As a Canadian business owner, managing your finances can sometimes feel like navigating a complex maze. Between running day-to-day operations and planning for the future, finding the time to focus on personal and business financial planning can be challenging. However, understanding the tools available for retirement savings and tax planning is crucial for long-term success.
Two of the most powerful savings vehicles at your disposal are the Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA). This guide aims to demystify these accounts and help you make informed decisions to maximize your financial growth.
Table of Contents
Understanding RRSPs and TFSAs
What is an RRSP?
A Registered Retirement Savings Plan, or RRSP, is a tax-deferred savings account designed by the Canadian government to encourage individuals to save for retirement. Contributions to an RRSP are tax-deductible, which means they can reduce your taxable income in the year you make the contribution. Additionally, any investment growth within the RRSP is tax-deferred, allowing your investments to compound over time without the drag of taxes. Taxes are only paid when you withdraw funds, typically during retirement when you may be in a lower tax bracket.
Benefits of RRSPs
RRSPs offer several key advantages that make them an essential part of retirement planning for many Canadians. One of the primary benefits is the immediate tax deduction you receive when you contribute. By reducing your taxable income, you would pay less in taxes for that year, effectively giving you an instant return on your contribution. This can be especially beneficial if you are in a higher tax bracket, as the tax savings can be substantial (up to 47.5% in Saskatchewan in 2024).
Another significant advantage is the tax-deferred growth of your investments within the RRSP. Since the income earned on your investments—whether it’s interest, dividends, or capital gains — is not taxed as long as it remains in the plan, your savings can grow more quickly compared to a taxable account where the CRA gets a piece of the earnings every year. This difference, compounded over many years, can significantly increase the size of your retirement nest egg.
Finally, RRSPs provides a moderately flexible but structured way to save for retirement. Contributions can be made regularly or in lump sums, and additional contribution room is created each year you report “earned income” on your personal tax return. By allowing contributions to be made on your economic timeline, and providing more potential contribution room each year that carries forward if not used, an RRSP is an readily accessible investment account for all types of investor.
What is a TFSA?
The Tax-Free Savings Account, or TFSA, is another powerful savings and investment vehicle introduced by the Canadian government in 2009 for individuals 18 and older. Unlike the RRSP, contributions to a TFSA are made with after-tax dollars—there is no deduction when you contribute. However, the true benefit of a TFSA lies in its flexibility and the tax-free growth and withdrawals it offers. Any investment income or capital gains earned within the TFSA are not subject to tax, and you can withdraw funds at any time without incurring taxes or penalties. This makes the TFSA a versatile tool for both short-term savings goals and long-term investing.
Benefits of TFSAs
TFSAs provide several benefits that make them an attractive option for Canadians. First and foremost is the tax-free growth and withdrawals. Since neither the investment income generated within the account nor the withdrawals are taxed, you can maximize the growth of your investments. This can be particularly advantageous for investments that generate significant income or capital gains over time.
Another key benefit is the flexibility TFSAs offer. Unlike RRSPs, withdrawals do not affect your taxable income. This means that accessing your funds won’t have negative tax implications or impact income-tested government benefits. Additionally, any amounts you withdraw are added back to your TFSA contribution room in the following year, ensuring you don’t permanently lose the ability to save that amount tax-free.
Finally, TFSAs have no maximum age limit for contributions. While RRSP contributions must stop after you turn 71, you can continue to contribute to a TFSA throughout your life, making it an ideal vehicle for ongoing savings and estate planning.
RRSPs and TFSAs for Business Owners
When you have your own incorporated business, you face unique financial considerations that can make retirement planning more complex. Unlike salaried employees, you have the flexibility to choose how you receive personal income from your business—whether through salary, dividends, or a combination of both.
This choice affects not only your personal tax situation but also your ability to contribute to retirement savings vehicles like RRSPs. Deciding whether to invest excess profits back into your corporation, contribute to an RRSP, or maximize your TFSA requires careful planning to optimize tax efficiency and ensure long-term financial growth.
RRSP Contributions for Business Owners
Contribution Limits
The amount you can contribute to an RRSP each year is based on your “earned income” from the previous year. For most individuals, this is straightforward. However, for business owners, particularly those who pay themselves in dividends rather than a salary, this can become more complicated. RRSP contribution room is calculated as 18% of your earned income up to an annual maximum limit, which is $31,560 for 2024.
Importantly, “earned income” for RRSP purposes includes employment income and self-employment income but does not include dividends. This means that if you pay yourself primarily through dividends, you will not generate RRSP contribution room. To maximize your RRSP contributions, you need to pay yourself a salary from your business.
Salary vs. Dividends
As a business owner, you have the option to pay yourself through salary, dividends, or a mix of both. It is important to remember that each method has its own tax implications and impacts your retirement planning differently.
Salary: Paying yourself a salary means that your business will treat you as an employee, deducting income tax and making contributions to the Canada Pension Plan (CPP) (but not Employment Insurance). Salaries are deductible expenses for the corporation, reducing its taxable income and therefore corporate income tax. Importantly for RRSP purposes, salaries are considered earned income, thereby creating RRSP contribution room.
Dividends: Dividends are payments made to shareholders from the corporation’s after-tax profits. Dividends are taxed differently than salary and often at a lower rate due to the dividend tax credit. However, they do not generate RRSP contribution room since they are considered investment income rather than earned income.
The choice between salary and dividends depends on various factors, including your current and future income, retirement planning goals, and the corporation’s financial situation. For example, if you aim to maximize your RRSP contributions, paying yourself enough salary to generate sufficient RRSP room is necessary. On the other hand, if immediate tax efficiency is a priority, dividends might be more attractive.
Example Scenario
Consider Sera, a professional operating her practice through a corporation in Saskatchewan. She earns $190,000 in Small Business Deduction (SBD) income each year. She faces a decision on how to distribute her income for the most tax-efficient retirement savings.
Option 1: Salary and RRSP Contribution
Sera could choose to pay herself a salary, maximizing her RRSP contribution room. This salary is a deduction from the corporation’s taxable income, saving the corporation income tax at the Small Business Deduction tax rate (10% in SK in 2024). However, the salary is taxable income to Sera, which she will pay personal income tax on as received (depending on her total taxable income, at marginal tax rates starting at 0% and reaching 47.5% for income over $246,752 in 2024).
By contributing the maximum allowable amount to her RRSP, she reduces her taxable income, resulting in immediate tax savings at the highest marginal tax rate she would otherwise pay. The remainder of her income is used to cover personal expenses and taxes. By contributing to her RRSP now, she defers personal taxes on that initial contribution and any related growth until retirement when she expects to be in a lower tax bracket.
Option 2: Corporate Investing and Dividends
Alternatively, Sera could pay herself just enough salary to cover her immediate personal expenses and leave the remaining profits within the corporation to invest. The corporation pays tax on the profits, and the after-tax amount is invested within the corporation. In the future, when Sera retires, she can pay herself dividends from the corporation’s accumulated investments to fund her retirement.
In this situation, the corporation has higher taxable income and pays more corporate tax, but at the low SBD tax rate, and the remaining funds would be invested. But the income on those investments would be taxable in going forward. Sera would pay lower personal income tax, as she did not take additional salary, but does not have the additional funds in her RRSP that will grow tax-free going forward.
The optimal choice between these options depends on several factors, including the expected rate of return on investments, differences in tax rates over time, and the impact of taxes on investment income within the corporation versus within personal accounts like RRSPs. Over time, the after-tax amounts available at retirement may vary significantly based on the chosen strategy.
TFSA Contributions for Business Owners
Funding TFSAs with Corporate Income
Contributing to a TFSA as a business owner involves withdrawing after-tax funds from your corporation. This means the corporation must first pay corporate taxes on the business income, and you must pay personal taxes on any dividends or salary used to fund the TFSA contribution.
While this is less tax-efficient in the short term due to the immediate tax implications of not being able to deduct TFSA contributions, the TFSA offers the benefit of tax-free growth and withdrawals, which can outweigh the initial tax costs over the long term.
Tax Implications
The process of funding your TFSA from corporate income involves several layers of taxation:
- Corporate Taxes: The corporation pays tax on its business income before any distributions are made.
- Personal Taxes on Dividends or Salary: When you receive income from the corporation to fund your TFSA, you will pay personal income tax. Dividends are taxed differently than salary, often at a lower rate due to the dividend tax credit, but they do not create RRSP contribution room.
- Tax-Free Growth within TFSA: Once the funds are in your TFSA, any investment income or growth is not subject to tax, and withdrawals are tax-free.
While there is an immediate tax cost to withdrawing funds from your corporation, the long-term benefits of tax-free growth within a TFSA can be substantial, especially for investments that are expected to yield high returns over time.
Example Scenario
Let’s say you want to contribute the maximum amount of $7,000 to your TFSA for the year. To have $7,000 of after-tax personal income, your corporation needs to generate sufficient pre-tax income to cover corporate taxes and personal taxes on dividends or salary.
Assuming your corporation earns $13,072 in SBD income in Saskatchewan, after paying corporate taxes, it has $11,765 available. If you distribute this as a dividend to yourself, you will pay personal tax (at rates between 0% and 40%), leaving you with at least $7,000 to contribute to your TFSA for tax-free investment. If you did not declare the dividend, the corporation would have $11,765 to invest, but its investment income would be taxable.
The specific amounts will vary based on the province, the type of income (SBD income versus general income), and the applicable tax rates. This example illustrates the need to consider both corporate and personal taxes when planning TFSA contributions from corporate earnings.
Comparing RRSPs and TFSAs
When to Choose an RRSP
RRSPs are generally most beneficial when your current income is high – either earning a high salary from a third party or self-employment, or if your incorporated business earns enough to not be eligible for the SBD tax rate, and you expect to be in a lower tax bracket during retirement. Contributing to an RRSP reduces your taxable income now, providing immediate tax savings at high tax rates. The tax-deferred growth within the RRSP allows your investments to compound over time without being diminished by taxes.
For business owners who pay themselves a salary sufficient to maximize their RRSP contribution room, and who are in a high tax bracket, using an RRSP can be an effective retirement savings strategy. It’s important to plan for the eventual taxation of RRSP withdrawals during retirement and to consider how this will impact your overall tax situation and eligibility for income-tested government benefits.
When to Choose a TFSA
TFSAs are a flexible and tax-efficient savings vehicle that can be advantageous in various situations:
If your current income is low, and you expect it to increase significantly in the future, contributing to a TFSA now allows you to invest and grow your savings tax-free. Later, when you’re in a higher tax bracket, you might choose to contribute to an RRSP to take advantage of higher tax deductions.
If you prefer flexibility, TFSAs allow you to withdraw funds at any time without tax consequences or penalties. This can be useful for both short-term savings goals and unexpected expenses.
For individuals over 71 years old, who are no longer eligible to contribute to an RRSP, the TFSA provides an ongoing opportunity to save and invest in a tax-advantaged account.
Additionally, since TFSA withdrawals do not count as income, they do not affect eligibility for income-tested government benefits like Old Age Security (OAS) or the Guaranteed Income Supplement (GIS).
Factors to Consider
When choosing between RRSPs and TFSAs, consider the following:
- Current and Future Tax Rates: If you expect to be in a lower tax bracket during retirement, RRSPs may provide more tax savings. If your tax rate will be the same or higher in retirement, TFSAs may be more beneficial.
- Income Level and Type: Remember that only “earned income”, such as salary or bonuses, generates RRSP contribution room. If you pay yourself primarily through dividends, you may have limited RRSP room and may need to focus on TFSAs or other investment strategies.
- Impact on Government Benefits: RRSP withdrawals increase your taxable income and may affect eligibility for income-tested benefits, while TFSA withdrawals do not.
- Retirement Goals and Time Horizon: Consider your long-term financial needs, retirement lifestyle expectations, and investment time horizon. The power of compounding and tax-free growth can have a significant impact over many years.
Strategies for Maximizing Returns
Combining RRSPs and TFSAs
In many cases, using both RRSPs and TFSAs can provide the best of both worlds. By diversifying your savings between these accounts, you can optimize tax efficiency during your working years and in retirement. For instance, you might contribute to an RRSP to reduce your taxable income when it’s high and use a TFSA to save additional funds or to provide flexibility for future withdrawals.
Corporate vs. Personal Investing
Another key consideration for business owners is deciding whether to retain excess profits within the corporation for investment or to withdraw funds and invest personally through RRSPs or TFSAs. Here are some factors to consider:
1. Corporate and Personal Tax Rates: Corporate investment income is generally taxed at higher rates than active business income. Additionally, when you eventually withdraw funds from the corporation, you will pay personal taxes on dividends. Investing personally may result in better after-tax returns, especially considering the tax advantages of RRSPs and TFSAs.
2. Types of Investment Income: The type of income generated (interest, dividends, capital gains) affects the overall tax efficiency. Some investment income may be more tax-efficient when earned personally rather than corporately.
3. Tax Deferral Opportunities: Retaining income in the corporation can defer personal taxes, leaving more funds available for investment overall but the benefits may be offset by higher corporate taxes on investment income over time.
4. Impact on Small Business Deduction: Excess passive investment income in a corporate can reduce eligibility for the Small Business Deduction, potentially increasing the tax rate on your business income.
Age Considerations
Over Age 71: RRSPs must be converted to a Registered Retirement Income Fund (RRIF) or an annuity by the end of the year you turn 71, and you can no longer make contributions. However, you can continue to contribute to a TFSA indefinitely. If you have excess income from RRIF withdrawals that you do not need for living expenses, contributing to a TFSA allows you to shelter those funds from tax on future investment income.
Younger Canadians: If you are early in your career and expect your income to rise significantly in the future, you might prioritize contributing to a TFSA now and save your RRSP contribution room for years when you are in a higher tax bracket. This strategy maximizes the tax savings when your income—and corresponding tax rate—is higher.
CPP/QPP Contributions
When you pay yourself a salary, both you and your corporation must contribute to the CPP – maximum contributions would be $8,068,20 in 2025. While this increases your current payroll costs, it also increases your CPP benefits in retirement. If you pay yourself solely through dividends, you will not contribute to CPP and will not receive benefits, which may necessitate increased personal savings to compensate.
Income Splitting Opportunities
RRSPs and TFSAs can be used to facilitate income splitting with a spouse or common-law partner, which can reduce the overall family tax burden. For instance, you can contribute to a spousal RRSP, allowing the lower-income spouse to withdraw the funds in the future at a lower tax rate. After age 65, RRIF withdrawals can also be split between spouses for tax purposes.
Similarly, you can contribute to your spouse’s TFSA without attribution rules applying. This means you can provide funds to your spouse to maximize their TFSA contributions, and any investment income or growth remains tax-free while invested in their TFSA. Outside of a TFSA, the investment income or growth could be taxable to the original spouse.
Loss of Small Business Deduction (SBD)
Corporations with significant passive investment income may see a reduction in their Small Business Deduction limit. The SBD allows eligible small businesses to benefit from a reduced corporate tax rate on active business income up to a certain limit. Passive investment income exceeding $50,000/year can erode the SBD limit, potentially increasing the tax rate on your active business income.
By withdrawing excess funds from the corporation and investing them personally, you can reduce passive income within the corporation, helping to preserve your SBD limit and maintain lower corporate tax rates on active business income.
Conclusion
Navigating the complexities of RRSPs and TFSAs as a Canadian business owner requires careful consideration of your unique financial situation, retirement goals, and the interplay of corporate and personal tax rules. Both RRSPs and TFSAs offer valuable opportunities to grow your wealth and save for the future, but the best approach depends on factors such as your current income, expected future income, preferred method of compensation, and long-term plans for your business and retirement.
By understanding the benefits and implications of each savings vehicle, you can make informed decisions that optimize your tax efficiency and align with your financial objectives. It’s often beneficial to seek guidance from financial advisors or tax professionals who can provide personalized advice tailored to your circumstances. With the right strategy in place, you can build a solid foundation for your financial future and achieve the peace of mind that comes with effective planning.
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FAQs
Can I open a TFSA or RRSP for my corporation?
No, both TFSAs and RRSPs are personal savings vehicle and cannot be opened directly by a corporation. However, as a business owner, you can withdraw after-tax funds from your corporation and contribute to your personal TFSA. This involves paying corporate taxes on the income and personal taxes on any dividends or salary used to fund the contribution.
What happens to my TFSA when I die?
When you pass away, the assets in your TFSA can be transferred to a designated beneficiary without tax consequences, provided the beneficiary is your spouse or common-law partner and you have named them as a “successor holder.” The successor holder can take over the TFSA, and the account continues to grow tax-free. If the beneficiary is not a spouse or common-law partner, the account ceases to be a TFSA upon your death, and any income earned after the date of death may be subject to tax. But the value of the TFSA at death, including any growth and income since investment, is received by the beneficiary tax-free.
What is the TFSA contribution limit for 2023?
The TFSA contribution limit for 2024 and 2025 is $7,000. If you have never contributed to a TFSA since its inception in 2009, and you were at least 18 years old and a Canadian resident since then, your total cumulative contribution room, up to Jan 1, 2025, would be $102,000. Unused contribution room carries forward indefinitely, allowing you to catch up on contributions in future years.
Can I have multiple TFSA accounts?
Yes, you can have multiple TFSA accounts at different financial institutions. However, your total contributions to all your TFSAs in a given year cannot exceed your available TFSA contribution room. Over-contributing to your TFSA can result in penalties from the Canada Revenue Agency (CRA), so it’s important to keep track of your contributions across all accounts.
Should I invest within my corporation or personally through an RRSP or TFSA?
Deciding whether to invest within your corporation or personally through an RRSP or TFSA depends on various factors, including tax rates, the type of investment income, your personal financial goals, and the impact on corporate tax considerations like the Small Business Deduction. Generally, investing personally through RRSPs and TFSAs may provide better after-tax returns due to preferential tax treatment and the ability to shelter investment income from taxation. Consulting with a financial advisor or tax professional is recommended to determine the best strategy for your specific situation.
How does paying myself a salary versus dividends affect my RRSP contributions?
Only salary or wages (earned income) generate RRSP contribution room. Dividends do not count as earned income for RRSP purposes and therefore do not create RRSP contribution room. If you wish to maximize your RRSP contributions, you need to pay yourself sufficient salary from your corporation. This approach also involves remitting payroll taxes and contributing to CPP/QPP. Paying yourself dividends may result in lower immediate taxation but won’t help build your RRSP contribution room.
