Some of you may have been tempted to skip learning about RRSPs because you have a CCPC and just pay yourself with dividends rather than building an RRSP.
Welcome back to the Jedi Academy. This is where we receive more advanced RRSP training from Master Yoda. This is not for the uninitiated. For the basics of RRSPs, take RRSP Anatomy 101 first. You can also download the Jedi Mindtricks Calculator to help your human mind process some of the mathematics for you.
Alas, the Sith Lords on the Dark Side of the Force have not been idle. They have changed the game with their personal income tax increases and attack on CCPCs. You must unlearn what you have learned.
There has been much debate about whether it is best to give yourself a salary versus dividends from your CCPC. The Canadian tax system is designed to be integrated, meaning that from the time a dollar is earned in your business to passing into your hands, the tax paid will be the same whether salary or dividends. There are some small inefficiencies where it does not line up perfectly depending on your marginal tax bracket and province. Accountants can figure out and exploit those inefficiencies, but it generally works as intended.
There are considerations beyond the tax rate.
A salary has the down side of having to make both employer and employee Canadian Pension Plan (CPP) contributions which takes money out of your pocket currently. The employer portion is considered a business expense deducted from your corporate revenue pre-tax. The potential disadvantage is built on the premise that you will not get your money’s worth from the CPP in the future when it is time to draw from it. Who knows. In its favour, CPP does provide some small disability and death benefits.
Another advantage of a salary is that if your corporation makes a large income that would put you over $500K/yr where the regular corporate tax rates kick in instead of the small business rate, the expense of paying out a salary can be used to pull your corporate income back down below $500K.
The main advantage of a salary is creating RRSP contribution room and getting the tax sheltered investment room plus tax refund that goes with it. Previously, many would take the route of dividends and leaving most of their excess investments in their corporation.
The proposed cap of ~1M on passive investment income for CCPCs may alter that argument to favour some salary. As long as you are going to build up $1M of retained earnings in your corp over your career, you can use the remaining income as salary. The good news is that a CCPC allows you to adjust your salary up and down to ensure you get the best contribution room and marginal tax rates to optimize your RRSP deductions.
It is important to understand the effects of salary on your RRSP deduction limits. Let’s look at a few examples.
Comparison of CCPC Dividends vs Salary and RRSPs for an Ontario CCPC in 2018 With a Net Revenue of 400K/yr
All three physicians have the same clinical revenue and the same annual personal cashflow to live on after taxes and RRSP contributions. The 2018 tax rates as of Dec 15, 2017 were used in the calculators. Corporate taxes are complicated and with the rules always changing, it is best to discuss the best strategy for your situation with your accountant. If you have a CCPC, an accountant is like underwear – not usually optional.
All three physicians end up with similar investments. The main difference is that the salaried physicians spread out their investments to diversify against the “political portfolio risk” of government changing the rules around a specific account type.
While the dollars amount of the initial invested money is very similar, some investment taxation nuances could tip you one way or the other. CCPC passive investment income is taxed at ~50%. Some of that tax is refunded to the physician when they take the money out of the corp as tax-free capital dividends. However, there is still some tax drag on investment growth within a CCPC. The investments within RRSPs can grow tax free, but are taxed at full marginal rate when removed.
For maximal tax efficiency, you can put your interest bearing investments (like bonds) into your RRSP and the more tax efficient parts of your balanced portfolio outside of your RRSP.
Further, as long as you remove the money from an RRSP whilst in a lower tax bracket, you save on tax overall too. That could be done with a personal RRSP if you plan to be in a low tax bracket in retirement.
An alternative would be to put it in a spousal RRSP and where it could be taxed in the hands of a lower income spouse as long as it is not withdrawn within 3 years of contribution. Sounds like the much vilified income sprinkling – shhhhh. The Sith have spies and bounty hunters everywhere.
If the proposed rules that punish passive investments in CCPCs over ~$1M goes through, then it changes the issue further.
For physician A, it will take under 7 years before they reach $1M passively invested in the corp. For physician C, it will take around 9 years and they will also have money in their RRSP. Physician C will end up with a larger RRSP, even if physician A starts contributing to their RRSP when they max out their corp investments. You can’t go back and make up RRSP room and it is capped at ~26K/yr indexed to inflation.
An alternative for physician A would be to start an Independent Pension Plan (IPP) when they max out their corp passive investments. An IPP is similar to an RRSP in tax deferral, but unlike an RRSP which is simply an investment account that you can put a variety of investments in, an IPP is a purchased financial product. That means it has other fees and regulations associated with it that can affect your returns. IPPs may be a good option for those who have pushed off retirement saving in their youth and need to try to make up for lost time because it allows you to make larger make-up contributions compared to an RRSP when you are over the age of 45.
You can never really make up for lost investing time as illustrated in the Battleschool post, but this could help. The cost-benefit analysis of an IPP versus RRSP previously favoured RRSPs in my case, but with the new CCPC rules, this needs another look. I need to learn more about it and will share that learning process with you when I do.