Over the last few years there have been a number of tax changes which have impacted Canadian corporation owners and have forced many tax planners to change their strategy as to what makes the most sense going forward. Traditionally, most people with corporations would choose to keep excess funds in the corporation, pay the small business tax at 9% in Manitoba and defer income tax until down the road when they may decide to draw funds out of their corporation. With the recent tax changes that can reduce the small business deduction, many entrepreneurs and professionals should re-evaluate where they are saving their money as for many of them, withdrawing excess funds and investing in an RRSP may be the better choice.
Quick refresher on RRSP limits because the kicker to this idea is that you must have sufficient RRSP room to utilize. Your RRSP contribution room is calculated as 18% of your previous year’s income to a maximum annual increase of $27,830. Your RRSP room accumulates if it has not been used. Based on this formula, you must have sufficient T4 income being generated to produce RRSP room vs. paying yourself a dividend as many owners are still doing. This is another consideration you may want to look at as originally the thought of most owners is that they would pay less tax by taking a dividend instead of income. The tax rules are generally supposed to be set up so that there would be no advantage of paying yourself a dividend (if you include the corporate tax rate) vs. paying yourself a straight salary. This however has changed somewhat in the last few years as well as a result of recent changes to tax rates and in fact there is a small tax cost to paying dividends vs. salary. This is true for most provinces except for New Brunswick as you can see from the following chart under General Income Tax savings (tax cost). I will not get too deep into this topic now but needless to say it is something that should be reviewed with a tax professional.
Getting back to my original question, let us look at an example. We will assume that you are an incorporated Dentist working in Ontario and you earn revenue of $180,000 per year into your corporation. Let us also assume that you need $105,000 for personal expenses annually. Here are the two options to consider:
Option 1: You take a salary for the full $180,000 and after paying all of your personal expenses you have $27,800 to invest into an RRSP.
Option 2: You distribute enough income to cover your personal expenses and leave the remainder in the corporation to be invested.
As you can see from these figures, by investing in the RRSP you will have $27,800 to invest as compared to the corporate account which will only have $24,400 to invest.
The next consideration to make will be what will the accounts accumulate to over time and with tax considerations down the road, will the RRSP still be a better fit long term? Generally speaking, if we assume that tax rates remain constant the RRSP will leave you with more money in pocket over time, unless the majority of your tax will come from deferred capital gains. In most cases however, in order to outperform the RRSP and assuming all else being equal, you would need to defer 100% of your capital gains until retirement. This is unlikely for most investors.
This strategy however does have limitations and for high earning corporation owners, especially beyond maximizing RRSP contributions, there are strong reasons to keep money in your corporation for investment purposes. Additionally, there are other considerations to make which include investing through a corporate life insurance policy such as Universal Life or Whole life, where tax will also be deferred on investment growth within the policy.
There are many variables which can ultimately impact what the best decision is for you and your long-term savings. The decision to leave money in a corporation is no longer a slam dunk as it might have used to be. For some, there is a strong case to be made that utilizing a personal RRSP will net you out more dollars over time but there is no one size fits all. The prospect of rising tax rates in the future also make planning that much more important. What is clear is that now is the time to start planning and reviewing as the previous path you have been on may need to be adjusted.
-Grant White, CIM®, CFP®
Grant White is a Portfolio Manager/Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
This information has been prepared by Grant White who is a Portfolio Manager for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered.