by Jenny Lee
It makes ‘absolutely no sense’ for those earning less than $500,000 to be making RRSP contributions: adviser
Small business owners and incorporated professionals should not make RRSP contributions if they are making less than $500,000 in afterexpense corporate profits, says investment management firm Nicola Wealth Management.
“That can sound like heresy because [RRSPs] are considered the bedrock of retirement savings for Canada,” Nicola president David Sung said in an interview.
Given low corporate tax rates of 13.5 per cent on the first $500,000 in after-expense corporate profits, it makes “absolutely no sense” for the incorporated business owner and professional to be making RRSP contributions, he said. “Their incorporated company is, in fact, the best tax savings vehicle they have to save for retirement.”
It used to be, business owners would take enough salary to maximize their RRSP contributions -that would have been $122,000 in 2010 to achieve the maximum allowable RRSP contribution of $22,000; pay a spouse a reasonable salary in order to split income; and then distribute after-tax corporate profits as dividends to family members over 18 years old. This strategy no longer makes sense and hasn’t for several years, Sung said.
Instead, don’t pay yourself a salary at all, Sung advised.
Pay your small business corporate taxes, then take what you need for lifestyle purposes in dividends. Income split with your spouse if you have one. Don’t contribute to RRSPs. Instead of buying investments inside an RRSP, invest in the same GICs, stocks or mutual funds using after-tax money in your corporate bank account.
It’s true that RRSP investments grow tax-free until you withdraw the money, but the downside is every dollar you pull out is fully taxed as earned income. If, on the other hand, you invest from within your business and are efficient with your portfolio structure, you can “dramatically reduce” your investment income tax to little or nothing, and when you eventually pull the money out as dividends, you’ll pay far less tax than you would have on RRSP withdrawals, Sung said.
“The numbers are not small numbers. It’s quite meaningful and quite significant,” Sung said.
There are some finer details. The salary paid to a spouse is subject to a “reasonableness” test and $25,000 to $30,000 is generally considered the maximum reasonable amount if the spouse is not active in the dayto-day running of the business. Dividends to shareholders, however, are not subject to reasonability and make for more efficient income splitting.
Additionally, employers paying their own Canada Pension Plan premium must pay both sides of a premium normally split between employer and employee.
“They would be far better off taking those same premium dollars and keeping them invested within the company,” Sung said.
If your after-expense corporate profits are over $500,000, pay yourself enough salary to maximize your RRSP contribution ($122,000 in 2010), make the RRSP contribution, pay out dividends to meet lifestyle expenses, but save the rest of your money within your business.
This strategy makes sense because profits above $500,000 are taxed at 27 per cent versus 13.5 per cent.