The potential benefit of tax optimized asset location when using a corporation is highly individual. It depends on when the corporation becomes inefficient and whether you plan to address that with lifestyle modification, financial products, or asset location strategies. This page goes through one of three representative ones to give some anchors that you can compare yourself against.
In The Wrong Spot?
For simplicity, let’s assume that our high-income professional maintains constant earning and spending over their career rather than adjusting income or lifestyle. The corporation earns $250K of active income after office expenses (excluding salary to the owner). They have personal spending of $125K/yr to fund their lifestyle.
That results in ~$65-70K/yr in combined personal and corporate tax depending on how they pay that out and use their RRSP/TFSA. This leaves $50-60K/yr of retained earnings in the corporation. This will change as the corporate income grows, but the primary driver will be to maintain after-tax cashflow and maximize combined tax efficiency.
We will assume that the Canada Pension Plan (CPP) is a pension and not a tax. So, it does not cause tax drag and the income stream has some value to the overall portfolio.
I used British Columbia personal and corporate tax rates.
How early will their corporation become inefficient?
To get a quick look at changes over time, I used the Corp vs RRSP vs TFSA Retirement Saving Calculator with the above income and cashflow parameters. They invest using a globally diversified 80:20 stocks:bonds portfolio in all account types (no asset location optimization attempt).
Total real return (adjusted for inflation to keep everything in today’s dollars) is 5%/yr after ETF fees. This simulator does a tax calculation each year to change the tax drag on portfolio growth and compares the strategy of using a corporation and dividends only vs Corp/TFSA vs Corp/RRSP vs Corp/RRSP/TFSA. They have been deemed to have reached financial independence with their portfolio supports a 3-4%/yr pre-tax/fees safe withdrawal rate. The portfolio value shown below is after-tax, as if it were liquidated.
Salient points from the above simulation.
The strategy of using a TFSA, RRSP, and Corporation was better than not using the personal registered accounts. This is in keeping with the findings of others.
The only scenario where the corporation became inefficient before age 65 was when the TFSA and RRSP were not used. That occured because the corporation hit the active-passive income threshold. It was still passing out enough dividends to attenuate the impact by using eligible dividends instead of ineligible ones. However, you can see the big drag that develops in growth by the declining green line in the lower panel. The other strategies did not run into major inefficiencies.
Each year, they will move money out of their corporation as efficiently as possible to meet their after-tax spending needs. That will be a combination of salary and dividends that results in the lowest combined corporate and personal tax rate each year.
When do they hit trapped RDTOH or passive income.
Options when the do.
Impact of asset location in accumulation. Retirement.