Canadian Taxation

For small business owners, TFSA’s are better than RRSP’s

Published On January 18, 2014 | By Joseph (Ken) | Retirement

RRSP

This article is a real world example of how, for a small business owner, TFSA’s are much better than RRSP’s.

In this case, the small business owner wants to save for retirement and their prior accountant advised them to increase their wages and buy RRSP’s.  It’s important to note that the client is reporting a $31,500 wage from their company.

The advice is faulty for the following reasons:

1) If you aren’t purchasing RRSP’s at a high tax rate and then withdrawing them later at a low tax rate, you are merely deferring tax. As well, the income earned in a RRSP is NOT tax free, it is merely sheltered so you pay the tax later and not now.

2) Although the RRSP’s offset the tax cost to increasing the wage from the company, they don’t offset the increased CPP cost. Small business owners pay both portions of CPP (so 9.9% vs 4.95%) and CPP is a terrible retirement vehicle. CPP can best to described as “better than nothing”.

3) It is rarely beneficial to report a larger wage than needed as the company is taxed at 14.5% whereas personal tax rates are higher by at least 50%.

Here is the math:

Dividends $0.00   $19,500.00   $31,500.00
Wages $31,500.00   $12,000.00   $0.00
Investment type RRSP’S   TFSA’S   TFSA’S
           
CPP cost (9.9%) 2,772.00   841.50   0.00
RRSP  2,400.00   0.00   0.00
TFSA 0.00   2,400.00   2,400.00
Personal tax 4,602.00   1,150.00   181.00
Corporate tax       0.00   2,967.46   4,768.47
   Tax cost 9,774.00   7,358.96   7,349.47
Addtnl Savings invested        0.00   2,415.04   2,424.53
    9,774.00   9,774.00   9,774.00
           
Total Retirement fund        
CPP (60%) 1,663.20   504.90   0.00
RRSP  2,400.00   0.00   0.00
TFSA 0.00   2,400.00   2,400.00
Additional TFSA        0.00   2,415.04   2,424.53
  4,063.20   5,319.94   4,824.53
Tax to withdraw     812.64      100.98         0.00
Funds in hand 3,250.56   5,218.96   4,824.53

Points I’d like to stress:

1) Small business owners and the self-employed pay BOTH portions of CPP and, therefore arguably, see a smaller cost to benefit ratio when they collect CPP.

2) CPP is a numbers game – if you live longer, you receive more benefits than you paid, BUT, if you die earlier, those benefits you paid that you didn’t receive go into the general pool and not to your beneficiaries.

3) RRSP withdrawals count as income and, therefore, work against any potential GIS supplement.  

4) Any income earned in a TFSA is TAX-FREE unlike RRSP’s where you are taxed on that “sheltered” income when you withdraw funds from your RRSP.

 

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About The Author

Joseph (Ken)
(Ken) is a Registered Public Accountant with over 25 years of public practice experience in the accounting profession. Ken specializes in accounting information systems, taxation and financial reporting.

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