Business Owners – why RRSP’s WILL save you Thousands of dollars in Tax: Dollar for dollar tax deferral

During RRSP season (And otherwise) it’s not uncommon for me to come across the argument that RRSP contributions are not worth it for incorporated business owners.

This usually comes from:

-??????????? Current incorporated business owners who believe salary results in more tax and want to avoid that and think not having RRSP room is a worthwhile sacrifice

-??????????? Accountants who believe that keeping the money in the corporation is better financially vs keeping it in the RRSP

-??????????? People (Incorporated or otherwise) who are later stages in life looking at the risk of a large RRSP and saying “oh – look at all that forced tax. I wish I hadn’t done this”.

Most of these thoughts are mistaken and I’ll explain why.

Before jumping into that though I want to make one thing clear about money in the corp vs money in your RRSP.

For most ACTIVELY OPERATING businesses (That is you are purchasing inventory, actively expanding, maybe you need cash reserves for payroll etc) – money in the corp will always be important vs RRSP’s from an opportunity cost standpoint.

This is when you get to the point where you are looking at true “surplus” funds. So you don’t have an equipment purchase or expansion on the horizon (Or the size of which necessitates a loan anyhow so you aren’t going to be stacking up millions of dollars of cash before investing in your next project).

Setting that aside – let’s talk about why RRSP contributions for Business Owners is so important from a tax deferral and wealth standpoint:

True 100% dollar for dollar Tax Deferral

Since an RRSP contribution (OR FHSA for that matter) is a deduction against your income – you can effectively take money out of your corporation and plop it right into your RRSP without any tax issues!

Here’s the Math:

You have $18,000 of RRSP room.

You need $100,000 of Salary to cover off your living expenses.

Your Corporation has generated $300,000 of “pre-tax profits” and now you are deciding how much to pay yourself.

In Ontario (Where the small business deduction rate is 12.2%) the math on $100,000 Salary would look like this for a non-RRSP contribution:

Non-RRSP Contribution

$300,000 of pre-tax profits - $100,000* of Salary= $200,000 of pretax profits.

Corporate Tax: 12.2% of $200,000 = $24,400 Tax owing.

Business Owner Tax: Income Tax on $100,000 of Salary

Remainder to “invest” = $175,600.

*I’m simplifying this a touch as there are some other considerations like employer CPP etc – but this get’s the point of RRSP’s across – you’ll see.

With an RRSP Contribution

With an RRSP Contribution the math is a little different.

Here’s why – we need to get $18,000 out of the corporation to fund the RRSP but the deduction mechanics work like magic ??

$300,000 of pre-tax profits - $118,000 of Salary= $182,000 of pre-tax profits

Corporate Tax: 12.2% of 182,000 = $22,204 of tax

Business Owner Tax: $118,000 - $18,000 of RRSP Contributions= Income Tax on $100,000 of Salary

Amount Available to invest:

RRSP: $18,000

Corporation: $182,000-$22,204 = $159,796

Total Available to invest: $177,796

THERE IS ACTUALLY MORE MONEY TO INVEST!

How does this benefit you?

First off – depending on the situation – there are specific needs such as going back to school or buying a house where those extra dollars all of a sudden because very useful when you consider the ability to get an interest free/tax free loan from your RRSP.

Second – more dollars means in general – faster compounding. I don’t think anyone’s going to argue with me about that.

What about the fact that it all comes out taxed as income?

This is easily the biggest veto for the RRSP. That eventually all the RRSP income comes out “taxed” as income vs a corporation where certain types of gains like capital gains or eligible dividends retain their special tax status. This seems good on the surface and “is true” but when you think about long term compounding – you’ll realize that paying a little bit of tax all along the way in this case doesn’t quite work out.

I’ll have more on this next week on my Friday segment for business owners.

Have a great weekend everyone