"Everything must be as simple as possible, but not simpler." — Albert Einstein
Mathematicians and scientists often consider the best solution to a problem to be the simplest. Simple of course doesn’t mean basic, cookie-cutter or the easiest way out. It refers to finding a problem’s optimal solution in as few steps as possible, while ensuring the outcome is arrived at efficiently.
But this isn’t just a task for mathematicians and scientists.
As a financial advisor working in Toronto, my clients have unique problems to solve that stem from the financial gap between where they are and where they want to be. Retiring is no exception. Some clients want to retire on their 65th birthday and never work another day of their lives to travel the world. Others are interested in “semi-retiring” at 55 to work three or four days a week for the next 15 years or so, etc.
My team and I look for the most efficient or "simple" way to plan your retirement, but we’re under no illusions that this is a static math problem. There are too many variables such as your health, changing family dynamics, and global markets to factor in perfectly. However, there are a number of tools entrepreneurs can use to get from A to B in the most efficient manner possible.
One such tool I'd suggest for business owners and doctors is saving for your retirement through your corporation. The first $500,000 of profits saved in a corporation in Ontario is only taxed at a rate of 15.5%. Once the funds are in your corporation they can be invested to grow as you see fit, with few restrictions.
The beauty of saving through your corporation is that you can withdraw the funds at a very low to potentially zero tax rate on your own terms and timing. In other words, the funds you save in your corporate account can be used to draw on throughout your retirement. Using this strategy would allow you to have a considerably lower net tax bill than either of the RRSP or TFSA strategies.
You’re probably thinking, what about RRSPs? When I first meet business owners and doctors, they’re often using their corporations to pay themselves a relatively large salary in order to invest in RRSPs and reduce their immediate tax hit.
This isn’t necessarily the worst strategy, but it usually isn’t optimal. If you’ve done this, come retirement, you’ll find yourself handcuffed to a large RRSP. As you may know, all withdrawals from your RRSP will result in that amount being added to your declared “income”, driving up the amount you owe in taxes. At 71, you’ll be forced to transfer these funds to an RRIF or annuity. With this, you have to cash in funds every year at an accelerated rate, whether it bumps you to a higher tax bracket or not.
Sometimes incorporated professionals attempt to avoid this future tax issue by using their TFSAs instead. Unfortunately, there are two problems with this. First, you can only save $5,500 a year in your TFSA, not nearly enough for many people. Even if you and a spouse were to both maximize your TFSA contributions, saving $11,000 a year, may be far short of your retirement needs.
The other issue with using your TFSAs is that it requires post tax money. For the 2014 Ontario tax year, every dollar of income you make over $88,000 is taxed at least 43%. In other words, you are left with at most 57% of what you originally earned to invest. Not the rosiest of prospects.
Although the point of this post is to highlight the utility of using your corporation to fund your retirement, it’s important to remember that your corporation can be used to pay for your children’s education (which I’ll discuss in a later post), to income split with your spouse, to subsidize your income should you have a slow year, as well as a few other options.
On the surface, the thought of choosing between the various corporate options may seem complex. However, all you really need to know is which financial goals are most important to you and your family. When you work with competent professionals that are willing to put the work in on your behalf, we can make everything seem very “simple” in the end.