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When Vanessa Green established her business in 2020, she became a sole proprietor.
Eighteen months later, when she incorporated creating a separate legal entity responsible for its own taxes, her accountant suggested a strategy that has her paying a minimal amount to the Canada Pension Plan (CPP) instead of the maximum yearly contribution of just over $7,000.
“I should have access to a lot of that cash,” says Green, 37, who is also a mother to young children. “When you pay CPP, you have to pay the employer portion when you’re self-employed.”
For working Canadians between 18 and 70, payments to CPP are automatically deducted from their paycheques with employees and employers contributing equally. If you earn $66,600.00 a year or more, your contributions max out at $7,508.90.
Instead of paying that amount, Green pays herself a minimal salary and takes the rest of her earnings in company dividends. The remainder of the money she earns stays in the company. She then takes the money that would have gone to max out her CPP contributions and invests it toward her retirement.
Choosing not to pay CPP is an option for business owners, but is a strategy advisers caution to be careful about, especially when planning for retirement. Even her brother, Alex Green, a certified financial planner and founder of GreenTree Wealth Management, was skeptical of his sister’s plan of paying herself a small salary and dividends.
Jackie Porter, a certified financial planner and adviser with Carte Wealth Management Inc., says a self-employed person should ask themselves about their financial resources.
‘The majority of people will need CPP’
“How much have you saved for retirement?” she says. “The majority of people will need CPP as another income stream, because who knows what’s going to happen to your business.”
Porter says that with CPP, there is a guaranteed stream of income on top of whatever else a person has squirreled away.
“It’s nice to have and it might end up being gravy,” she says. “But it might mean that you have that much more cash flow in retirement. If you don’t need it, you’re just reinvesting it into your investments, creating a larger pool of assets for your heirs.”
Iftikhar Mahmood, a certified financial planner at CreateWealth Planning, says a combination of dividends and salary is part of a tax planning strategy for business owners. He says paying oneself a dividend versus salary makes more sense for some business owners from a taxation perspective.
“That advantage still exists,” he says, “but to a smaller degree, as tax rates for people who are self-employed business owners.”
Airikka Passmore, Green’s financial adviser, says that Green’s business structure of paying herself a small salary and larger dividends is an option for some business owners who need access to cash.
“A lot of the time when accountants are working with clients,” she says, “we are recommending that this is a better opportunity because it is a cheaper tax option for small businesses.”
Paying dividends means business owners can keep their personal tax rate low as the dividends are taxed through the corporation at the business tax rate, which is generally around 15 per cent — freeing up more money for Green.
The key to this investing strategy is discipline
The key to making this strategy work, says Passmore, is discipline because you’re not automatically maximizing your CPP contributions. Instead, she says, business owners need to set aside the money they would have contributed to CPP, factor in inflation as CPP does, and invest it in your retirement. She always warns clients, though, that going down this path will have an impact on future savings for retirement.
“We discuss how to compensate for that and I always say to people, ‘Is there a better way for you to invest $10,000 a year for your own retirement that is outside of registered retirement savings plans because that doesn’t really help people as they might be in a higher tax bracket (when they retire),’” Passmore explains.
This is where she recommends business owners work with an adviser to navigate the tax benefits while funding their company’s growth.
When you own a corporation, says Porter, depending on how you structure things, taxes still need to be paid. So as the business is growing, it’s taxed depending on what it’s invested in. When you withdraw from it, that money is also taxed.
She says those are considerations to keep in mind whether or not you’re looking to take dividends instead of just paying to CPP and creating that other stream of income.
“I vote for CPP as another guaranteed stream of income,” she says. “Not to say that she can’t use dividends as a part of a strategy, but multiple strategies often are better than one.”
As part of the process, Passmore talked directly with Green’s brother Alex, explaining the reasoning behind Green’s current business structure, reassuring him that Green, who says she leaves the planning conversations to Passmore and her brother, wasn’t going to end up playing catch-up in retirement.
And Green says her current payment structure is not a permanent thing. The ability to adjust the amount she can pay herself as a salary and as dividends means she can shift her strategy based on her needs.
“There’s always an opportunity to change your tactics, and I think that gives me a little bit of solace,” she says. “If I decide, ‘Maybe this isn’t the right decision anymore,’ then I can talk with (Passmore) and she would be open to it. Obviously, she makes her recommendation, but she’s going to do what her clients asked of her.”
Renée Sylvestre-Williams is a Toronto freelance writer focusing on finance.
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