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Using your Corporation to Fund your Retirement

March 24, 2021

A Better Tax Deferral Strategy for Business Owners

The best place to save for retirement and grow your wealth may be your corporation, not an RRSP or IPP. Examples below are based on 2021 personal and corporate tax rates for BC taxpayers. Does your business earn $500,000 or less? In 2021, the tax rate on corporate income below the small business deduction threshold of $500,000 was 11% in BC1. In our view that is a very low tax rate! Instead of using personal after-tax income that has been taxed at a much higher rate, a better strategy may be to use corporate after-tax income taxed at only 11% to purchase investments or other financial products like insurance. In terms of investments, Canadian eligible dividends and capital gains are most attractive if earned corporately, as they attract the least amount of tax and income generated can be paid out to shareholders at a low tax rate. Interest and rental income generated corporately from rental real estate offer no added tax benefit, so you may find it is best to invest personally rather than within your corporation. For most business owners, the best strategy is to take out a combination of salary and dividends to meet personal expenses while leaving excess cash for saving or investing in the company. Consider a BC investor earning $120,000/year. Their marginal tax rate is 42.8%2. As an example, to pay a $1,000 insurance premium inside of the corporation the investor would need $1,124 (pre-tax). Paying the same $1,000 premium outside of the corporation would require $1,754 (again, pre-tax). The investor paying the premium inside their corporation is tax advantaged by 43.78%!

When its Time to Retire

In retirement there are several ways to extract funds from your corporation tax-efficiently using investments, insurance, or a combination of both. Canadian eligible dividends and capital gains from your corporation provides an opportunity to remove funds from the corporation tax-efficiently. There are several insurance-based strategies that effectively remove funds from the corporation tax-free. If your spouse is a shareholder, you may be able to split income in retirement.

Establishing a Corporate Structure

Your corporation should be ideally structured according to your need for creditor protection, your plans for income splitting with family members, and whether you plan to sell your business and qualify for the small business capital gains exemption. Most business owners will set up a holding company for their investments, and some a family trust as well. A professional accountant can recommend the most suitable corporate structure for you. They will provide necessary instructions to your lawyer for setting up any additional holding companies or trusts. There are expenses involve in setting up and maintaining the additional corporation and any trusts. As a general rule of thumb, if you plan to save over $500,000 between now and retirement, investing in your holding company may be the most attractive option.

Sample Corporate Structure

When Should You Use Registered Accounts? 

Registered accounts like Individual Pension Plans, RRSPs, and TFSAs may be beneficial

under the following circumstances:

⚫ You are unlikely to save $500,000 in your corporation between now and retirement. If this is the case consider saving for retirement using RRSPs and TFSAs.

⚫ You have passive income in your corporation in excess of $50,000. Passive income may reduce your small business deduction limit.

⚫ Your earnings in your corporation exceed $500,000 in any particular year, and you chose to bonus the excess earnings to yourself from your corporation.

⚫ You are in a professional practice with a number of partners and qualify for only a small portion of the $500,000 small business deduction limit.

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