Some of you may have been tempted to skip learning about RRSPs because you have a CCPC. You could just pay yourself with dividends rather than building an RRSP. That approach has been and still is suggested by many accountants. However, it may not be the best approach.
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.
It should not matter, but it might.
There has been much debate about whether it is best to give salary versus dividends from a 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. Generally, tax integration favors earning income directly rather than flowing it through a CCPC. Except for Saskatchewan and Newfoundland. Accountants can figure out and exploit those inefficiencies, but it generally works as intended.
There are considerations beyond the tax rate:
Canada Pension Plan Contributions
A salary has the down side of having to make both employer and employee Canadian Pension Plan (CPP) contributions. This 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. The return on investment is likely to be slightly better than inflation. So, it is not lost money. However, you could likely make more by investing.
I would think of it as part of the fixed-income portion of my portfolio. That allows me to tolerate more investment risk in the rest of my portfolio.
Also in its favor, CPP does provide some small disability and death benefits.
Loss of the Small Business Deduction Rate
Paying salary may also be advantageous when your corporation makes a large income that would put you over $500K/yr small business deduction threshold where the regular corporate tax rates kick in. The expense of paying out a salary can be used to pull your corporate income back down below $500K.
Creating RRSP contribution room
A corporation has a tax-deferral advantage for investing of about 85% at the small business rate and 72% at the general corporate rate. The RRSP deduction makes it 100% tax-deferred investing.
Plus, the growth is tax-sheltered in an RRSP while investment income in a CCPC will experience some tax drag.
The recently legislated passive income tax changes for CCPCs may alter that argument to favour some salary. Salary can be used to lower active business income and create more room for passive income. A CCPC also allows you to adjust your salary up and down to ensure that you get the best contribution room and marginal tax rates to optimize your RRSP deductions.
Spreading out your investment portfolio beyond your CCPC can help to delay or avoid the new tax threshold. It also diversifies your portfolio against the political risk of more tax attacks on corporations.
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 cash flow 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. Tax integration slightly favours paying out more salary for physician C. However, the main difference is that the salaried physicians spread out their investments to amongst different account types. That gives more room to grow a portfolio overall before hitting contribution or passive income limits.
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.
A salary is also a pre-requisite for an Independent Pension Plan (IPP)
An IPP is similar to an RRSP in tax deferral. 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. However, this could help. The cost-benefit analysis of an IPP versus RRSP previously favoured RRSPs in my case. With the new CCPC rules, this may need another look. I need to learn more about it and will share that learning process with you when I do.