Navigating Corporate Investments - RRSPs, Corporate Insurance Policies, And More

With so many tax changes over the past number of years, you may be left confused about the best strategy to incorporate to maximize your hard-earned dollars as a business owner.

When determining whether investing in your corporation is a better move than contributing to your RRSP, the answer isn’t completely straightforward.  As with anything in the accounting world, the answer will very much depend on the individual situation.

RRSPs - A QUICK OVERVIEW

Most people want to do whatever makes sense to help lower their tax bill while setting themselves up for retirement. And that’s where RRSPs come into play. An RRSP (registered retirement savings plan) is a savings plan you can withdraw as income once you retire. 

If you choose to put funds into an RRSP, the government will give you a bit of a tax break and any money you contribute to an RRSP (up to your individual allowable limit) can be deducted from your taxable income. 

The amount you contribute to RRSPs is calculated at 18% of the previous year’s income to a maximum of $30,780 for the 2023 taxation year (plus any unused contribution room from prior years).

You also won’t pay taxes on the money you earn in your RRSP until you withdraw it. And when you do, because you’ll likely have lower income, you’ll be taxed at a lower rate.

RRSPs - OTHER CONSIDERATIONS

Now, if you choose to withdraw your RRSP before retirement, the tax hit can be pretty high, and is dependent on how much you are withdrawing (subject to your current tax rate).  The only exceptions to this are:

• First-time home buyers - You can borrow money from your RRSP tax-free, up to $35,000, for a down payment for the purchase or build of your first home.  However, this has to be repaid in equal increments over a 15-year period

• Education - you can also borrow up to $10,000 for training or full-time education for you or your spouse.  This also has to be repaid in equal installments over 10 years to avoid penalties

In addition to withdrawing the funds early, you also need to be careful not to OVER contribute.  You can be penalized 1% per month on any part of a contribution that went over your deduction limit by more than $2000.

For those who hate risk, RRSPs could be stress inducing as highs and lows will always impact the funds in your RRSP.  But remember, this is a long game, and you’ll still likely be ahead over a longer period of time. 

RRSPs vs. OTHER INVESTMENTS

All this to say, for a business owner, you have to determine if it’s better to generate enough T4 income to create RRSP room, or if looking at alternate ways to invest your money in the corporation is the way to go.

Before 2018, it was a no-brainer for corporations to put most (or all) of their investment income into the corporation, as they were taxed at 12.2%. They could then reinvest that income into higher yield GICs, etc. and have the potential to make a lot of money.

However, in 2018 the federal government decided this was unfair to T4 individuals, as they were taxed 50% on the same amount. So, to level the playing field, the government started to erode the Small Business Deduction by the amount of passive income they received (passive income includes items such as GICs, dividends, interest, rental income, etc.).

The passive income cap has been set at $150,000 (with active income at $500,000). But earning $150k of passive income completely erodes the $500,000 of active income eligible at the 12.2% tax rate. Any income not eligible for the small business deduction is taxed at 26.5%.

For instance, if you earn $150,000 of passive income in a year, any active income is now taxed at 26.5% and erodes slowly over the $150,000.

Take note that for business owners who own several corporations, the small business deduction is shared between any corporations. There are a couple of loopholes, but being aware of any cross-ownership of other corporations will help you avoid potential penalties.

OTHER INVESTMENT OPTIONS

If you are a business owner, investing your money while paying as little tax as possible is the option most choose. So if RRSPs or investing in your corporation aren't quite hitting the mark, another option exists.

This is where Corporate Life Insurance comes into play. This type of investment is income that is "tax-sheltered" in that policy and won't erode your Small Business Deduction. Corporate life insurance can also show as an asset on the corporation's balance sheet, providing opportunities down the road for the corporation or shareholder(s).  

There are several reasons a corporation may want to consider a corporate life insurance plan. For instance, it can be used as collateral for a loan (which some choose to use as retirement income), or to access some redemptions from the policy (although this can result in tax levels which can vary greatly). 

As a corporate insurance policy is considered a passive asset, most corporations consider holding the policy in a holding company, rather than the operating company itself. And upon death, it is viewed as a capital gain, so the tax rate is greatly reduced vs. taking out the same amount as a salary. 

A word of caution - there are a few possible areas which you could encounter issues with in terms of corporate life insurance.  The beneficiary must be the same as the corporate owner (to avoid triggering any shareholder benefit), you should be a Canadian resident and any change in ownership or sale of the company could initiate taxable dispositions. 

This is certainly an interesting avenue to consider, however, this is a long-game and isn't for those who are impatient about using their invested funds. There can also be tax implications if you are selling or winding up your corporation, so speaking with a professional before investing in a corporate insurance policy is a must. 

CONCLUSION

If you are a business owner already drawing a salary from your corporation and have RRSP room, make sure to contribute your maximum. In addition, I suggest looking into other, potentially more advantageous investment options, such as a corporate life insurance policy.  

But the key to navigating the nuanced (and confusing) tax implications is to ensure you consult with a professional and experienced accountant who can help you fully understand the risks and benefits of your investments. 

For more information on how M.Y. Accounting Services can help you or your business, feel free to contact me at marioyu2@gmail.com or 416-566-8806.