With current low corporate tax rates some professionals are opting to forego taking money out of their company to place into an RRSP and are instead leaving the money in the company to invest, saving within the company and then using dividends from the company as a way to fund retirement. Is this a tax efficient approach? CIBC thinks it is. Their recent report on this topic can be found here:
For professionals, those whose companies value consists of their expertise and service, such as doctors, dentists, lawyers, engineers and consultants, there may be good logic to this approach:
- corporate taxes are low, when taxable income is below the $500,000 limit for small, private companies in Canada, so investing in the company with after-tax corporate dollars is relatively cheap.
- to make an RRSP contribution the owner/manager must first withdraw income from the company in the form of salary which must be high enough to generate RRSP contribution room for the subsequent year and thus is taxable each year
- leaving the money in the company defers the personal tax paid and thus leaves more money available to invest over the accumulation period, generating larger returns
- not taking salary eliminates the cost of annual CPP premiums that would be paid by the company, but which is offset by reduced CPP benefits for the professional at retirement, so the investment return would have to outperform your CPP return
- taxable investments in a corporation benefit from the treatment of capital losses and gains that are not available inside an RRSP, making the investments more efficient
The model prepared by CIBC demonstrates that this strategy can substantially increase your after tax cash position available for retirement under a number of investment scenarios.
There are risks, however, to this strategy that should be considered before adopting such a strategy.
- Will your investments in the company be at risk from creditors?
If so, consider using a holding company for investment purposes or a family trust
- Will you compromise your ability to benefit from the Capital Gains Exemption if you sell the shares of your company?
This is a risk if you don’t plan ahead and purify your company at least three years in advance of a contemplated sale.
These are just a few risks to consider for this strategy, but there is certainly enough potential benefit that you should consider having your tax advisor examine your personal circumstances to determine if this is a viable option for yourself.