The article “When should you withdraw money from your corporation to invest?” was originally published in MoneySense on October 3, 2022.
Is taking money out of a corporation to invest in RRSPs, TFSAs and real estate a good decision? What happens when you retire or die?
“I am a small business owner and have a corporation. I am a truck owner operator with just one truck for now but it will expand. I always get money out of my corporation to invest in personal real estate, TFSAs and RRSPs. But if I were to leave money within the corporation and build wealth within it, does that make more sense? What happens when I retire or at the end of my life?” Varinder
Corporate investing 101
There are a lot of facets to your question, Varinder, so I will try to touch on all of them at a high level.
First off, a business owner with a corporation can generally use the corporation to buy whatever investments they want. There may be a restriction for a practicing professional using a professional corporation, as sometimes their professional bodies do not allow investing in certain assets, such as real estate (unless it is an office that is used in the business).
Corporate investment income, called passive income, is taxed at a relatively high rate that is comparable to what a top marginal rate personal taxpayer might pay. Tax rates vary slightly by province, but the point is corporations pay a high rate of tax on investments.
That does not necessarily mean you should take money out of your corporation to invest personally, because doing so generally results in paying personal tax on the withdrawal, and this may leave you with less money to invest.
Receiving income from a corporation
A business owner can pay themselves a salary as an employee or a dividend as a shareholder.
A salary is deductible to the corporation and taxable to the business owner as the employee. With a dividend—which is a distribution of after-tax corporate profit—a bit of corporate tax is payable on the corporate profit and a bit of personal tax is payable on the dividend. The combined tax on the dividend (personal plus corporate) is supposed to be the same as taking a salary so that there is no difference.
In practice, a business owner who receives a dividend will usually pay slightly more combined tax than if they were to receive a salary. It depends on the province, their income level, and applicable tax deductions and credits.
Withdrawing from a corporation to invest in RRSPs and TFSAs
There are tax benefits when you take money out of your corporation to invest in a registered retirement savings plan (RRSP) or tax-free savings account (TFSA)—in the form of deductions for your RRSP, and tax-free growth for your TFSA. These benefits make them worth considering.
Receiving a salary creates RRSP room for the business owner, and most business owners will have more after-tax income in retirement if they contribute to their RRSP compared to forgoing RRSP contributions and only saving in their corporation. However, RRSP contributions may not be advantageous for a business owner who is in a lower tax bracket during their working years than in retirement.
TFSA contributions also generally make sense. This is particularly true for business owners whose income is below the top tax bracket or who are more conservative investors. Building cash in a TFSA can also come in handy for a business owner who expects to need a large withdrawal from their corporation in the future (for a renovation, car purchase, etc.); they might be able to pay less tax by spreading the income over multiple tax years.
So, I am generally on board with the RRSP and TFSA contributions you are making, Varinder. On real estate, I might take a different approach.
Using a corporation to invest in real estate
Unlike an individual, a corporation cannot have an RRSP or TFSA. A corporation can buy real estate, though.
If a corporation buys a rental property, it will generally need a 20% down payment, just as an individual would. A corporation may pay a slightly higher mortgage rate than an individual because a corporation tends not to have the same credit history. A corporation also has limited liability, so it may be less adversely impacted by not making mortgage payments. An individual’s credit rating is more valuable, giving non-corporate borrowers more reason to say on top of their payments.
The real benefit of investing in real estate using your corporation, Varinder, is to avoid the tax hit on taking a withdrawal. Depending on your income and province or territory of residence, the tax payable to withdraw money from your corporation for a personal down payment could be 40% or more. That only leaves you with $0.60 out of $1 to invest, compared to having the full dollar to use if you buy real estate corporately.
When you buy investments in your corporation, you may be exposing those investments to corporate creditors. So, if you get sued, your corporate investments may be exposed. This may not be a big deal for someone running a business with few liabilities, such as a company that designs websites. But for a trucking business, I suspect you have lots of potential liability.
When should you create a holding company?
Should you decide to buy real estate corporately, you may want to consider setting up a second corporation, Varinder. The purpose would be to transfer cash to invest, on a tax deferred basis, from your operating company to the new corporation. This new corporation would be referred to as a “holding company,” because its purpose would be to hold investments.
The incremental legal fees and accounting costs may not be worth it for modest investments, especially for low-risk businesses. But for larger investments or riskier businesses, holding companies are common and advisable.
Holding on to your corporation in retirement
When you retire, Varinder, you can continue to have your corporation. You do not need to close it. If you have two corporations at that time—your business and your holding company—you might consolidate them into one to reduce the ongoing maintenance costs.
You can pay dividends to yourself in retirement. Remember, a dividend is a distribution of after-tax corporate profit. You do not normally continue to pay yourself a salary in retirement because you cannot generally deduct a salary if you do not have ongoing business income. In addition, the dividend would be taxable at a lower rate.
When you die, your corporation is taxable just like any other non-RRSP, non-TFSA investment. You are deemed to dispose of it at its fair market value (the value of all the investments and real estate if it is a holding company) and you have a capital gain based on the adjusted cost base (ACB).
A business owner typically buys their shares of their corporation from the corporation itself when they start it. This creates an ACB that is relatively nominal—often it is $1, $10 or $100, based on the original price you paid the corporation to acquire your shares. And tax payable at death may be up to 27%, based on the on the top marginal capital gains tax rate in Canada.
The beneficiaries of your estate may be able to take steps to pay very little incremental tax to get the assets out of the corporation, but there are a lot of other factors to consider that go beyond this already lengthy answer to your original question, Varinder.
In summary, I think you are probably on the right track with your RRSP and TFSA contributions, but I would reconsider your real estate investing strategy moving forward.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.
