Planning for freelance workers and the self-employed

The economic impacts of the COVID pandemic – roller-coaster stock markets, job losses, struggling businesses – have left many Canadians concerned about their financial security. The world crisis has reinforced the importance, at any age, of having a detailed financial plan that can help you realize your dreams and retire comfortably.

This five-part series of articles highlights the importance of having a financial plan, and how an advisor can help you be prepared for market corrections, as well as all the big events in your life. In Part 4, we look at the key benefits having a financial plan affords small business owners or self-employed gig workers.

Small businesses are often called the engine of the Canadian economy. That’s because 98% of all businesses in Canada have fewer than 100 employees and in 2018 employed nearly 70% of the workforce, accounting for more than a third of Canada’s GDP. 

While they are busy keeping the country going, entrepreneurs often don’t have the time or the skills to plan for their own future financial needs. Having a financial plan can help them balance their business and life goals, retain some of the wealth they are accumulating, plan for the ‘what ifs’ and save time and stress.

“Business owners I know are crazy busy, work long hours and have a family,” says Melanie Hardie, Investment Specialist and Financial Planner, Global Wealth Management at Scotiabank. “So what’s important to them when we get together every year to update their plan is that I make them carve out the time to do it.”

Hardie, who works with small business owners, says spending time up front means many decisions or questions that come up throughout the year can be quickly dealt with because the bare bones of the plan are already in place. The alternative is having an opportunity come up and having no idea what that looks like for their long-term plan.

“The minute you don’t have the luxury of an employer taking care of certain aspects of your finances is when you need to engage a professional to help you put some structure into your finances,” says Tonya Campbell, Regional Vice President, Central Canada Mobile Advice Team at Scotiabank.

Whether you run a small business, are self-employed or a gig worker, a financial planner can help you work through the added layer of complexity to your finances, including tax planning; balancing the flow through of cash to themselves versus reinvesting in the business; and retirement funding. The important thing is to find the advisor best suited for your needs. That will require asking about their experience working with business owners and what their credentials are and understanding what those credentials mean.

Once you’ve found the right person, you’ll need to share with them all the information that makes up your life story and that of the business. That means doing a deep dive of your own income and expenses, a list of assets and liabilities, your goals for the future — shorter and longer term — and an understanding of your risk tolerance, as well as documents detailing the business’s cash flow, liabilities and future goals.

“The thing that is important is going to be your business, and that extra layer of complexity it brings will have a direct impact on your finances, your future and your cash flows,” Campbell emphasises.

One of the first rules of entrepreneurship is to never mix business and personal finances, but for many busy small business owners it is the last thing on their mind. “What we see happen quite often is small businesses start out small and the lines are blurred between personal and business income, and as they grow the need for that separation becomes greater,” Campbell says.

In every financial plan there will be trade-offs, but for a small business owner the decisions often are between drawing income now to finance a big item, putting money into retirement savings or leaving the money in the business to expand the operation. An advisor can guide you in setting up a plan that includes savings and investment strategies, income planning, risk management — planning for the risk of those assets and other risks in your business or personal life — insurance to cover some of those risks, taxes and estate planning.

“There’s got to be a balance on both sides and a financial planner can help you make thoughtful decisions about the trade-offs,” Campbell says.

The time for separation of finance often boils down to your situation, Hardie says, noting that it’s not unusual for the owner of a sole proprietorship, whose business is a big part of who they are, to have a lot of overlap of cash flow and net worth. “However, if you are married and your spouse has a completely different source of income and you have children, then it makes sense to have all of that in one plan that can develop as you go, rather than trying to throw it together five years from retirement,” she advises.

The Income Tax Act favours people who work for themselves and there are several advantages for those who own a business. You’ll want to ensure you are maximizing every tax strategy available, from income splitting, to employing family members, and using the ownership structure of the business (sole proprietorship, partnership, or limited company), or having a holding company for liquid assets.

“All of those strategies have very different tax consequences and differ as far as how they work with your personal life,” Hardie says, who recommends clients work with an accountant to set up the right structure for their business. Even the nature of your business can be a factor, Hardie says, citing the example of a sole proprietor with a home office, who can write off a lot of expenses against earnings, which in a lot of cases are also personal expenses, such as mortgage or rent, heating, hydro, and Internet. That’s not the case if you own a retail store, she says.

A key benefit of having a financial plan is peace of mind, which for business owners means having the flexibility to keep on track when a ‘what if’ scenario happens. For example, do you have a plan if the market value of your business is less than expected when you’re ready to retire or nobody is interested in buying it? What if there is a major business disruption? What if your sales disappear?

“COVID-19 has helped make the ‘what if scenario’ seem a little more real than it might have a year ago,” Hardie says. She has seen retail business owners struggle to pay for the next season’s products and keep the business going, because the pandemic erased the previous season’s sales and there is no cash flow. She wonders what it might mean for their retirement down the road. Will they be able to get what they might have two or three years ago when they go to sell the business?

Many small business owners don’t plan their retirement funding beyond thinking that the sale or transition of their business might be their plan, either through a lump sum payment or residual options from the company. A huge part of a personal plan for a business owner is being able to transition the money in the business to themselves now and over time.

What you need to think about is would either option provide the level of income you need in retirement and if not, figure out how can you draw enough income in the years leading up to retirement to create your own pension plan. “Unless you are planning for both and augmenting the business’s growth with your personal financial growth, it’s that old ‘putting all your eggs in one basket thing’,” Hardie says.

A registered retirement savings plan, a tax-free savings account or both are all good options for small business owners, and particularly sole proprietors. Contributing to a registered retirement savings plan makes sense during earning years to decrease your tax bill. However, if you have sufficient deductions to reduce your taxable income to less than $40,000, it makes more sense to simply build up a tax-free savings account, Hardie says. “What I normally recommend is that you do an RRSP contribution then use the refund to build your TFSA to maximize your tax savings,” Hardie says.

If you have a larger business and are a high-income earner, Individual Pension Plans (IPP) and Retirement Compensation Arrangement (RCA) are options you can discuss with an accountant. Generally, they are set up between a business and a trust company for the owner and key executive team and while they siphon profits from the business, they allow these high-income individuals to build an RRSP with no personal limit.

While your situation may not be as complex as a business owner’s, self-employed workers need to plan to cover what an employer normally would, including putting aside money for income tax payments and saving for retirement.

“What I’ve seen is people with great big tax bills that they weren’t planning for and didn’t set the money aside for. Once you make that first mistake it’s hard to start recovering because now you have to fix that one and then put aside money for going forward,” Campbell says.

A financial planner can help you carve up your income for those things as well as a for a health insurance plan and a contingency fund. Campbell recommends having three to six months’ worth of living expenses in a savings fund to manage through seasonal fluctuations in cash flow, the loss of a big client or an illness. COVID-19 shutdowns have emphasized the need for that for many workers in the gig economy, some of whom did not qualify for CERB or other government benefits.

Added expenses
What small business owners and the self-employed need to tuck money away for:

• Income tax planning
• Health insurance
• Contingency fund for ‘what if’ scenarios that affect your income
• Retirement savings
• Cash flow for life’s expenses