Case Study: Retirement Investing for Small Business Owners



Linson Chen

Financial Advisor & Portfolio Manager


You have excess cash that is accumulating in your corporation that you do not need for personal or business purposes. You want to save for retirement and would like to know your options to maximize your future retirement savings.

The two main options for deferring taxes are to leave the excess cash in your corporation for investing or you can withdraw the funds and invest in a Registered Retirement Savings Plan (RRSP).

The main advantage of investing inside your corporation is the corporate tax rate is lower inside a corporation than personal income, which allows for a deferral of tax, so you have more money to invest. Consider the example of a BC resident at the highest marginal tax rate. If they retain $100,000 in their corporation and they qualify for the small business deduction, their tax rate is 11%, which leaves $89,000 to invest. If they withdrew $100,000, they would need to pay 53.5% tax personally, only to be left with $46,500 after tax to invest if they are not contributing to an RRSP.

Having an additional $42,500 to invest in your corporation is a great benefit, but you will be taxed at the highest marginal tax rate for interest, dividends, and realized capital gains earned from that investment every year. Paying tax on your distributions, you lose the compounding growth over time on that amount.

When you finally draw an income from your corporation for retirement, you will likely pay yourself dividends. However, dividends are paid from a corporation’s after-tax profits, meaning that you have already paid corporate income tax on that income. To avoid double taxation, the Canadian income tax system employs a dividend gross-up and a dividend tax rate credit to account for the tax that the corporation has already paid. So that additional $42,500 available to invest is merely a deferral of tax until you withdraw the funds out of your corporation.

Due to the ongoing taxation of distributions inside a corporation, you will want to make your investments as tax efficient as possible. A focus on investments that allow for the deferral of capital gains will be the most favourable taxwise inside a corporation. Ideally, you will be investing in growth investments with high potential capital gains and minimal distributions or corporate class funds to defer distributions. If you plan on holding investments that generate interest or dividend income, investing in an RRSP first would be the better option. Of course, you must be comfortable with the investment risk you are taking, as “interest-earning” investments tend to be safer while growth equities tend to be the most volatile or risky. You never want to take on more investment risk solely for tax purposes.

The other option is to withdraw funds from the corporation and invest inside a personal RRSP account. The maximum RRSP contribution room is 18% of earned income up to a maximum of $29,210. This will require a salary of $162,278 from 2021. To generate RRSP room, you will need earned income in the form of salary compensation as opposed to dividends from your corporation. If you want to invest in an RRSP, you will need to pay yourself a salary.

Contributions to an RRSP are made with pre-tax dollars and considered a tax deduction. This means that they can be deducted on your tax return, reducing the total amount of taxes you pay. Investments made inside an RRSP are tax-sheltered. Any interest, dividends, or capital gains earned inside an RRSP can grow tax deferred if the money remains within the RRSP. Not having to pay tax on your distributions every year, you can compound the growth on that amount over time, which is a big advantage. This can help you delay, reduce, and avoid paying taxes over the long term.

Since 2019, changes in tax rules mean that investing in a corporation is treated less favourably than in previous years for corporations earning more than $50,000 in passive income. A Canadian Controlled Personal Corporation’s access to the small business limit is reduced for corporations that have between $50,000 and $150,000 of investment income. The business limit is reduced by $5 for every $1 of passive income above the $50,000 threshold, and the small business limit is entirely eliminated once $150,000 of passive investment income is earned in a year.

Typically, investing in an RRSP first is the better strategy for most income investors unless you have a higher risk tolerance and invest only for capital gains that can be deferred over a long period of time. Corporate investing does not provide tax-sheltered growth since the investment income will be taxed in your corporation in the year it is earned. This contrasts with an RRSP, which provides a tax shelter for any earnings inside.
An additional dollar of passive income generated inside a corporation will impact your access to the small business deduction. Depending on the extent of active business and passive income earned in a corporation, you will need to weigh the possible benefit of deferral against the clawback of the small business limit.

Investing in a corporation will add opportunities and compli-cations in meeting your retirement goals. Speak with your advisor to discuss your situation in detail. ■

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