Starting a business? Here’s what it means for your financial plan

Guest post by Claudia DoRego, Planswell

For many hopeful entrepreneurs, giving up their 9 to 5 lifestyle to become their own boss is a long-awaited dream. But the reality of self-employment can come as a serious shock, especially if you haven’t done your research.

Starting your own business can lead to significant changes in your lifestyle, as well as your finances. The importance of updating your financial plan to fit this life change is crucial.

In the early stages of entrepreneurship, you are often more focused on creating sufficient cash flow than on your overall financial plan. But once your business has solid footing, there are multiple ways your plan will differ from a non-business owner.

Here are five ways that your financial plan might change if you start a business.

Tax deductions

As a business owner in Canada, there are a wide variety of potential tax deductions that you can use to reduce the amount of income tax you are required to pay at the end of the tax year, or even to receive a tax refund.

Generally, anything you need to spend in order to run your business can be deducted from your taxable income for the year. Even with a small home-based business, these deductions could cut the cost of things like your cell phone, internet service, part of your rent or mortgage interest, and car lease roughly in half.

Just make sure to save all your business-related receipts as the Canada Revenue Agency (CRA) may ask to see them and disallow anything that isn’t documented.

Incorporation

In Canada, a corporation is treated like its own person. It can earn its own money, pay its own taxes, borrow its own money, and handle its own legal issues. This can have some advantages for you as a business owner.

If your incorporated business generates more income than you actually need to maintain your lifestyle, you can take a salary just for the amount you need and leave the rest in the corporation, which pays a lower rate of tax than you do. If members of your family work for your business, you can also pay them salaries and spread the tax burden around, which may lower the overall tax rate of your household.

Once your corporation has a track record of earnings, it can qualify to take out loans or lines of credit that you may need to grow your business. And if your business ever runs into the unfortunate event of being sued, the corporation itself can bear the liability, which means you can limit the risk of losing personal assets, such as your home and your retirement savings.

Cash flow

The freedom that comes with being your own boss can, however, come with at least one drawback – your income may be less predictable than when you had a regular job. Things can get stressful if the income isn’t rolling in as fast as you’d like and the bills start to pile up.

The first thing to think about is having an emergency fund. A good rule is to have six to 12 months worth of business and personal expenses combined set aside. You probably don’t want to invest this money into anything risky, because you could need to draw on it at any time. A high interest savings account is just one example.

The second thing to think about is a line of credit. The idea is not to carry a balance, but to smooth out your cash-flow from month-to-month. For example, to pay a bill that’s due before your client has paid you. As a newbie, you’ll probably need to secure your line of credit with some type of collateral, such as your home. Once your business is more established and creditworthy, an unsecured line of credit should be easier to obtain.

Health benefits

Once you’re self-employed, you’re no longer part of a cushy corporate benefits package – you’re on your own. Fortunately, there’s a great solution you can use called a Health Spending Account (HSA).

Essentially, you take pre-tax earnings from your business and put it in your HSA. You then take money from your HSA tax-free to pay for your medical or dental expenses. In short, you can make anything from routine medications to deep tissue massage sessions tax-free perks of your job.

HSA benefits can also be extended to employees of your company, which is generally a more flexible and cost-effective option than purchasing a group benefits package. You just decide how much HSA money to give each person, and they spend it as they see fit.

Retirement

One of the unique strategies that’s possible with an incorporated business is retirement planning using a corporate-owned life insurance policy. This strategy is designed to help you withdraw money that you’ve built up within your corporation without having to pay the tax you’d normally pay if you simply withdrew it as a salary or a dividend.

The basic concept is this: you use some of the earnings within your corporation to purchase a whole life insurance policy. You pay premiums for typically 10-20 years, and the policy is set up so that it will pay a tax-free death benefit if you pass away in the future.

When you reach retirement, instead of withdrawing money from your corporation, you actually use the insurance policy as collateral to  take out a personal loan. You get the loan proceeds tax-free, and when you pass away, the tax-free insurance benefit repays the loan for you.

That’s a simplified description and you need some expert advice to make this work, but the potential tax-savings can be huge, so it’s worth checking out if you’re a business owner.

Everybody needs a good financial plan, and that’s doubly true for budding entrepreneurs. You want to free up as much time and mental bandwidth as possible to focus on building a great business without worrying about financial risks and missed opportunities. When a good business plan and a good financial plan come together, truly great things can happen.

Grow your wealth. Manage your borrowing. Protect your assets. Planswell gives you a free plan that ties investments, insurance and mortgages together so you can maintain your lifestyle throughout work and retirement.