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Starting your own business? Prepare your finances first

Whether you’re just starting out and want to set your own path, looking for a mid-career change or saying no to a traditional retirement, launching a business can be an enticing option. But when it comes to your finances, there’s more to becoming your own boss than meets the eye. Here are a few ideas on navigating the transition from employee to entrepreneur to avoid unpleasant surprises.

Working for yourself: what’s different?

Self-employment has a number of financial advantages. For one, you don’t have to pay into federal Employment Insurance if you don’t want to. Then there are the potential tax benefits, from having a wide range of deductible expenses to splitting business income with family members.

What you do need to be aware of, however, is that as a self-employed person, you’ll be on the hook for both employee and employer Canada Pension Plan premiums. Remember that you will no longer have paid vacation time, group health plans and a company pension. You’ll have to put different strategies in place to compensate.

Devising an income plan

How much will be coming in each month? How much will be going out? What discretionary spending could you pare back? Answering these questions will let you calculate the amount of money you’ll need from your venture to meet operating costs, as well as fund your own living expenses. Keep in mind a variable income can make getting credit more difficult.

If your business is incorporated, you’ll have more discretion when managing income. You can draw income as salary or dividends. There are advantages to each. Salary is earned income for purposes of calculating RRSP contribution room. Dividends receive preferential tax treatment. Your advisor can further map out the pros and cons of each option and how to use both for your individual circumstance.

If you’re an older entrepreneur, there’s another wrinkle to consider when devising your income strategy: how to handle Canada Pension Plan (CPP) benefits.

Extending your career beyond the normal retirement age has implications for deciding when to begin receiving CPP. If you can afford to, holding off until after age 65 to collect can boost your monthly payout – as much as 42% if you wait to age 70. Remember, it’s considered taxable income, so plan carefully. Tacking CPP onto your business and other income could force you into a higher marginal tax rate.

Keeping your business and personal expenses separate

You may be used to your employer managing routine tax deductions from your paycheque. Once you’re working for yourself the chore of managing income tax falls to you alone. The good news is you’ll be able to deduct costs related to your business operations, from office supplies, advertising and your cell phone, to vehicle expenses. Have a home office? You could be eligible to deduct a portion of residential expenses like utilities, property taxes and mortgage interest.

Identifying those tax-saving opportunities will be simpler if you establish separate bank and credit card accounts for your personal and business transactions right out of the gate. The Canada Revenue Agency requires financial records be kept for a minimum of six years to support your filings, so it’s important to be organized.

How often must you remit? Once your net tax owing for the current year, and either of the previous two years, exceeds $3,000, you’ll have to pay income tax quarterly. And, don’t forget about additional obligations like CPP premiums.

Ready to take more control of your retirement savings?

Not only should entrepreneurship prompt a review of your retirement plans, quitting your job also means you can no longer contribute to a company pension, putting more responsibility for your retirement savings in your hands.

The upside if you’re incorporated is you’ll see generally lower tax rates, plus, you can build wealth by reinvesting in your business.

At the same time, there’s danger in leaning too heavily on your business’ value to pay for your retirement. Your enterprise could hit hard times, or you might have trouble finding the right buyer when you’re looking to sell. Don’t ignore the diversification and tax-saving benefits of contributing to your RRSP and TFSA.

You’re not alone

There are plenty of moving pieces when you transition from employee to running a business of your own. The more you know about the financial implications with entrepreneurship up front, the smoother the road ahead. Devise an income plan, separate your business and personal expenses and proactively manage your retirement savings.

If you want help navigating this change, consider drawing upon the expertise of a team, including your financial advisor and business advisor. They will work with you to build a financial plan that’s comprehensive so you can accomplish your personal and professional goals.

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This article is provided as a general source of information and should not be considered personal financial or investment advice or solicitation. The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete.

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