SMALL BUSINESS OWNERS MAY BE SHORTCHANGING RETIREMENT SAVINGS BY INVESTING IN
RRSPs: CIBC'S JAMIE GOLOMBEK

New CIBC Report finds ways to put more money in clients' pockets

TORONTO, Oct. 19 /CNW/ - Canadian small business owners may be better off in retirement if they invested excess cash inside their corporation rather than paying out a salary merely to make an RRSP contribution, finds a new report by Jamie Golombek, CIBC's Managing Director of Tax & Estate Planning.

Coincident with the launch of Small Business Week, which recognizes the significant contribution small businesses make to Canada's economy, the report ("Rethinking RRSPs for Business Owners: Why taking a salary may not make sense") reassesses the age-old maxim that Canadian small business owners should always pay themselves enough salary or bonus to ensure they can maximize their RRSP contributions each year regardless of whether they actually need the cash.

Mr. Golombek argues that to the extent that the business owner needs cash personally, it may be preferable to extract the cash from the corporation in the form of dividends and forgo the RRSP contribution. Second, he argues that if the business owner does not need to withdraw the cash immediately, a significant tax deferral can be achieved by simply leaving the money inside the corporation and investing the funds within the corporation instead of paying them out as a salary to be taxed and investing the cash in RRSPs and non-registered personal accounts.

"Business owners may end up with more money after-tax by funding their personal living requirements with dividends and leaving the excess cash in the company as opposed to paying the salary required to maximize the RRSP contribution," he says. "The basic premise is that the amount the owner manager would have contributed to an RRSP is instead left inside the company and invested in the same manner as an RRSP. At retirement, instead of withdrawing funds from an RRSP or RRIF to live on, the business owner would sell corporately-held investments and extract the after-tax proceeds as a dividend."

Mr. Golombek believes that Canadian business owners have long been advised to maximize RRSP contributions based on the assumption that the tax paid on salary income is exactly equal to the combined small business corporate tax paid by the corporation and the personal tax paid on the subsequent dividend by the owner.

"The reality is, however, that we don't live in a perfect world," he adds. "Absolute tax savings can be realized by having income taxed inside the corporation at the small business tax rate and then paid out as a dividend rather than having the corporation pay a tax-deductible salary to be taxed in the hands of the individual.

"The result is that, in every province other than Quebec, the tax a business owner pays on income earned personally is actually higher than the sum of the corporate small business tax and the personal tax paid by the shareholder on income earned through a corporation and paid out as dividends."

For owners that have other sources of cash to fund personal living expenses and do not need to extract any funds from the corporation, the advantage of the tax deferral can be even greater. He advises these owners to have business income eligible for the small business rate (generally up to $500,000) taxed in the corporation at the preferential small-business rate and reinvested inside the company. This tax deferral ranges from a low of 25 per cent in Alberta to a high of over 35 per cent in PEI.

Mr. Golombek built a model with the help of Deloitte & Touche LLP's Private Company Services Group to compare the net after-tax cash amounts to a business owner under two hypothetical scenarios over a 20 year period. In both scenarios, the funds are invested in the same portfolio of investments, the pre-tax rate of return on all investments is five per cent, Ontario tax rates are used for both the corporation and the individual and payroll taxes are ignored.

In the first scenario, a business owner receives enough salary to maximize his RRSP contribution and lives off his remaining after-tax salary (his "after-tax spend amount"). In the second scenario, instead of making an RRSP contribution, surplus funds are invested within the company. The corporation pays the business owner sufficient dividends to have the same after-tax spend amount each year as under the first scenario.

The model reviewed, for each scenario, three investment portfolios (equity, balanced and fixed income) and concluded that under each investment portfolio, after 20 years, the business owner would have more after-tax cash available if she/he received dividends and left surplus funds inside the corporation instead of paying enough salary to maximize an RRSP contribution.

There are 3 reasons for this result:

    
    1)  There is simply less tax paid by having the income taxed in the
        corporation and flowing it to the shareholder as a dividend.
    2)  There is more money to invest in the corporation when personal tax is
        not paid immediately on cash not needed currently by the owner.
    3)  The preferred tax treatment afforded to capital gains and Canadian
        portfolio dividends is not available when the investments are in an
        RRSP.
    

Mr. Golombek also notes that business owners who are paid salary must contribute to the Canada Pension Plan. In 2010, this works out to a maximum CPP premium of $4,326 to cover both the employee and the employer share. While paying enough salary to maximize CPP entitlements is often touted as one of the benefits of salary over dividends (which are not considered pensionable earnings for purposes earning CPP entitlements), he notes that it's questionable whether, over the course of a 40 year career, the premium savings could not be independently invested in a diversified portfolio to ultimately produce a larger pension income.

For business owners with 40 per cent or less of the voting shares of the corporation they would also pay up to $1,794 a year in combined Employment Insurance premiums, adding yet another cost to paying salary instead of dividends, which are not subject to EI premiums. As well, some provinces levy an additional payroll tax, a burden that is not payable on dividend remuneration.

To view the detailed numerical results of the model or to view Mr. Golombek's tax planning reports, please visit www.cibc.com.

For further information: or to receive a copy of the report, contact Kevin Dove, Senior Director, External Communications and Media Relations, CIBC, Tel: [phone], [email protected]