Should I save in my TFSA or in my corporation? Case study ⋆ Financière des professionnels

For incorporated professionals, determining the best way to grow their savings is not a given!

Some of the questions that always come up are: “Where should I accumulate my annual surpluses? Is it preferable to withdraw an additional amount from my corporation to maximize my TFSA? Or should I simply let all the surpluses grow in my corporation?”

Unfortunately there’s no universal answer, since the decision depends on a number of factors, the most important being your asset allocation.

A factor to consider: taxation

The major difference between saving in your TFSA and leaving the surpluses in your corporation is the fact that the returns generated in the TFSA are not taxable, whereas they are taxable in the corporation. However, you should know that the amounts you want to contribute to your TFSA will first have to be withdrawn from your corporation and that this income will then be taxed immediately.

Bond portfolio versus stock portfolio

If your risk tolerance is such that it is preferable for you to hold investments that generate interest income, you will be better off investing these amounts in your TFSA rather than in your corporation. Conversely, if the investments in your corporation are concentrated in stocks, it is not tax advantageous to contribute to your TFSA.

Example

The tables below show the results you can expect if you contribute to your TFSA (scenario 1) or leave the surpluses in your corporation (scenario 2).

SCENARIO 1 BOND PORTFOLIO
INTEREST INCOME 3.9%
Years	COMPANY INVESTMENTS	RTDOH¹	NET TO THE SHAREHOLDER	TFSA
0	$11,163	–	$6,000	$6,000
5	$12,288	$694	$6,978	$7,265
10	$13,527	$1,458	$8,054	$8,796
15	$14,890	$2,299	$9,239	$10,651
20	$16,392	$3,224	$10,544	$12,896
25	$18,044	$4,243	$11,979	$15,615
To obtain an amount net of tax of $6,000 to contribute to your TFSA, you will first have to pay yourself a dividend of $11,163 (assuming a taxation rate of 46.25% on an ordinary dividend). Assuming an interest return on bonds of 3.9% per year, note that after 25 years, the net value of the TFSA would be $15,615 By leaving the amounts in the corporation, the net value to the shareholder would be $11,979. The difference in favour of the TFSA would therefore be $3,636. Since this example is based on only one contribution, the difference would be even greater if the exercise were repeated each year.

SCENARIO 2 STOCK PORTFOLIO
CAPITAL GAIN RETURN 6.4%
Years	COMPANY INVESTMENTS	RTDOH¹	NET TO THE SHAREHOLDER	TFSA
0	$11,163	–	$6,000	$6,000
5	$14,106	$603	$8,815	$8,182
10	$17,825	$1,364	$12,372	$11,158
15	$22,524	$2,327	$16,867	$15,215
20	$28,463	$3,543	$22,547	$20,748
25	$35,967	$5,080	$29,725	$28,294
With a portfolio that is composed solely of stocks and that generates a capital gain return of 6.4%, the result is different. Note that the net value to the shareholder is slightly higher here than that of the TFSA. The reason is that the capital gain is more advantageous from a tax standpoint than interest income. It therefore becomes more tax advantageous to keep the amounts in the corporation and to benefit from the preferential tax treatment.

¹ RTDOH stands for refundable tax dividend on hand. It is an account for overpayment of tax on a corporation’s investment income. This tax paid in advance is, however, recovered by the corporation when it pays dividends to the shareholder.

A theory on the subject states, however, that regardless of your investor profile, it is preferable to maximize your TFSA each year, because no one knows what the tax rules will be in 20 or 30 years. The best strategy is undoubtedly to allocate your investments among different vehicles and to diversify them to protect against the tax changes that will inevitably occur.

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