Business owners can sometimes get ahead with a no-RRSP strategy


By Jenny Lee 

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Click on the image above to watch Carl Jacobson explain why he uses a dividend compenasation strategy.

But while paying less tax today – with more cash to invest – sounds appealing, experts warn it’s tricky.

Business lawyer Carl Jacobson used to contribute to his registered retirement savings plan like clockwork – after all, it was the careful, responsible thing to do, wasn’t it?

Then one day, a client’s off-hand comment made him stop in his tracks. He began to rethink the contribution he’d been making faithfully, every year, and ended up seeking more tax and investment advice.

These days, Jacobson lets February come and go with barely a murmur.

Here’s why: “The conventional wisdom is that RRSPs are the best way to save for retirement, but for many business owners, that is simply not true,” says David Sung, president of Nicola Wealth Management in Vancouver. Small business owners and incorporated professionals should not make RRSP contributions if they are making under $500,000 in after-expense corporate profits, Sung said.

In fact, it’s probably best not to take a salary at all.

Instead, pay your small business corporate taxes, take just enough dividend income to live on, save and invest within your company with a carefully balanced asset mix to minimize investment taxes, and income split with your spouse if you have one, Sung said.

The result? You’ll pay less tax today, and have more cash to invest.

The combined federal and provincial tax rate on active business income is just 13.5 per cent, and you won’t be paying tax at a high marginal rate to pull a salary. What’s more, no salary means no CPP contributions, so you’ll have more money to invest.

“You can reduce your taxes by anywhere from two to 30 per cent,” Sung said. “Your business is a wonderful tax deferral vehicle.”

You’ll also have more flexibility to manage your investments, and be able to income split more effectively both now and in retirement. Freedom from RRSP restrictions means you can invest in real estate and other vehicles. Income splitting through dividends is more efficient than paying your spouse a salary.

When Jacobson was an employee, RRSP contributions made perfect sense. But after he incorporated, the numbers told a different story. Even though investing within his company means possibly paying corporate tax on investment income of up to 44.7 per cent, with a careful asset mix, he can reduce that to 10 per cent or less, Sung said.

“The downside to having saved corporately is you won’t have the perfect tax deferral on investment income like the RRSP,” Sung said, “but the flip side is that during retirement, you will have to withdraw much more money from your RRSP than from your company to end up with the same amount of spending money.”

This strategy works as long as you’re making more than you need to live on, Sung said. Those making more than $500,000 in after-expense corporate profits should take a salary and make an RRSP contribution to offset higher corporate taxes with lower personal taxes. Fine-tuning includes adding a family trust to split income with more family members, and keeping the investments in a holding company for extra protection if your company is sued.

“With a family trust, you can pay up to $38,000 to individuals and pay virtually no tax,” Sung said.

Technically, the no-RRSP strategy does work, said Chris-tine McCaffrey, a tax partner with KPMG Enterprise in Vancouver, but it requires personal discipline to save, constant knowledgeable monitoring, and additional accounting and legal fees.

“The risks of going offside are high,” she said. “I don’t have any clients who are pursuing this approach.”

McCaffrey would rather most clients go the RRSP and CPP route. Investments held in a company are too easy to draw out and spend.

“I view CPP and RRSP as a safety net for retirement years,” she said.

More considerations: In a marital breakup, RRSPs are easily split through a provision in the Income Tax Act. Splitting assets in a corporation may be more complex. You’ll also need to manage some fine details when you sell your company. At sale, more than 90 per cent of the fair market value of the assets must be used in an active business. And two years before your sale, more than 50 per cent of the fair market value of the assets have to be used in an active business.

“Although savings can be achieved by the no-RRSP strategy, unwinding the structure is more complicated, and legal and accounting fees are likely to be higher,” McCaffrey said. “It’s more intricate. You have to be on top of a lot more things and constantly managing and looking to the future.”

The strategy would likely work well for owners of mature businesses without debt, for a period of time, McCaffrey said. “I’m comfortable having my family nest egg in my company because I saw the math and it made sense,” said Jacobson of Synergy Business Lawyers in Vancouver. “It’s just math,” he said, but warned it’s critical to have advisers who under-stand the intricacies of the tax system.

“For me, personally, as long as I know I’m getting a little ahead every year, I’m happy,” he said. “They ran me through the detail and I forget most of it.”

This year’s RRSP contribution deadline is Feb. 29.