Episode 222: How to Create Tax Free Passive Income With Your Retained Earnings

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Are your retained earnings quietly shrinking under taxes and inflation — even though your business is thriving?

If you’re an incorporated business owner, you’ve likely felt boxed in by bad options: pull money out and lose nearly half to tax, leave it sitting idle, or invest and watch passive income get hit with punitive rates. Meanwhile, wealthy families seem to grow corporate wealth smoothly, access liquidity when they need it, and pass money on with minimal tax friction. This episode breaks down why that gap exists — and how the rules of the Canadian tax system actually reward those who know how to structure properly.

In this episode, you’ll discover:

• How holding companies and connected corporations can turn retained earnings into 0% tax investment income
• Why most “safe” corporate investments are tax traps — and what replaces them
• The missing strategy that allows you to access corporate wealth tax-free during life and at death

Press play now to learn how incorporated business owners turn retained earnings into a tax-free corporate wealth flywheel.

Resources:

• Ready to take a deep dive and learn how to generate personal tax free cash flow from your corporation? Enroll in our FREE masterclass here. 
• Book a Discovery Call with Kyle to review your corporate (or personal) wealth strategy to help you overcome your current struggle and take the next step in your Canadian Wealth Building Journey!
• Discover which phase of wealth creation you are in. Take our quick assessment and you’ll receive a custom wealth-building pathway that matches your phase and learn our CRA compliant tax optimized strategies. Take that assessment here.
• Dig into our Ultimate Investment Book List
• Follow/Connect with us on social media for daily posts and conversations about business, finance, and investment on LinkedIn, Instagram, Facebook [Kyle’s Profile, Our Business Page], TikTok and TwitterX. 

Calling All Canadian Incorporated Business Owners & Investors:

Consider reaching out to Kyle if you’ve been…

• …taking a salary with a goal of stuffing RRSPs;
• …investing inside your corporation without a passive income tax minimization strategy;
• …letting a large sum of liquid assets sit in low interest earning savings accounts;
• …investing corporate dollars into GICs, dividend stocks/funds, or other investments attracting cordporate passive income taxes at greater than 50%; or,
• …wondering whether your current corporate wealth management strategy is optimal for your specific situation.

Corporate wealth management for Canadian business owners goes far beyond basic investing—it’s about building a complete Canadian wealth plan that turns retained earnings into tax-free income while supporting long-term financial freedom in Canada. Through smart corporate tax strategies like holding company structures, life insurance planning, salary vs dividends optimization, and tax-efficient investing, entrepreneurs can create reliable passive income, accelerate early retirement strategies, and support a modest lifestyle wealth approach without unnecessary tax drag. By combining corporate wealth planning with RRSP optimization, capital gains strategies, real estate investing in Canada, and clear financial buckets, business owners can balance personal vs corporate tax planning, diversify investments, and strengthen estate planning in Canada. The result is a repeatable financial system that supports financial independence, business owner tax savings, and a lasting wealth legacy—designed specifically for Canadian entrepreneurs focused on building long-term wealth with clarity and control

Transcript:

Hey everyone, Kyle here from Canadian Wealth Secrets. Today we’re diving into one of the most important and misunderstood topics for incorporated business owners in Canada. How to turn your retained earnings into tax-free passive income while building long-term liquidity and reducing the tax bill your family will eventually face. If you’ve ever wondered how do I grow my corporate wealth without paying 50 % tax on passive income,

How do I access that money personally without losing half the tax? And how do wealthy families structure things so elegantly? Then this video is the one you’ve been waiting for. And if you’re incorporated business owner, this might literally reshape your financial life. Hi, I’m Kyle Pearce and I’m the president of corporate wealth management at Canadian Wealth Secrets, where we educate and guide Canadian incorporated business owners to developing strong personal

and corporate wealth management systems designed to help you build your net worth during your growth years, access tax-efficient cashflow during your retirement, and leave a legacy that lasts for your family and charitable organizations. Now that we’ve cleared that up, go grab a pen and let’s dig into the content. The problem with retained earnings. Here’s the challenge that so many Canadian business owners face. You build a great business,

You generate strong profits, you reinvest, you hire, you create value, and eventually you build up retained earnings in your corporation. But here’s where the system turns against you. Option number one, you can pull the money out personally. Boom, hit with personal tax. Depending on your province or territory and assuming you’ve already taken a reasonable income through salary or dividends, any additional funds you wish to withdraw will likely cost you between 39 %

and even upwards of 54%. Option number two, you can let the money sit in the corporate bank account. Now this is a safe and liquid option, but now you’re losing value every single year to inflation and in turn, the amount of goods and services you can buy with those dollars decreases with every passing year. Option number three is you can invest in traditional assets inside the corporation.

Now, while many fixed income assets such as high interest savings accounts, money market funds, GICs or other safe and non-volatile assets can generate consistent and predictable passive income, the CRA steps in and takes 50 % in passive income tax on that corporate investment income. So the average business owner feels trapped. If I withdraw it, I lose half to tax. If I leave it in the corporate bank account, I lose to inflation.

If I invest in safe and predictable fixed income assets, I lose half to passive income tax. If I invest in capital gain generating growth assets, I take on more risk, less liquidity, and must pay capital gains taxes on the eventual realized capital gain. But that’s only because most business owners have never been exposed to other strategic structures and opportunities. Let me show one modern corporate wealth system that can actually work in your favor.

First, we’re going to talk about the holding company advantage. The first step in building a modern corporate wealth system is creating a holding company or a hold co for short. Think of your hold co as a vault, an investment platform, a tax-efficient container, a place where retained earnings can grow without risk of liability from your active income generating operating company. It does four things really well. It’s going to protect assets from lawsuits or business risk.

It’s going to centralize retained earnings from multiple businesses. It’s going to create investment flexibility that operating companies don’t have. And most importantly, it allows you to pass your after corporate tax earnings from your operating company, what we call retained earnings, up to your holding company tax-free. Now this makes sense because your holding company is what the Income Tax Act refers to as a connected corporation, which means that the money can move as an inter-corporate

dividend from one connected corporation to the other without triggering any additional tax. Since no new income has been created, there is no new tax to pay. So let’s pause to think about the significance of that. Your operating company earns active business income. You’re going to pay your normal small business tax rate of 9 to 12.2 % on the first $500,000 of profit, depending on your province or territory.

And then instead of leaving that money exposed inside your operating company, we can sweep it up into the holding company with zero tax impact. No personal tax, no additional corporate tax, just a clean tax-free transfer of your retained earnings into a safer, more flexible corporate structure. That’s what lets your holding company become your wealth engine and not just a bank account. However, it isn’t all roses.

Because our income tax rules are designed in a way to try to be as fair as possible to all Canadians, there are some rules in place that can actually end up penalizing those incorporated business owners who are not educating themselves in order to minimize the amount of taxes they pay inside their corporate structure. For example, one tax rule that’s actually more punitive for business owners and it really designed to encourage incorporated Canadians

withdraw more money out of their corporation is the passive income tax rate. The assumption is made federally and provincially that when selecting income tax rates for passive income generated in a corporate structure, that the shareholder must be in the highest tax bracket and therefore it brings on an approximate 50 % income tax rate for passive income if the earnings are not withdrawn by the shareholder each year to a personal level.

That means placing corporate retained earnings, whether in an operating company or a holding company into a high interest savings account, GICs, money markets, bonds, even income generating rental properties means the earnings are taxed at about 50 % depending on your province or territory. But here’s where things get interesting. Once those retained earnings are sitting safely inside your holding company, you’re actually now in a position to use those dollars to

buy shares in other Canadian incorporated active businesses. And if your holding company buys more than 10 % of the voting shares and more than 10 % of the actual equity value of that business, your holding company and that operating company you’ve just invested in become connected corporations. And that one classification changes everything.

Because now, just like your own operating company can send dividends up to your hold-co tax-free, that other business can do the exact same thing. You’ve essentially extended the inter-company dividend benefit beyond your own business, directly into the private businesses you choose to invest in. Which means, passive investment income from GICs, savings accounts, dividends from publicly traded companies, or rental income, that’s going to be taxed at around 50%.

but dividends from an active business that’s considered a connected corporation to your holding company, those dividends flow into your hold co at a 0 % tax. So now your corporate structure isn’t just protecting assets, it’s giving you a pathway to grow your retained earnings completely tax-free on the investment side as well. This is one of the most powerful and underused corporate tax rules in Canada.

This is why private equity groups like PEGATE, who we’ve collaborated with on this topic, structure their deals so that business owners can actually qualify for that connected status. Because once you do, you’ve now created a tax-free corporate compounding machine. Your retained earnings can grow at 8%, 12%, even 20%, depending on the business, without triggering any additional passive income taxes.

This alone can make the difference between retiring wealthy and simply retiring. But as powerful as the 0 % dividend rule is, there’s a major limitation almost no one talks about. And it’s a crucial one. The hidden problem nobody warns you about. Let’s say your hold-co earns $100,000, $200,000, maybe even $500,000 per year in 0 % tax dividends. Amazing. But

What happens when you actually go to use that money personally? What if you want more retirement income? You want to help the kids? You want to fund lifestyle or transfer wealth to heirs? At that point, every dollar that leaves the corporation is taxed at your personal bracket. This means that the retained earnings that you’ve grown so efficiently inside the corporation suddenly become tax-trapped when you try to pull them out and will likely trigger upwards of 39 to 54 %

pull them out as a dividend or salary. This is the problem that wealthy families look to solve and most small business owners never do. And the solution is surprisingly elegant. It’s not complicated, it’s not risky, and it’s not something the CRA is trying to discourage. In fact, it’s intentionally built into the Income Tax Act and it’s called corporate owned life insurance.

Now when most people hear life insurance, they immediately think death benefit or expenses or protection. But in corporate wealth management, those things are simply bonuses that come with crafting an efficient corporate wealth system. It’s actually a tax strategy. It’s a liquidity strategy. It’s a surplus extraction strategy. And it’s one of the only ways to get retained earnings out of your corporation tax free.

Here’s what high early cash value corporate owned participating whole life insurance does. Number one, it provides tax sheltered growth inside the corporation. Premiums go in, cash value grows, tax sheltered, predictably and without volatility. This gives your holding company a second compounding machine, similar to a fixed income substitute. Number two,

You have access to capital while you’re alive and without taxes. Through an immediate financing arrangement or an IFA, you can borrow up to 100 % of the cash value and it’s tax free. This gives you corporate liquidity, even personal liquidity if structured properly, investment capital, retirement income flexibility, all while your policy continues to compound untouched. Number three, you also get a tax free payout

at death. When the insured individual passes, the corporation receives the death benefit of the policy tax free. And at the same time, the capital dividend account or the CDA is credited with the net death benefit. Therefore, the funds can be paid out to your heirs, the new shareholders, tax free. This is the cleanest surplus extraction tool available in Canada. Number four, it solves the personal tax trap.

By combining 0 % tax dividends being passed from operating companies to your holding company, tax-sheltered corporate-owned cash value policy growth, tax-free leverage against cash value while you’re living, and tax-free extraction at death through the capital dividend account, you now have a structure where your wealth compounds tax-free during life and flows out tax-free at death. That’s the missing piece.

This is the bridge between building corporate wealth and actually using it without being penalized with tax along every step of the way. The Tax-Free Corporate Flywheel Let me walk you through the exact flywheel step by step. Number one, you have an existing operating company that’s generating profits. Number two, after corporate tax profit or retained earnings are moved into your holding company.

Number three, the holding company is then going to buy greater than 10 % of the ownership of an active business. That’s 10 % of the equity and 10 % of the voting rights. Number four, the dividends from the new business investment are going to flow into your holding company at a 0 % tax rate. Number five, those dividends or other retained earnings then fund a corporate owned life insurance policy. Number six, the policy’s cash value then grows tax free.

Number seven, you can optimally borrow against the cash value for liquidity, again, tax-free. Number eight, investments continue compounding uninterrupted. Number nine, upon death, the death benefit pays out to the holding company tax-free. And finally, 10, at the same time, the net death benefit is credited to the capital dividend account, providing shareholders, this could be your spouse, children, charity, with a tax-free capital dividend.

to put money in their personal pockets. Again, tax-free. This is not a loophole. This is how wealthy families and high net worth Canadian incorporated business owners have operated for decades. The CRA built these rules intentionally to encourage capital reinvestment, to strengthen Canadian businesses, and to support intergenerational wealth transfer. This is the system that business owners deserve to know about. So let’s talk about a real example.

Let’s say you’ve got $2 million of retained earnings in your operating company. Based on the connected corporation rules, you’re able to sweep those $2 million of retained earnings up to your holding company that owns the shares of your operating company. From your holding company, you then invest $1 million into an active private company. They pay you 12 to 20 % in dividends. Now again, this is going to be based on the company you’re investing in and you’d have to know this upfront and do your due diligence.

That means that you’d be earning somewhere between $120,000 to $200,000 per year up to your holding company tax-free. Now you can use those tax-free dividends to fund a corporate owned high cash value policy. Inside the policy, the money’s going to grow like a GIC, but tax sheltered. You can borrow against the cash value for access to liquidity while you’re living. And when you eventually pass away, your holding company receives the death benefit tax-free.

and your heirs get to receive money in their pocket tax-free through the capital dividend account. You’ve just possibly eliminated the biggest tax bill in your financial life. So in closing, now Canadian incorporated business owners represent less than 10 % of the population, but you shoulder more risk, create more jobs, and contribute more to the economy than most Canadians ever will. You deserve a wealth system that treats you accordingly.

So if today’s breakdown helped you clarify how you can grow corporate wealth tax-free, create tax-efficient liquidity, reduce future personal tax, preserve estate value, and build a multi-generational legacy, then please let us know in the comments. Now if you want to receive our ultimate guide to using your retained earnings to produce tax-free passive income, drop the word passive in the comments below.

And course, if you head over to the Canadian Wealth Secrets website, you can take our free Wealth Health Assessment, you can watch our free Retained Earnings Masterclass, or you can even book a discovery call. Thanks for watching, and we’ll see you in the next video.

Canadian Wealth Secrets is an informative podcast that digs into the intricacies of building a robust portfolio, maximizing dividend returns, the nuances of real estate investment, and the complexities of business finance, while offering expert advice on wealth management, navigating capital gains tax, and understanding the role of financial institutions in personal finance.

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