RRSP for Incorporated Individuals

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RRSP for Incorporated Individuals

Post by 6miths »

Norbert's thread on 'How Big of an RRSP is too Big?' got me to thinking about advice from financial planners on RRSPs for incorporated individuals. The advice often given is to take minimal or no salary so as to avoid the self-employed double CPP hit and also keep all of the money in the corporation and do not have any RRSP. Flexibility is the main reason cited as well as not taking the big hit on death. Any thoughts from this wise crowd?
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Re: RRSP for Incorporated Individuals

Post by ghariton »

That is what I did. It worked out very well for me.

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Re: RRSP for Incorporated Individuals

Post by Springbok »

Have no opinion on it, but this link from G&M may be of interest.

http://www.theglobeandmail.com/globe-in ... e22680927/

One problem of not taking income, is that CPP benefits are affected. Maybe not a problem if the business is successful, but taking enough to qualify for max CPP might be a consideration. Would the savings on the double hit on CPP contributions buy you an indexed annuity of same value as CPP at retirement?
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Re: RRSP for Incorporated Individuals

Post by DmDave »

I myself have a CCPC and I only take dividends out. I also take out enough to contribute to my TFSA. I haven't done the math to see whether money in CCPC or being taxed and then TFSA will come out ahead, but I'm happy to see my money grow tax free in my TFSA.

Read up on Jamie Golombek's articles here:

http://www.jamiegolombek.com/jamie_publications.php

They should give you an idea. Generally there is no tax benefit with a CCPC here in BC, only tax-deferral benefits.
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Re: RRSP for Incorporated Individuals

Post by 6miths »

Thanks for the articles. The latter group from Jamie Golombek look interesting. Paying oneself a salary to get the CPP benefit doesn't seem psychologically worth it as one is paying double the amount that an employee would be paying to get the same benefit. The question about the annuity is really the right approach though.
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Re: RRSP for Incorporated Individuals

Post by 6miths »

And sorry George. Did you mean that you took dividends only and left all excess in your corp.
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Re: RRSP for Incorporated Individuals

Post by Park »

Assume you have $50K in foreign dividends and interest in your holding corporation. If you take $50K in salary, you've effectively converted that foreign dividends and interest into salary, with all three being taxed at about the same rates.

That salary now gives you RRSP room, which you didn't have before. It means that I also have to pay CPP.

But I look on CPP as positive, as long as I don't have to create salary just to get CPP. Right now, I'm not interested in fixed income, but I will be in retirement. A case can be made for CPP as fixed income in retirement.

I look on CPP as the equivalent of a federal government inflation indexed bond. I get inflation indexing and assume the credit risk of the federal government.

That federal government inflation indexed bond has tax advantages. I get a tax credit on my contributions as an employee, and a tax deduction as an employer. In a CCPC, that tax deduction will be at the small business rate. But if you're taking salary from a holding corporation, the tax deduction will be at a considerably higher rate. CPPIB doesn't pay any Canadian taxes on its investments.

I get tax diversification. If CCPCs become politically unpopular, I will be hurt less by any punitive actions against them.

Based on my health and the lifespans of family members, there's a good chance that I will benefit from the mortality credits inherent in CPP.

The following link comes from Jamie Golombek, and it addresses the question of return on your CPP contributions.

https://www.cibc.com/ca/pdf/jg-rethinking-rrsps-en.pdf

"For example, ignoring inflation of both CPP contributions, the retirement
pension and ignoring any real growth in wages, imagine investing $4,326
for 40 years to collect a $11,210 CPP pension from age 65 to say age 82.
The implicit real rate of return in this admittedly unrealistic example is a mere
0.49%. This also ignores the tax deductibility of the CPP to the business and
the tax credit to the employee, which mitigates the cost of both the employer’s
and employee’s contributions. Informal discussions with several actuaries more
realistically estimated internal rate of return for present CPP contributors to be
around 3%."

3% on fixed income is not bad.

The question would be whether you're better off buying an inflation indexed annuity at the time of retirement. Another option would be RRBs.
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Re: RRSP for Incorporated Individuals

Post by ghariton »

6miths wrote:And sorry George. Did you mean that you took dividends only and left all excess in your corp.
Yes.

No salary, hence no CPP, no EI, no headaches. Maximum flexibility in investing retained earnings. Income splitting with my children and wife for tax purposes.

Currently I'm gradually paying out the remaining retained earnings in the form of dividends, with one eye on OAS clawback and the other eye on coming RRIF withdrawals. A nice problem to have.

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Re: RRSP for Incorporated Individuals

Post by Park »

EI is a form of taxation, but I get salary from my corporation, and have never had to pay it. I agree that dividends are better when it comes to income splitting than salary. However, an employee profit sharing plan at least used to be a way around that. Outside a corporation, one can use a family trust or spousal loan to income split.
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Re: RRSP for Incorporated Individuals

Post by Park »

Park wrote:But I look on CPP as positive, as long as I don't have to create salary just to get CPP. Right now, I'm not interested in fixed income, but I will be in retirement. A case can be made for CPP as fixed income in retirement.

I look on CPP as the equivalent of a federal government inflation indexed bond. I get inflation indexing and assume the credit risk of the federal government.

That federal government inflation indexed bond has tax advantages. I get a tax credit on my contributions as an employee, and a tax deduction as an employer. In a CCPC, that tax deduction will be at the small business rate. But if you're taking salary from a holding corporation, the tax deduction will be at a considerably higher rate. CPPIB doesn't pay any Canadian taxes on its investments.

I get tax diversification. If CCPCs become politically unpopular, I will be hurt less by any punitive actions against them.

Based on my health and the lifespans of family members, there's a good chance that I will benefit from the mortality credits inherent in CPP.

The following link comes from Jamie Golombek, and it addresses the question of return on your CPP contributions.

https://www.cibc.com/ca/pdf/jg-rethinking-rrsps-en.pdf

"For example, ignoring inflation of both CPP contributions, the retirement
pension and ignoring any real growth in wages, imagine investing $4,326
for 40 years to collect a $11,210 CPP pension from age 65 to say age 82.
The implicit real rate of return in this admittedly unrealistic example is a mere
0.49%. This also ignores the tax deductibility of the CPP to the business and
the tax credit to the employee, which mitigates the cost of both the employer’s
and employee’s contributions. Informal discussions with several actuaries more
realistically estimated internal rate of return for present CPP contributors to be
around 3%."

3% on fixed income is not bad.

The question would be whether you're better off buying an inflation indexed annuity at the time of retirement. Another option would be RRBs.
A major problem with fixed income is the effect of inflation, which is an advantage of CPP. As mentioned in my previous post, other options for inflation indexed fixed income are inflation indexed annuities and RRBs.

Michael James had a recent post in his blog about annuities and inflation:

http://www.michaeljamesonmoney.com/2015 ... ities.html

About RRBs, the top yield on an RRB is 0.32% at present:

http://www.bankofcanada.ca/rates/intere ... ian-bonds/

Maximum 2015 CPP benefit is $12,780.

http://www.newswire.ca/en/story/1467819 ... ary-1-2015

To get $12,780 from an RRB portfolio, you'd need $3.99 million in RRBs.
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Re: RRSP for Incorporated Individuals

Post by ghariton »

Park wrote:Maximum 2015 CPP benefit is $12,780.

To get $12,780 from an RRB portfolio, you'd need $3.99 million in RRBs.
Not directly comparable. CPP effectively includes return of capital, the RRB number you show excludes it.

I agree that at present CPP offers a much better return than can be obtained with fixed income. But that is unsustainable IMHO. Either returns on FI will increase (and investors will benefit upon rollover), or returns will not increase and CPP with its present contributions and benefits becomes unsustainable.

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Re: RRSP for Incorporated Individuals

Post by Park »

http://www.osfi-bsif.gc.ca/eng/oca-bac/ ... #Toc-tbl21

From table 21 of the above link, the internal real rate of return is about 2.3%; that takes into account contributions and benefits, but ignores operating expenses. If you have a long time until retirement and are reasonably good at investing, you might be able to beat that 2.3%.

http://www.cppib.com/en/public-media/ne ... e2014.html

CPPIB has about $219 billion in assets. In the last 8 years, operating expenses were $2.5 billion. So operating expenses are around 0.142%; this might be an underestimate, as my impression is that CPPIB assets have been growing quickly lately.

OTOH, the 2.3% is for cohorts. If you live longer than the average of the cohort, you'll do better than 2.3%.

My impression is that the 2.3% ignores taxes. With CPP, you’ll have a greater principal than you would if you invested on your own, as the employee contribution gets a tax credit of 15%, and the employer contribution gets a tax deduction. Also, there is tax deferral on returns, until the time you take a benefit. If you invest on your own, there will be no tax deferral. When you get the CPP benefit, it will be taxed as ordinary income, whereas you might be able to pay less tax if you had a DIY approach. Unlike RRSPs, there is the potential for double taxation on the employee contribution, as one's marginal tax rate may be above 15%.

To beat CPP, you'd have to invest in stocks. Even if fixed income returns and CPP returns were more comparable, the tax advantages of CPP mean it would outperform fixed income in a taxable account.

Alexandra MacQueen (Pensionize Your Nest Egg) states that CPP will be cheaper than a private annuity.

http://canadianmoneyforum.com/showthrea ... lue-of-CPP
Last edited by Park on 15 Mar 2015 19:08, edited 2 times in total.
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Re: RRSP for Incorporated Individuals

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Park wrote:Alexandra MacQueen (Pensionize Your Nest Egg)
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Re: RRSP for Incorporated Individuals

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Park wrote:the internal real rate of return is about 2.3%
Thank you. I had seen the report but hadn't bothered to read the appendices. And yet the best stuff is often in notes and appendices. :wink:
that takes into account contributions and benefits, but ignores operating expenses
Yes. I've earned 4% real in my LIRA since 1999, and that's after expenses. Of course, going forward, I expect the return to be lower.
I also get the impression that that 2.3% doesn't take into account the tax credit on the employee contribution and the tax deduction on the employer contribution.
Not explicitly, no. But it is a before-tax rate of return, and so it implicitly does, or so I understand the situation.
Alexandra MacQueen (Pensionize Your Nest Egg) states that CPP will be cheaper than a private annuity.
Yes. I'm not surprised. When I last looked a couple of years ago, the MER on individual annuities ranged between 2% and 3%. It's very hard to overcome that.

On another thread, there was discussion of the possibility that the federal government could offer, on a voluntary basis, indexed annuities at an actuarially fair price. I would strongly endorse that as an option (realizing full well the insurance industry's opposition).

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Re: RRSP for Incorporated Individuals

Post by Park »

The two strategies discussed so far with CPP are all or none; either contribute to it or not. An in between strategy might be a reasonable alternative. Invest on your own and make no CPP contributions until 5-20 years prior to retirement. When within 5-20 years of retirement, start making CPP contributions.

CPP will probably outperform, on a risk adjusted basis, fixed income investment by individual investors; that includes those in tax advantaged accounts. At least in part, that's because CPPIB doesn't just invest in fixed income.

My expectation is that one would invest in stocks. The 5-20 years corresponds to a time period where one would be confident that stocks would outperform bonds. I realize that 15 years is a substantial spread, but it would depend on the comfort level of the individual.

Another advantage of such a strategy is that it minimizes to some extent the risk of early mortality, which is a major weakness of pensions.
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Re: RRSP for Incorporated Individuals

Post by ClosetIndexer »

I own both an operating corp and a holdco, and I currently pay myself a salary, but used to just take dividends. A few more factors to consider, in addition to the above:
  • It used to be that there was a small advantage in terms of tax paid to taking dividends instead of salary from a CCPC. Tax bracket changes a couple years ago corrected the integration though, so now there is no straight benefit either way.
  • Regarding CPP vs an indexed annuity, CPP is strange in that every real dollar you put into it today is worth the same as a real dollar contributed immediately before retirement. So during your working career, it's as if all the contributions you've made to date are indexed to inflation, but don't grow. Therefore, contributions made close to retirement tend to be a fantastic deal compared to buying an annuity, and contributions made early in life a pretty dreadful one. (With a crossover point somewhere in the middle.)
  • When investing inside a corp, you essentially have to withdraw any investment earnings each year, to avoid being taxed at a punitive rate. So holding investments in a corp is only really useful if the funds to buy them originated in a corp, and therefore you are able to invest them having paid only the small business tax, not personal tax. However, there can also be an advantage here, if you do have active business income. On a year when your investments are up, you can choose to realize some capital gains, which will allow you to withdraw some funds tax-free. (You can do this if you draw a salary too, as long as you have investments in the corp. Just reduce your salary for that year such that you end up with the same after-tax amount, and you get to keep more money invested (after using business income to replenish the shares that you sold). Can't do that in an RRSP!
  • On the other hand, and RRSP allows for completely tax-free compounding, which the corp doesn't. (In a corp, you effectively pay the small business tax rate on investment income, assuming you can offset it by reducing your draw on active business income, as described above.)
  • EI is a non-issue, as you don't pay it either way.
  • As an edge case, there may be a liability advantage to taking a salary instead of dividends, as the salary may not be included in a measurement of the corp's profits. That's only going to be an issue if you get sued and lose though, so hopefully not a concern for most people!
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Re: RRSP for Incorporated Individuals

Post by Park »

If you want to contribute to an RRSP, but not to CPP, one option might be an employee profit sharing plan. I use the word might, as I have no personal experience with such as plan.
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Re: RRSP for Incorporated Individuals

Post by Stan »

Until retirement a few years ago I had an operating co. and holdco. Paid salary to meet RRSP available amount and, if necessary balance in dividends. Any excess stayed as retained earnings. Investing done in holdco so operating co. met requirements for lower tax rate. Stopped contributing to my RRSP in my 50's and contributed to spousal RRSP. At 60 took early CPP(hence no double contribution). When retired merged operating and holdco into one and now take dividends from that until must convert to RRIF (too soon). Accountant blends income to best meet our family requirements and minimize taxes.
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Re: RRSP for Incorporated Individuals

Post by Koogie »

Stan wrote:Until retirement a few years ago I had an operating co. and holdco. Paid salary to meet RRSP available amount and, if necessary balance in dividends. Any excess stayed as retained earnings. Investing done in holdco so operating co. met requirements for lower tax rate. Stopped contributing to my RRSP in my 50's and contributed to spousal RRSP. At 60 took early CPP(hence no double contribution). When retired merged operating and holdco into one and now take dividends from that until must convert to RRIF (too soon). Accountant blends income to best meet our family requirements and minimize taxes.
This is very much the route I am going down, although I am still in the accumulating/operating stage in my early 40s. Our Holdco owns our Opco and my wife and I own Holdco. We are employees of Opco and by design pay ourselves just enough normal salary to meet household needs (I am painfully frugal by upbringing) and max. our TFSAs. Any additional funds we may need for one off purchases (like a home purchase currently) are paid out by dividend as well.

Retained earnings are flowed up to Holdco and invested there. Mostly FI but I am working on changing my psychology and investing a more significant portion in EQ. Time will tell if I can re-program myself.

I started my company fairly young and never accumulated much of an RRSP (less than 5% of our net worth) This was by happenstance at the beginning but by design later on after doing some reading and discussing things with our accountant. We aren't planning on contributing much more to our RRSPs although we do have a lot of unused room. Our timeframe and plans have changed recently due to my wifes health as we had planned to shut Opco this year and take a career break. Instead we have agreed to doing another 5 - 6 year stint and then re-evaluating. She will be in her mid 50's by then and working very little so it may be beneficial to do an analysis soon to see if it is worth topping up the RRSP now and melting it down early.
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Re: RRSP for Incorporated Individuals

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Park wrote:The two strategies discussed so far with CPP are all or none; either contribute to it or not. An in between strategy might be a reasonable alternative. Invest on your own and make no CPP contributions until 5-20 years prior to retirement. When within 5-20 years of retirement, start making CPP contributions.

CPP will probably outperform, on a risk adjusted basis, fixed income investment by individual investors; that includes those in tax advantaged accounts. At least in part, that's because CPPIB doesn't just invest in fixed income.

My expectation is that one would invest in stocks. The 5-20 years corresponds to a time period where one would be confident that stocks would outperform bonds. I realize that 15 years is a substantial spread, but it would depend on the comfort level of the individual.

Another advantage of such a strategy is that it minimizes to some extent the risk of early mortality, which is a major weakness of pensions.
Park - I don't think contributing to CPP for as few as 5 years is a wise strategy from a retirement pension perspective. At age 65, a CPP retirement pension is based on your average earnings for your best 39 years. This means that your 5 years of earnings would at best give you a retirement pension of approx. 12.8% of the maximum, or about $136.50 per month in 2015 dollars.

This strategy also ignores the fact that CPP provides benefits as a result of disability or death, but only if you contribute fairly regularly. The disability and death benefits can be especially important if you have dependent children.
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Re: RRSP for Incorporated Individuals

Post by ClosetIndexer »

Dogger1953 wrote: Park - I don't think contributing to CPP for as few as 5 years is a wise strategy from a retirement pension perspective. At age 65, a CPP retirement pension is based on your average earnings for your best 39 years. This means that your 5 years of earnings would at best give you a retirement pension of approx. 12.8% of the maximum, or about $136.50 per month in 2015 dollars.

This strategy also ignores the fact that CPP provides benefits as a result of disability or death, but only if you contribute fairly regularly. The disability and death benefits can be especially important if you have dependent children.
That doesn't sound like a bad deal to me. CPP max contribution is currently about 4700 per year if you're paying both halves. (And it's largely pre-tax money. Tax-free for employer share, and credit for employee share.) So you're paying a total of 23500 in 2015 dollars over 5 years.) You end up with $136.50/month, or 1638/year, or about a a 7% real return on your investment for rest of life. That's considerably better than any inflation-indexed annuity would pay.

So contributing for 5 years prior to retirement is definitely a good idea. Contributing for longer of course is likely also a good idea, but the years closest to retirement will always provide the best ROI, since real dollars contributed are worth the same amount toward your eventual stipend regardless of which year they're contributed in. So as I mentioned in an earlier post here, in early years, it's a pretty bad deal. In later years, as shown in this post, it's a great deal. Somewhere in-between in crosses over.
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Re: RRSP for Incorporated Individuals

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Some nitpicks:
ClosetIndexer wrote:CPP max contribution is currently about 4700 per year if you're paying both halves.
A liitle more, as from the horse's mouth:
CRA wrote:The maximum employee and employer contribution to the plan for 2015 will be $2,479.95 each and the maximum self-employed contribution will be $4,959.90. The maximums in 2014 were $2,425.50 and $4,851.00.
ClosetIndexer wrote:but the years closest to retirement will always provide the best ROI, since real dollars contributed are worth the same amount toward your eventual stipend regardless of which year they're contributed in.
Not exactly true, since YMPE has historically risen a bit faster than inflation, hence early contributions are "better than real" dollars.
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Re: RRSP for Incorporated Individuals

Post by ClosetIndexer »

Ah, yes, I did a 2 second google search to find that figure and it looks like I grabbed the 2013 value.

No guarantee that YMPE will continue to rise faster than inflation though, and even if it has, I highly doubt it has risen at the rate that you could earn by instead investing that money, even in a risk-free portfolio.

I think the points stand. That said, we're talking about micro-optimizations here.
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Re: RRSP for Incorporated Individuals

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I'm of the opinion that a DB pension is a good thing. Having said that, CPP is even better for contributions early in the career, followed by a stop. For the typical DB pension plan, leaving the company means your contributions get frozen, while doing the same with the CPP, the value of the older contributions continue to rise with the YMPE, essentially getting average raises while not working any more.
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Re: RRSP for Incorporated Individuals

Post by 6miths »

Good discussion. Thanks for the input.
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