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Just taking care of business?

First, take care of yourself with a diversified RRSP portfolio, experts tell DIANNE RINEHART. That will help you take care of your company as well

If you think your business is the only retirement investment you need, you may want to reconsider.

There's a natural tendency for small business owners to invest their disposable income back into the business, instead of buying RRSPs, says Kathryn Del Greco, an investment adviser at TD Waterhouse Canada. "Their belief is that their best asset is their own ability to generate wealth." They generally own a home and their company and feel that those assets will be enough for their retirement.

But there are serious pitfalls to that planning, experts warn.

First, if personal health problems or an economic downturn mean you have to sell, "your proceeds might be considerably less" than expected, warns Julie Sheen, vice-president BMO Term Investments.

Then, there's the question of who will buy your business. Rob Paterson, senior vice-president of CIBC small business banking, says you may be disappointed. A 2004 poll conducted by CIBC found that 31 per cent of small business owners plan to use their businesses for retirement and about the same percentage were not buying RRSPs. But the study also found that 60 per cent of those within the prime retirement planning period of 55 to 64 hadn't even discussed succession with family members or business partners.

When they do, Mr. Paterson warns, they may find that family members and business partners don't want to buy them out. Or they may discover they've overvalued the business because it's built on their own skills and networks. So when they leave, it's worth a lot less.

That's why it's important to "diversify their net worth by also investing in their retirement through RRSPs," Ms. Del Greco says.

She'll get no argument from John, a Toronto contractor who asked that his real name not be used.

He was in business with his father and brother and they decided to put all their money back into the company. But during the recession in the 1980s, work was more scarce and bids had to be more competitive, he says. "At one point, we had 11 people plus our office staff of three. When the recession hit, we still had all those salaries. It really drained our company."

In the end, the partnership dissolved - John's brother launched his own business and their dad retired. "We didn't have what we intended to have in the company at the end of the day," John says. "If I was to do it all over again, I would certainly have put all of my money into RRSPs at the very beginning." He now invests in them regularly.

There's no denying that RRSPs can help entrepreneurs plan not only for retirement, but for downturns in business cycles.

Here's how:
  • RRSPs give you the opportunity to invest globally in new trends and businesses outside your industry. "One company is very rarely able to offer all the investment opportunities of a well-balanced diversified portfolio," Ms. Del Greco says.
  • RRSP assets are very liquid, allowing you to adjust them according to market circumstances much easier than you can restructure your business to respond to market change, Ms. Del Greco says. "If you go through a difficult business climate and retirement is five years away, you're not going to start building X instead of Y. Whereas what you can do in your RRSP is restructure them in a more conservative fashion to preserve your assets."
  • Your RRSP is "a source of emergency cash," Ms. Sheen says. And well-diversified RRSPs that won't be subject to the same market pressures as your company can help smooth out the cyclicality of income that so often accompanies running a small business. For example: You can claim a high RRSP contribution in a year when your income is subject to higher tax rates, and not in years when you haven't made very much and don't need the write off as much. As well, in a downturn, the cash is at hand - at a lower tax rate than in boom years - if you need it.
  • You can use RRSPs to split your income. A contribution in your spouse's name - if he or she is earning less than you - translates into a deduction at the higher earning spouse's tax rate. But if those RRSPs are needed during a lean year, they're cashed in at the spouse's lower tax rate. So why don't more small business owners invest in RRSPs?

The biggest challenge is a lack of cash flow: They're not likely to contribute to an RRSP until their business is in the black and making money, Ms. Del Greco says.

But that's not good enough, Ms. Sheen warns. "Have a plan because the years can go by very quickly. Give up a few coffees every week and put it in." Another piece of advice: Your salary determines what your RRSP limit can be, Mr. Paterson says. "So you need to make sure you're taking the right amount of money out of the business because it affects your contribution level."

If your business is at a more mature stage - that is, you're over 40 and have a T-4 income of at least $100,000 - you may want to consider an individual pension plan or IPP, says Ms. Del Greco. "It's an alternative to an RRSP, but it acts just like an RRSP."

The difference is that you have significantly higher contribution limits, she says. "And generally the corporation is allowed to make the contributions on your behalf ..... as opposed to you using your after-tax income for RRSP contributions."

In short, Ms. Sheen sums up, your RRSP is the perfect small business owner vehicle for income splitting, creating tax-free compounding income for slow years, and diversifying your risk - not to mention retirement planning.

Much needed advice, one expects, for the 500,000 small business owners with $1.2-trillion in business assets who, according to a CIBC study released last week, plan to retire in the next five years and create "the largest turnover of economic control in generations."

Special to The Globe and Mail

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