023 tax return. But there’s very little tax planning that can happen right now for 2023, but a lot can happen for 2024. As a financial planner you can really help with the tax planning concepts and introduce them early in the year.”