Tuesday, May 22, 2012

Pay yourself or pay the business?

Which is more tax-efficient for the incorporated small business owner – pay yourself via a salary or dividends, or a combination of the two?  The answer appears to be easy and obvious – all three options should result in the same tax bill.  That’s because the Canadian tax system is based on integration, a theory that says there should be zero difference between personally earned income and income earned in the corporation and paid out as dividends.  The reality is, however, integration doesn’t work perfectly in a country where personal and corporate taxes vary significantly depending on your province of residence.

And here’s another important consideration: Leaving more money in your company might also gain you more tax-advantaged money in retirement.  It works like this:
  • Active Business income that you leave in your corporation is taxed at the much lower small business corporate tax rate. 
  • When you take money out of your corporation as salary, the tax rules allow your company to deduct that amount as an expense and the money you receive is taxed in your hands at your marginal rate. 
  • When you pay yourself with after-tax dividends from your corporation, your company doesn’t get a deduction for that expense and the dividends are taxed in your hands but at a lower tax rate than for a salary. 
  • Until recently, financial planning experts often advised small business owners to take enough in salary from the corporation to maximize Registered Retirement Savings Plan (RRSP) contributions. Recently, a new theory has gained traction - take only enough money from your corporation in dividends to pay personal living expenses, leave the rest inside your company, and reinvest those funds as you would for an RRSP. You’ll pay tax on the dividends at a lower rate and the money left inside your corporation is taxed at the lower small business rate. 
  • When you retire, instead of withdrawing funds from your RRSP, you can sell your corporate investments and take the after-tax amounts as dividends. Unlike RRSP contributions which must be transferred to a Registered Retirement Income Plan (RRIF) by age 71, and unlike RRIFs which require that you take specific withdrawals, dividends give you better control over when you take your savings and how much tax you will pay. 
  • By paying yourself with dividends, your corporation is not required to make Canada Pension Plan (CPP) contributions or make EI premium or other provincial payroll deductions on your behalf. That could be a benefit or a drawback because your CPP income will be reduced at retirement.
Salary vs. dividends; corporate vs. RRSP investments – which is right for you? Before you make your decisions, talk to your professional advisors.

Monday, May 14, 2012

Making the most of what you’ve got -- retirement tax planning strategies

You’ve worked hard, planned carefully, saved and built your wealth – now it’s time to retire and enjoy the life you’ve dreamed about.  But to be certain your retirement dreams aren’t pierced by the reality of an eroding income, you need to make the most of what you’ve got by taking advantage of all the retirement tax planning strategies available to you.  Here are some basic strategies to help you keep more of what you’ve earned.
  • Tax credits Retirees can take advantage of a number of federal tax credits (some with equivalent provincial credits) that can reduce the amount of tax you pay.
    • Pension income credit – Available on your first $2,000 of pension income.  Canada Pension Plan/Qu├ębec Pension Plan (CPP/QPP) or Old Age Security (OAS) benefits do not qualify for this credit.
    • Age credit – You may qualify for this credit if you are 65 and your net income is below a pre-determined threshold.
    • Medical expenses credit – Pooling expenses on the return of the spouse with the lower income can generate a larger credit.
    • Disability credit – Available to those suffering from a severe and prolonged physical or mental impairment.
    • Charitable donations credit – Combine spousal donations to earn a higher credit.
  • Keep your taxable income to a minimum. Lower your taxes and take full advantage of the Age Credit while preserving your OAS benefit.
    • Split pension income and/or CPP/QPP benefits with your spouse.
    • Live off capital rather than income.
    • Withdraw only the minimum from your Registered Retirement Income Fund (RRIF).
    • Select non-registered investments that offer preferential tax treatment.
    • Take full advantage of the tax sheltering benefits of your Registered Retirement Savings Plans (RRSPs) by making your maximum contribution for as long as possible – up to the end of the year you turn 71.
    • Contribute to a spousal RRSP until your spouse turns 71.
The benefits of some of these strategies – such as income-splitting – depend on your personal situation and can have unexpected tax implications. There are also many other good strategies for maximizing your retirement income. Your professional advisor can help you decide which strategies will work best for you.

Tuesday, May 8, 2012

Your life insurance risk profile

As part of your financial plan …as part of your estate plan …as essential protection for your family – any way you look at it, life insurance is important.  But do you know that how you live your life can have an impact on the cost and availability of insurance?

It works like this: To obtain insurance, you must qualify—meaning that you must provide evidence of insurability on a range of health, medical, lifestyle and other risk factors through a process called underwriting.  Taken together, they add up to your life insurance risk profile.  Some risk factors you can’t control but you are much more likely to get insured at rates that fit your budget by lowering those you do control:
  • Age. Intuitively, you probably know that the older you get, the higher the premiums for your insurance. Although you cannot control your age, you may be able to control some of the other factors that will affect your premium. Remember, the younger you buy your insurance, the lower the premium will be.
  • Smoking. You can anticipate higher insurance costs for using any product that contains nicotine, including cigarettes, chewing tobacco, snuff, pipe tobacco, cigars and even nicotine supplements like patches or gum. Something to consider: with most companies you are considered a nonsmoker after 1 year of quitting.
  • Health factors. Your rates may be affected if you have a history of some medical conditions, dependent on the severity, number of occurences and your current health. In many cases, a standard life insurance policy can be issued.
  • Family history. Many medical conditions are hereditary – especially cancer and cardiovascular disease. If your parents or a sibling died of cancer or heart attack prior to age 60, insurance companies may consider you to be of higher risk. But your healthy lifestyle and other health factors can have a positive effect on your insurability and rates.
  • Hobbies and avocations. Scuba diving, motor vehicle racing, skydiving, mountain climbing and any type of flying are considered high risk and if you engage in any of them, you may face higher premiums or an exclusion of coverage while participating in those activities.
  • Driving record. Multiple driving violations, accidents and convictions, especially for driving under the influence of drugs or alcohol will seriously affect your insurability.
  • Alcohol and drug use. If you are a recreational drug user, or have been treated for these substances, will likely affect your insurability and rates.
  • Travel. Short term travel for vacation usually doesn’t adversely affect your rates. But continuous or extended travel to specific countries where there is unrest could increase rates. An exclusion of coverage may be applicable, but will depend on several factors.
  • Financial situation and history. If you apply for a large amount of insurance, you may need to disclose specific financial information such as your income level, net worth,assets and liabilities, otherwise only an estimate is required. Detailed financial information is required to obtain business insurance.
With personal life insurance, full disclosure of your health at time of application ensures that the insurer has determined your risk and is providing the insurance coverage that is tailored to your individual situation. Unfortunately not all individuals can purchase insurance at standard rates. That is why it is critical you work with a professional advisor who can help you get the life insurance coverage you need at a fair and equitable price based on your situation.