Most business owners think about how to save taxes on their personal income by taking Corporate Dividends however, you’re missing out on planning solutions that could save you hundreds of thousands of dollars in taxes and future value of your retirement income.
How often have I talked with a business owner and been informed they only take dividends from their corporation versus taking a salary. Do they also know taking dividends means they cannot make CPP contributions? The argument is that this strategy lowers taxes owing and you negate having to pay CPP premiums.
Let’s contemplate a retirement without CPP. To keep the math simple let’s assume inflation and discount rates are equal. Don’t think the Canada Pension Plan & Old Age Security are important to your retirement (especially with the recent CPP enhancement)? Consider this, the present value of the maximum CPP benefit for a 65-year-old over 20 years is $282,199, and for a couple, that’s $564,398!
By paying yourself a Corporate Dividend, you’re giving up
$564,398 of retirement income!
~ David Aaron
If a business owner does decide to go the dividend route, they should consider how they are going to replace the CPP income. Obviously, that means saving more.
A compromise might be the best solution to try and get the best of both worlds. The business owner could pay themselves a salary equal to the Yearly Maximum Pensionable Earnings ($58,700 for 2020). This way they can contribute the maximum to CPP and create some RRSP room.
They could also save in the business corporation so that the CPP benefit can be replaced by dividends in the future.
What else are you losing out on by paying yourself a Corporate Dividend?
Registered Retirement Savings Plan (RRSP)
Taking a salary also creates RRSP contribution room, which is deductible from your personal income and allows you to save and invest in a tax-sheltered account. While I don’t automatically endorse the use of RRSP’s for business owners, they are a useful retirement planning tool given all other options are exhausted.
Individual Pension Plans
Arguably the most powerful retirement savings solutions for incorporated business owners provided they qualify. Individual Pension Plans provide the mechanism to move cash off the corporate balance sheet which otherwise could be subject to Passive Income Tax, and into your personal pension plan.
The catch here is, you must be incorporated and corporate dividend income does not qualify as income used to calculate your eligible contributions. Only Salary income can be used in the calculation for pension contributions.
One of the key advantages of an IPP (besides increasing your retirement assets by as much as 65 % more than an RRSP) is creating large tax deductions for your corporation. Especially in the case of selling your business, the deductions could wipe out all or significantly reduce the amount of taxes owed to CRA.
Here are a few benefits:
- An excellent way to increase your retirement assets and have your company make large tax-deductible contributions
- Allows for significant additional tax-deductible contributions at inception and retirement
- Tax-deductible unused room (Past Service) contributions from your company, up to $900,000+
- All costs associated with the pension plan are tax-deductible to the company
Tax-Exempt Corporate Whole Life Insurance
Tax-Exempt Corporate whole life insurance could also fit the bill here, giving the corporation access to cash for business opportunities or challenges in the future. The key benefit of using corporately owned life insurance is creating a tax shelter. Moving cash off the balance sheet which could be subject to passive income tax, and into a Tax-exempt corporate life insurance policy. Growth within an exempt life insurance policy will not affect a CCPC’s passive investment income earnings under the new passive income rules.
Long-term planning is required for this strategy to be an effective tool in providing an income stream during retirement or to use as leverage against a loan.
Personal Credit
Finally, having salary income will help you with a mortgage application, if you intend to buy a house. The banks don’t consider dividend income as stable when looking at how much of a mortgage you can afford.
Bottom Line
Once you’ve set aside as much savings as possible inside your corporation, I recommend drawing salary to fund your lifestyle needs. This will maximize your CPP contributions and your RRSP contribution room, along with some of the other benefits mentioned. This recommendation may change in years to come since tax rates are constantly changing, but for now, salary is the clear winner.
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