For lack of time and availability, professionals often fail to clearly define their savings plan at the beginning of the year. Your profession is very time-consuming, and most of you probably don’t realize the medium- and short-term impact of this lack of planning.
Know, however, that a good savings plan can have very positive effects on your wealth and enable you to realize the life projects you care about.
How do you get started? Here is an example to illustrate this.
Couple in their late forties with children
Corporation: $400,000 after expenses (before paying salary)
Caroline: $335,000 in the form of salary (from the corporation)
Caroline and Daniel’s RRSP’s: maximized
Five-points optimization strategy
1. Income splitting
It would be advantageous for Caroline to split her income, i.e. pay a part of it to another family member whose tax rate is lower than hers. Paying a $60,000 dividend to Daniel could balance the household income and reduce the couple’s tax burden.
2. Dividend to the adult children
From a tax standpoint, paying an income to a minor child generates no benefits. However, Caroline has the option of paying dividends to her son Shawn, in this case, a $20,000 dividend to cover his cost of living. The amount could be higher, but the objective is not to enrich Shawn, but simply to pay his already budgeted expenses. When Oliver turns 18, the same strategy can be applied.
3. Capital dividend account (CDA)
Once income splitting has been optimized, tax accounts can be as well. Rather than paying herself a taxable income (salary or dividend), Caroline would be better off paying herself a non-taxable capital dividend. When a corporation makes profits on its investments, the value of its CDA increases. It is from this account that the non-taxable dividend can be paid. Caroline has $20,000 in her CDA after six years of practice: this amount should be paid first, before any source of taxable income.
4. Refundable tax dividend on hand (RTDOH)
RTDOH represents taxes already paid by the corporation on investment income, which can be recovered in the form of a tax refund when a taxable dividend is paid to one of the shareholders. By paying dividends totalling $80,000 to Daniel and Shawn, the corporation can obtain a full refund of its RTDOH account, which comes to $30,000.
5. Choice of salary
To determine her compensation, Caroline must first establish her tax status. If the total hours worked by Caroline and her employees come to less than 5,500, it would be better for her to choose compensation in the form of salary. Since Caroline has been able to take advantage of income splitting and the CDA, she can cover her family’s living expenses with a salary of $160,000. With this plan, her marginal tax rate would be 47.46%, versus 53.31% for professionals whose taxable income exceeds $202,800.
With these different strategies:
- The amount of savings in the corporation increases from $41,000 to $111,000, a gain of $70,000.
- The level of spending remains the same at $200,000.
- The current RRSP savings are maintained.
|Salary||Dividend||CDA dividend||RRSP savings||Corp.savings|
|Shawn (oldest son)||$0||$0||$0||$0||$0|
|Shawn (oldest son)||$0||$20,000||$0||$0||$0|
With the strategies used (income splitting, dividend to an adult child and CDA), Caroline can reduce the salary she pays herself ($160,000 instead of $335,000) and reduce her marginal tax rate by close to 6%, while maintaining the same standard of living as before.
The additional amount of $70,000 generated by this optimization will increase the savings in the corporation: in future years, this amount can grow and increase the couple’s wealth. However, Caroline and Daniel will have to review their savings plan annually with their advisor, to ensure that it is efficient and to adjust it to their reality and to tax changes.
At the end of the day, this plan will provide the couple with much more substantial savings, without having to lower their standard of living, but rather by reallocating existing amounts. Clearly, a well-considered savings plan can have very positive effects on your wealth!
Benoit Chaurette, M. Fisc., F. Pl.
Tax Specialist and Financial Planner, Professional Practice
Steve Lamontagne, B.A.A., F. Pl.
Wealth Management Advisor
The tax strategies mentioned in this article may not apply in all cases. Please consult your tax advisor. The opinions expressed here do not necessarily represent the views of Professionals’ Financial. The information contained herein has been obtained from sources deemed reliable, but we do not guarantee the accuracy of this information, and it may be incomplete. The opinions expressed are based upon our analysis and interpretation of this information and are not to be construed as a recommendation. Please consult your Advisor.