In part one of my salary vs dividend dilemma update, I provided you with a summary of the absolute and deferred income tax savings available in respect of paying a dividend versus a salary. I concluded that in Ontario, from an absolute income tax basis, you are somewhat indifferent as to whether you receive a salary or dividend, from your
I also reflected that there is a significant tax deferral advantage for active income, whether eligible for the small business deduction or not.
An issue that naturally falls out of the above tax rate discussion is whether you as a small business owner/professional are better off financially paying a salary and contributing to your RRSP or leaving the money in your corporation, creating your own "corporate RRSP", so to speak?
Funding Your RRSP vs Leaving the Money in Your Corporation?
Jamie Golombek, the Managing Director, Tax & Estate Planning of CIBC has written several outstanding papers on whether small business owners should take a salary or dividend and whether they should contribute to their RRSP or leave the money in their corporation.
When I initially wrote the draft for this blog post a couple months ago, I had a summary of Jamie's papers by year and their conclusions. But as fate would have it, Jamie and CIBC just issued a new report earlier this month, titled "RRSPs: A Smart Choice for Business Owners". Thus, I just deleted all my prior work to avoid any confusion.
In his latest paper, Jamie now concludes, that for a 30 year time horizon, with a 5% rate of return, where tax rates remain constant, small business owners are better off to take a salary and make a RRSP contribution where their RRSPs earn interest, eligible dividends or they realize capital gains annually. This is also true where you hold a balanced portfolio in your RRSP.
The exception is where you have deferred capital gains (not typically likely). This conclusion may come as a bit of a shock to many small business owners who have been leaving their excess cash in their corporation and creating their own "Corporate RRSP".
As you would expect, the paper notes that where your personal tax rate is lower at RRSP/RRIF withdrawal, this strategy is more beneficial and where your tax rate is higher, the strategy is less beneficial or possibly detrimental.
The conclusions in this paper reflect that income tax strategies must be fluid and answers are not static. Jamie's strategy/conclusions in respect of funding a RRSP have changed significantly since the issuance of his first paper back in 2010, due to changes in personal and corporate tax rates and there effect upon the integration of the income tax system.
Here is a link to a recent interview Jamie did on BNN where he discusses his new paper.
Jim Yih, a well-known financial commentator and author of the popular blog Retire Happy had this to say on my LinkedIn page after I posted Jamie's article: "Hey Mark, my accountant did the same calculation for me based on being in Alberta, the math in this article and results marginally favoured investing in the company over RRSPs. People need to do the math because the assumptions might change the results. Still a thought provoking article!"
Thus, as Jim notes and Jamie discusses in his BNN interview, it is very important you review the CIBC paper in context of your individual circumstances. Various factors such as age, time to retirement (CIBC uses a 30 year time horizon), other income sources, family income, rates or return and provincial tax rates all need to be considered. For example: if both spouses are shareholders of the corporation, have limited or no other income and do not have significant lifestyle needs, then paying dividends would likely be the way to go.
Other Considerations for Paying a Salary in Lieu of a Dividend
Based on Jamie's data, you would likely lean to paying a salary and contributing to your RRSP. However, there are other factors you may wish consider. I briefly discuss some of these factors below.
Self-Discipline - I have noted in the past, that as a consequence of utilizing a dividend only strategy, you “park” your retirement savings in an easily accessible and tempting location (an operating company or a holding company) and human nature being what it is (I have observed this on many an occasion), one may tend to dip into this cash for personal use purposes ranging from home renovations to vacations to buying an expensive sports car. Thus, financial discipline and restraint is very important if you leave your money in your corporation and don't make a RRSP contribution.
CPP - If a salary is not paid, your CPP entitlement at retirement will be significantly reduced or eliminated. However, as Jamie notes in his paper, "it is conceivable that, over the course of a 40 years career, the premium savings might be independently invested in a diversified portfolio to ultimately produce a larger pension income". I would suggest most people do not have the financial control to invest non-contributed CPP funds each month and thus, I personally still favour contributing unless you are extremely disciplined.
OAS Clawback - For income tax purposes, the actual dividend you receive from a private corporation will be grossed-up for tax purposes. This "artificial increase" in income can result in a partial clawback of your old age security, subject to your actual net income.
Child Care - For those of you with young families, if you are the lower income spouse and paid solely by dividend, you will not have any earned income and will not be entitled to claim your child care costs. If you and your spouse are both shareholders and take only dividends, you may need to take some salary to maximize your child care claim.
Capital Gains Exemption - To be eligible to access the $835,716 capital gains exemption (this amount is indexed each year) upon the sale of your corporation’s shares, certain criteria must be met (see this post I wrote on this complex topic). If you utilize the dividend strategy, your corporation may accumulate too much cash and put the corporation offside the rules.
Asset Protection – If you accumulate substantial funds in your corporation, they could be at risk should the company be sued. You may be able to alleviate this concern by utilizing a holding company or a family trust with a holding company beneficiary.
Research and Development – If your corporation is engaged in R&D, a dividend only strategy will likely result in a reduced Investment Tax Credits claim as the company’s taxable income will be higher.
Remuneration planning is very fact specific. You should always consult your professional advisor before making a decision in regard to paying a salary and/or dividend.
This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.Please note the blog post is time sensitive and subject to changes in legislation or law.
You mentioned you would be indifferent to a salary or a dividend as a high rate tax payer in Ontario.ReplyDelete
What about if your income is between $120-$140k for years, would a combination of salary and dividends be best?
I would need to know your specific circumstances, that is something your accountant should doDelete
The outcomes vary depending on tax bracket, length of time inside the corp, effective tax rate on profits (ie were capgains deferred). See http://www.retailinvestor.org/ods/taxIntegration.xlsxReplyDelete