By Richard W.R. Yasinski CFP
Incorporated business owners have the option of earning salary or dividends or a combination or the two. Don’t think this is exciting? As a financial planner working with business owners and their long term income plans, I know it’s not how much my clients make but what they get to keep. How would you like to keep more?
There are a number of strategies and opinions on the ideal salary/dividend mix and I’ll explain mine. You can check the numbers below with this simple income calculator https://simpletax.ca/calculator. I encourage you to use your own numbers and drop me a note if you have questions.
Assuming you earned $150,000 of salary from your incorporated business in Ontario you would pay $48,172 of federal and provincial taxes and keep $101,172. However you would also have to contribute $2,479 to CPP personally and your corporation would contribute another $2,479 on your behalf.
Your corporation would avoid paying tax on its contribution so your total personal and corporate payment to CPP would be about $4,586, in effect paying for two Canada pensions but only ever being able to draw one. So in earning a salary you would end up paying a total of $52,758 in taxes and CPP contributions. Each year you contribute to your CPP increases your pension – I’m still working on get-ting exactly how much it does increase your CPP but I’m finding it difficult to get this info.
How you feel about paying into a Canada pension is an important consideration regarding how you divide your salary and dividends. Our Canada pension provides an indexed income for life – typically the only guaranteed income (along with Old Age Security) a business owner will ever get. Our Canada pension also pays disability benefits and a survivor pension which may be important to some people.
However, in my own incorporated practice, I find it distasteful having to pay for two Canada pensions if I withdraw a salary even though I will only ever collect on one! I’m also very comfortable investing the $4,586 I would have paid into Canada pension and having the flexibility of when and how much I withdraw in retirement. So I’m not compelled to contribute to my Canada pension given it costs me twice as much and am comfortable investing those contributions.
If we went to the other extreme and withdrew $150,000 of dividends (ineligible – because they are from your private corporation) the amount of tax paid would be $33,659, no CPP contributions, and you would keep $116,341. Drawing dividends allows you to keep $15,169 plus the $4,586 in CPP contributions for a total of $19,755. Now, if you in-vested that $19,755 in a diversified equity portfolio I wouldn’t have to do the math to confirm you would be farther ahead than you would with your Canada pension.
The disadvantage of earning dividends is no RSP room is created. RSP room is created only when a salary is earned – 18 per cent a year to a maximum of $24,930 for 2015 increasing each year with CPI. However, with TFSAs and corporate investment accounts, there are other arguably more long term tax efficient options for your investments. Investing for business owners will be the topic of my next article.
A variation on the strategy – what if you had all kinds of RSP room? You can then take advantage of that room by earning in salary exactly equal to your RRSP contributions and withdrawing the rest as dividends. Your salary is 100 per cent tax deductible so the small business corporate tax rate of 15 per cent is avoided.
Yes you would pay 4.95 per cent of your salary to CPP and your corporation does contribute the other half (4.95 per cent) on your salary but if your RSP contribution is $20,000 then you pay $990 to CPP, your corporation pays the same but avoiding 15 per cent corporate tax so the net effect is you get to make an RRSP contribution of $20,000 and costing you only $1,813 (4.95 per cent of $20,000 = $990 + (990 – 0.15 per cent of 990) in CPP contributions but avoiding $3,000 in corporate tax.
Withdrawing dividends from your corporation can mean you keep more of your income – up to certain limits. Some of this additional income is withdrawn at the cost of not contributing to CPP. However, this does give you greater freedom to invest more flexibly and for greater long term tax efficiency – and as a business owner you are investing right? You don’t have all your future retirement income tied up in your business, do you?
I’ll cover this in my next article.
Richard Yasinski is an independent financial planner with his own firm, Financially Sound Inc., in practice in Ottawa since 1996. He can be reached by email at email@example.com or by phone at (613) 271-9994 ext. 101.