Ep # 93 - The Overlooked CPP Strategy That Saves Business Owners Thousands with Aravind Sithamparapillai
Joe and Aravind explore the merits of contributing to the Canada Pension Plan (CPP) through salaries. Despite the dual contributions required from business owners, CPP offers guaranteed, inflation-adjusted income in retirement, providing a secure financial foundation.
The discussion highlights the tax credits and deductions associated with CPP contributions, emphasizing their value in reducing taxable income. Additionally, it underscores the long-term benefits of RRSPs, which grow tax-free and can offer significant tax savings, making them a crucial element in retirement planning for business owners.
What You’ll Learn in Today’s Episode
Tax Efficiency of Dividends: Dividends are often a tax-efficient method for business owners to receive income due to the advantages provided by notional accounts like the Refundable Dividend Tax on Hand (RDTOH) and the Capital Dividend Account (CDA). These accounts enable corporations to reclaim certain taxes when dividends are paid, making dividends beneficial in many scenarios.
When to Consider Salaries: Once notional accounts are depleted, salaries become a strategic option. Salaries provide benefits such as creating an RRSP (Registered Retirement Savings Plan) room, which allows for tax-sheltered retirement savings, and offers advantages through tax integration, which can reduce the overall tax burden.
Canada Pension Plan (CPP) Contributions: Contributing to the CPP via salaries, despite requiring dual contributions from business owners, is discussed as a beneficial move. CPP contributions lead to guaranteed, inflation-adjusted income during retirement, providing a secure financial foundation.
Tax Credits and Deductions: The podcast highlights the tax credits and deductions associated with CPP contributions. These contributions can reduce taxable income, offering immediate tax relief and enhancing overall tax efficiency.
Long-term Benefits of RRSPs: Emphasis is placed on the importance of RRSPs in retirement planning. RRSPs grow tax-free, offering significant tax savings and serving as a crucial element in a business owner's retirement strategy.
Ideas Worth Sharing
· "Dividends can be very tax efficient for business owners, thanks to mechanisms like the Refundable Dividend Tax on Hand (RDTOH) and the Capital Dividend Account (CDA), which allow corporations to reclaim certain taxes when dividends are paid."
· "Once your notional accounts are exhausted, it makes strategic sense to consider salaries. Salaries not only provide benefits like RRSP room but also help in achieving tax integration, thereby reducing the overall tax burden."
· "Contributing to the CPP through salaries, even with the dual contributions required from business owners, is advantageous because it ensures a guaranteed, inflation-adjusted income during retirement.”
· "CPP contributions come with associated tax credits and deductions that can reduce your taxable income, providing immediate tax relief and enhancing your overall tax efficiency."
· "RRSPs are a vital part of retirement planning for business owners. They offer significant tax savings by growing tax-free and play a crucial role in securing your financial future."
Resources in this episode
The Salary vs Dividend conversation on CPP – Article by Aravind
Twitter: https://x.com/AravindSitham
Instagram: https://www.instagram.com/asithamparapillai/
Ironwood Website: https://www.instagram.com/asithamparapillai/
5 Key Factors to Consider When Structuring Owner Compensation
Deciding how to pay yourself as a business owner - whether taking a salary or dividends - involves weighing several key factors. With the right analysis, you can craft an optimized compensation strategy.
When considering Canada Pension Plan (CPP) contributions, one question that arises is whether these premiums are purely an expense or more of an investment towards securing retirement income. The CPP provides a lifetime, inflation-adjusted pension based on your contributory history. Rather than a tax, view contributions as securing guaranteed retirement income to complement your portfolio.
A key concept here is tax integration - the idea that from an overall tax perspective, there is minimal difference between taking $1 of salary or dividends. While dividends avoid payroll taxes like CPP, the net tax paid across the corporation and personally generally works out to near equal amounts. The tax math tips slightly in favor of salaries, with about 0.2% lower total tax versus dividends in most provinces.
Situations that favor dividends include accessing refundable dividend tax accounts, like the general rate income pool (GRIP), which generate tax refunds when paid out to the shareholder. Also, capital dividend accounts from assets sales allow tax-free payouts. However, most owners lack enough passive/capital income to rely solely on these accounts for distributions.
Arguments for paying salary include crediting RRSP contribution room to boost tax-deferred savings. Salaries also facilitate debt qualifications using T4 income. Deducting CPP employer premiums directly reduces corporate taxes owing.
Upon deeper analysis, CPP costs much less than simply tallying your contributions. The employee CPP expense generates federal and provincial tax credits, recovering ~20% of premiums. Enhancement deductions above the base 4.95% rate create larger credits in higher tax brackets. Employer CPP contributions operate as pre-tax business deductions.
The optimal baseline strategy combines salaries to maximize credits and deductions, while periodically distributing dividends to clear refundable tax accounts. But also evaluate integrating personal and business goals, like retaining profits for operational investments. With customized planning, you can optimize compensation for long-term success.
What are your thoughts on compensation strategies for business owners?
Frequently Asked Questions
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Contributions to CPP provide tax advantages by lowering taxable income during your working years, allowing tax-deferred growth, and offering a steady, partially indexed income in retirement. CPP complements other retirement savings vehicles and can be strategically managed to optimize tax efficiency throughout retirement.
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Dividends can benefit business owners in tax planning by offering a tax-efficient method to extract profits, as they are often taxed at lower rates than regular income. Additionally, dividends enable income splitting among family members who are shareholders, potentially reducing the overall tax burden. Strategic timing of dividend distributions can help manage tax liabilities, while dividends may also qualify for favorable capital gains tax treatment in certain jurisdictions. Ultimately, integrating dividends into tax planning strategies allows business owners to optimize their tax position and effectively manage their company's financial health.
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Episode 93 of our podcast discussed how, once notional accounts like RDTOH and CDA are depleted, transitioning to salaries can be a strategic move. Salaries offer benefits such as creating RRSP (Registered Retirement Savings Plan) room for tax-sheltered retirement savings, leveraging tax integration to reduce the overall tax burden, and optimizing business owner payouts.
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In addition to the points discussed in our blog, Contributing to the Canada Pension Plan (CPP) offers numerous advantages. It secures a dependable retirement income, allows for tax deductions, safeguards against inflation through indexed benefits, and provides survivor benefits to protect loved ones. Overall, CPP contributions lay a strong financial foundation for retirement, ensuring stability and peace of mind.