Episode 106: Avoid Throwing $90K Down The Drain In This Canadian Passive Income Trap [Secret Sauce Ep21]

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Are you unknowingly giving away tens of thousands of dollars in taxes each year by being too conservative with your passive income and business earnings?

For many business owners, keeping retained earnings safe and secure is a top priority, but this cautious approach can often come with a hidden cost—unnecessarily high tax payments. If you’re like many Canadians, you might be trying to save wisely, opting for conservative investments like GICs, only to see nearly half of your hard-earned gains going straight to taxes. This episode unpacks how conservative choices in a corporate structure, while low-risk, can end up holding you back financially.

In this episode, Kyle Pearce shares a real-life scenario of an incorporated business owner caught in a “tax trap” from passive income on retained earnings and explores a powerful solution: rethinking how these funds are invested using strategies that offer security without sacrificing growth. By shifting toward tools like whole life policies, this client could see significant compounding growth with far less tax erosion, transforming their conservative approach into one that builds wealth sustainably.

• Learn how to avoid the “passive income tax trap” and keep more of your wealth intact.
• Discover how whole life policies offer both security and significant tax benefits for conservative investors.
• Understand the long-term impact of leveraging retained earnings to maximize both present and future wealth.

Tune in now to find out how small shifts in your investment strategy could save you thousands and boost your wealth-building potential!

Resources:

• Like this short, “Wealth Secret Sauce” Episode? Tell us in your rating and review on Apple Podcasts. 
• Dig into our Ultimate Investment Book List
• Book a Discovery Call with Kyle to review your corporate (or personal) wealth strategy to help you take the next step in your Canadian Wealth Building Journey!
• 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 corporate passive income taxes at greater than 50%; or,
• …wondering whether your current corporate wealth management strategy is optimal for your specific situation.

Are you holding onto retained earnings in conservative investments like GICs, unknowingly facing high taxes on passive income? Many Canadian business owners prioritize safety but risk seeing a significant portion of their earnings lost to income tax. In this episode, we explore how leveraging participating whole life insurance, infinite banking, and corporate tax strategies can help minimize liabilities, generate passive income, and provide a substantial death benefit—all while preserving wealth within a business structure. Don’t let taxes erode your hard-earned wealth; discover how a strategic approach to permanent life insurance can unlock sustainable, tax-efficient growth for the future. Tune in to learn how small shifts in your investment strategy could boost your wealth-building potential!

Watch Now!

Transcript:

Hey there, Canadian wealth secret seekers. It’s Kyle here with another Friday secret sauce episode. And today we’re going to be unpacking yet another client who has been throwing away a lot of money each year. This year, it’s going to be another $90,000 that’s being thrown away due to not understanding or not recognizing some of the tax implications with different buckets in our lives. 

Now, back on Secret Sauce episode 13, we chatted about the Canadian passive income tax trap, and the trap has got another one, and I want to run you through this scenario here today. Now, the bucket we’re gonna be talking about on today’s episode is, yes, inside of the corporate structure, and once again, someone who is trying to be a conservative investor and really just saving.

They earn a significant amount of income inside the business each and every year, and they’re just trying to, you know, put enough away so that they can not only live a comfortable lifestyle for the remainder of their lives, but also potentially leave a legacy for their children. So with this particular individual, we’re going to call them Joe. They reached out to me recently and they shared their scenario. They are incorporated. They do have a business and that business is earning a significant amount of income. 

Now this business could be any type of corporate or corporation earning active income. So that could be realtors with prex, it could be medical or medicine corporations, so MPCs. It doesn’t matter how you’re earning the active income, once it’s earned inside of the structure, folks tend to leave money. in there as retained earnings and then do something with it from there because they do know that if they take too much out in any given year, they’re going to trigger a ton of personal taxes. And that’s what’s happening here. They do take a relatively high income each year, but they have a lot of money left each and every year in retained earnings. So the amount of retained earnings they have right now is actually more than $4.5 million, but I’m gonna use the number 4.5.

And they have those dollars primarily in GICs and that is interest bearing GICs and when we’re earning interest income inside of a corporation, we are actually getting passive income tax applied. So we’re no longer being taxed at 12.2%. We’re actually being taxed here in Ontario anyway, above 50%. The lowest province would be Alberta and I believe it’s around 46 % total on that income. So when you think about this, we have a person who wants to be conservative. So they’re making the right choice to pick something conservative, like say a GIC instead of putting money in the markets. 

They don’t like the idea of volatility. So they’ve selected something very conservative. I’m not here to judge whether someone should be more aggressive or less aggressive. that it’s really up to the client to decide what are they most comfortable with? How are they gonna emotionally be able to handle ups and downs of the markets? So for these individuals, they have a significant amount of income where if they continue to do this, they will be just fine. So this isn’t an issue as if they won’t have enough for retirement, but they are leaving a significant amount on the table.

So when I flip over, I’m gonna just share on a quick little spreadsheet comparing and ultimately share one of the possible solutions here. Now, for some of you, you’re thinking, listen, just don’t put it in GICs, put it into something else that’s going to provide a capital gain. And I would agree that would make a ton of sense, right? Putting it into equity indexes, that sort of thing, that could be definitely a very helpful way to go here. However,

They’re not comfortable with that. So if they want something conservative, we had discussed on our call about the idea of considering a permanent insurance policy, specifically a whole life policy, because a whole life policy doesn’t depend on the markets. It is going to be based on a dividend pool like a pension fund, as we’ve described before, and it’s only going to go up. It will never go backwards, which is one of the big things here.

Not only that, it also has a large death benefit. One of the challenges that people have with GIC investing, right now it feels like a good idea, right? And for many people, if you’re doing it at a personal level, it can be a good idea. We were in a high interest rate environment for the past two years, and therefore you could lock in at decent rates. Now these rates are still lower than what we were experiencing with inflation, so that’s a challenge. But ultimately at the end of the day,

The thought is that over these next couple of years, rates are going to come down, we’ll call it normalizing, to something more in the middle between our COVID lows and what we’ve just experienced with these large spikes. However, that’s not what we’re gonna discuss here. We’re gonna talk about how when we invest in something and we’re paying a significant amount in taxes, the returns aren’t what they seem.

If they’re locked in at 4 % per year in their GIC, they’re really netting 2 % because each and every year they’re going to lose 50 % in passive income tax. So here this $4.5 million, those who are on YouTube with me can see the screen right now, $4.5 million. When you compound it at 2%, by the next year, you’re gonna have $4,590,000. They’ve earned $90,000.

a pretty awesome return, we’ll say. I mean, I shouldn’t say return, but it’s really awesome to see $90,000 being generated passively. The problem is if they could have earned that 4 % tax free, that $4.5 million, if you see here in the second column where we compare about what you might expect with a policy, an average rate of return in the 4 % range, it’s usually 4 to 5 % over your lifetime,

you would have taken that $4.5 million and turned it into $4.68 million. So we’re talking about taking that same amount of money and you’re increasing it in one year by $90,000. So that 90,000 that went to the government instead, we could be compounding it inside of this policy tax-free. So that’s a $90,000 difference.

If we move out all the way to year five, and we’re talking about not even adding any more money here, they have more money earning every year, which means they’re gonna be adding a significant amount to this bucket each and every year. Here by year five, without even adding any funds, their GIC that’s compounding, and we’re assuming that they’re gonna continue to get around 4 % a year, which may or may not be the case over the next couple of years.

you’re looking at $4.87 million and change, right? So we’re talking about just short of $4.9 million. Whereas if this was in a policy that’s been growing and compounding over time, you’ll get about $5.26 million. That’s a $393,000 difference just in five years by picking one bucket over the other. And the beautiful part is there’s actually no

real difference in the risk that we’re talking about here. GICs are guaranteed certificates from the bank. The policy is guaranteed from the insurance company. Now the one nuance here is that they don’t guarantee the dividend on the policy. However, no company that we have used here in Canada has not paid a dividend. So some of the big guys like Sun Life or Equitable Life, they have always paid a dividend.

And that dividend typically is based on the income that they’re generating on the premiums that you’re putting into these policies. Aside from that, you’re getting this massive death benefit. We haven’t even discussed what that death benefit would look like once you’ve got about $4.5 million of premium put into it. But it’s going to be quite significant. Now, that difference after five years is about just short of $400,000. We look after 10 years.

We’re talking about a million dollar difference. After 15 years, it’s $1.8 million difference. And if we look all the way to the average age of about 85 when this individual may pass on, that would be 39 years down the road. That’s a $10 and 1 half million difference just in the growth of the cash value. So what we’ve been suggesting to them is to consider taking some of these funds and

slowly funding a policy. Now the hard part here is there’s no right way to do this. There’s no way to pick the right policy amount or premium amount for you and your family. However, if you think like me and we only think rationally, I want to get as much of that four and a half million dollars into premium as I can. Noting that this individual would be adding about 400,000 in retained earnings per year.

I would wanna see the premium amount quite significant. They wanted to see a maximum contribution amount of about 125 per year, 125,000, which over here on the screen, you’ll see leaves just short of 50,000 as the minimum they can contribute. That’s great, that’s fine. After a 10-year period, they’ll have about 1.25 million in this.

policy and you’ll see that the cash value has grown significantly from 1.25 million to about one and a half million just north of one and a half million of cash value and they’ve accumulated about four and a half million dollars of death benefit which will just continue to go up and up over the rest of their lifetime they can of course choose to offset this policy after 10 years or they can continue to fund it.

In their situation, it wouldn’t make sense not to continue funding it because they’ve got already have four and a half million dollars sitting there waiting and losing the upside by about 50 % in their GIC investment that they’re making right now. If we look over to a $250,000 premium amount per year, that would allow them to have a minimum premium of about 95,000, meaning they have flexibility in one year they can pay 95,000.

another year they can pay 150. They can pay all the way up to 250,000 per year. And let’s assume for 10 years they do that. They max fund it at 250 per year. That only gets two and a half million dollars into this particular policy. So once again, they have not, they’ve just broached that halfway point in getting those GIC funds into the policy where we can later use leverage strategies against the cash value for.

Tax-free income and of course a tax-free death benefit. With this policy they would be starting off with a cash value. Again, there’s a little opportunity cost so they’ve got about $216,000 of cash value by the end of year one that’s available to them if there’s an emergency, they wanna leverage against it for investments, whatever it is that they wanna do and a $4.4 million death benefit right away in year one. That death benefit grows to about

$9 million by year 10. If they stop paying premium and they just hold this policy by the time they’re about 85, their cash value will be about $11 million and a death benefit of $13.9 million or so dollars as well with a significant portion of that available to come out in this case by 85, all of it available to come out through the capital dividend account in their company.

So these are big, big policies, of course, but we’re trying to solve a big, big problem. If we look at a $500,000 max funded policy for the next 10 years, that will get $5 million in. That’s gonna mean that one of their retained earning years that’s coming up over these next 10 will be necessary to fully fund this thing for 10 years. However,

they will have still more retained earnings that they’re gonna have to deal with, either by slowly taking it out as a salary or dividend, or by essentially letting it sit in there and then eventually getting taxed on it in a big way. So here, if we were putting in 500,000 per year into this policy, the minimum that they could fund each year is just south of 185 per year. So again, a lot of flexibility there. They don’t have to pay 500,000 every single year.

They can use the minimum amount. They can go anywhere in between. But if we assume that they did do this for 10 years straight, you’ll notice that right off the bat, they’re gonna have a $9 million death benefit. And by year 10, their cash value, 5 million in, has turned to $6.1 million in cash value and a death benefit of 18 million, north of $18 million.

And of course, as we continue to let this go, even though they’re not funding this policy any longer after year 10, they are allowed to, they can, but they were just illustrating if they didn’t, you’ll see that by age 70, there’s gonna be a cash value of 11 point almost $8 million and a death benefit of $20.5 million with 17.2 million of it available to come out tax free through the capital dividend account to

their heirs. This is a massive, massive tool that can help to solve not only passive income problems like we’re hearing in this particular episode, but to also address legacy concerns, as well as giving you the opportunity to leverage against the cash value in different ways. One of the most common ways, as we’ve discussed on this episode and in this podcast in general, is to use it as an opportunity fund

to make investments. For this couple, they’re not going to do that. They’re not that style of investor, and that’s okay. There’s nothing wrong with that. But for those who are listening, thinking, I’m not gonna put $4.5 million into GICs, what you have available to you is GIC-like growth, but tax-free, and it’s available that you can leverage at at similar rates so that you can make an additional investment and keep the money working in two places.

at once. Any additional cash flow that comes back to the investment, you can bring it back and actually knock down whatever was borrowed to make that investment in the first place. For other people, they’re looking at this and they look at the cash value and they say, well, like how much can I borrow against my cash value? For these individuals, if they start leveraging in year 11, they’ve put 5 million into this, they can easily pull 240 per year.

And again, that’s not gonna be taxable in this particular case. We’re gonna get a loan here and we’re gonna do it from a third party lender, right? To make sure that we can consider this not income from this particular policy. Let’s assume a 5 % interest rate and you can see that they can pull 240 from the age of 57 all the way until age 100, which is about 44 years worth of income coming out.

and still have about $5.8 million left after they pay off the loan at death at age 100, while getting that $240,000 of income. That’s about a $400,000 before tax income that you would have to be pulling in order to achieve the same result if you were paying yourself in the traditional sense. So in this particular episode, trying to keep it sweet,

trying to keep it short, but ultimately at the end, we are focusing too much on rates of return in many cases and too little on how or where we’re making these investments in order to keep as much of our money whole as possible to then grow and compound it from there. If you are an incorporated business owner and you’re finding yourself with the retained earnings trap where this money is sort of quote unquote stuck in there,

And even if you’re choosing to put it into capital gain type assets, you see the road ahead of you means if I ever wanna touch this money in my personal hands, I’m going to be experiencing a significant amount of tax or my estate will be experiencing a significant amount of tax. You should be reaching out to us over at CanadianWealthSecrets.com forward slash discovery and we’ll take you through your scenario and we’ll create a plan that makes sense for you.

for your company and your family so that you get the win-win-win scenario where you get to utilize the money that you’re earning now, but also take care of your family over the long term while you watch your net worth continue to grow instead of depleting through a decumulation strategy. For those who don’t have an incorporated business, but they’re thinking, I do have assets and I know that there’s taxes to be paid on these assets and…

You know, you’re looking for adding something to the mix so that you can be a more efficient investor, a more efficient steward of your capital. You can also reach out over at Canadianwealthsecrets.com forward slash discovery. And I look forward to having a conversation with you real soon.

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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