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Weekend Reading: Salary vs. Dividends Edition

One big decision I need to make as I transition from salaried employee to entrepreneur is whether to take a salary from my business or pay myself dividends. I set up a corporation for my online business back in 2012. My wife and I are 50/50 owners of the small business, and we’ve used the corporation to stream dividends to my wife for the past seven years. I earned a salary and my wife stayed home full time, so this structure allowed us to split our income somewhat and save on taxes.

We’ll need to change things up next year and decide whether to pay ourselves a salary, continue to pay dividends, or come up with some combination of the two.

Pros and cons of a salary

The main advantage of taking a salary from the business is that it will give us a personal income. That means we’ll pay into CPP, and also earn contribution room for our RRSPs. A salary paid out will also be a tax deduction for our small business. 

One potential disadvantage is the pain-in-the-ass factor of setting up a payroll account with the CRA and filing all of the related paperwork. We’ll also have to pay into CPP twice as both the employer and the employee. Finally, personal income is taxed at a higher rate than dividend income, potentially increasing our tax burden.

Pros and cons of dividends

We’ll definitely pay less personal tax since dividends are taxed at a lower rate. My quick estimate is an average tax rate of 13 percent with dividends, versus 27 percent with a salary. We’ll also save money (today) by not paying into CPP.

Dividends can be declared at any time, helping smooth out our cash flows throughout the year, and optimize our tax situation come tax time.

Paying dividends is fairly straightforward. We simply write a cheque to ourselves and then update our corporate minute book. 

The disadvantages of receiving dividends is that we won’t pay into CPP, which will lessen our entitlements in retirement. We also won’t have eligible income to create RRSP contribution room.

Salary vs. Dividends: Why not do both?

An accountant once told me to pay ourselves a salary up to the RRSP contribution maximum and then top-up with dividends as needed. He also suggested to leave as much money in the corporation as possible to keep taxes low.

Reality check. The RRSP contribution limit is 18 percent of income, up to a maximum of $26,500 (2019). To earn the maximum deduction limit you’d need income of $147,222. Each. That’s not going to happen.

A more realistic approach for us would be to pay ourselves enough salary to max out the Year’s Maximum Pensionable Earnings (YMPE) for CPP. The CPP maximum for 2019 is $57,400. 

We plan to pay ourselves between $66,000 and $70,000 each to meet our spending and saving goals. So we could pay ourselves a salary of $57,400 and then top-up with dividends for the remainder of our needs. 

This hybrid approach would allow us to max-out our CPP benefits, while also creating ~$10,000 each in RRSP contribution room per year.

This Week’s Recap:

November is Financial Literacy Month and this week I asked whether banks should have a hand in promoting financial literacy.

Over on the Young & Thrifty blog I took a long look at passive investing and why it’s about to finally take off in Canada.

I went on a bit of a shopping spree at Amazon recently, in anticipation of some extra free time on the horizon. I’d like to read more in 2020, and I’m getting a head start now.

I just finished Malcolm Gladwell’s latest – Talking to Strangers: What We Should Know about the People We Don’t Know. In the typical Gladwell fashion, he shares several interesting stories that are all connected around a central theme. It’ll have you questioning your own assumptions around complex topics like police shootings, terrorism, espionage, sexual assault, and deception.

Next on my list is Profit First: Transform Your Business from a Cash-Eating Monster to a Money-Making Machine.

Weekend Reading:

What’s the best Aeroplan credit card? The Credit Card Genius team compares the TD Aeroplan Infinite Visa vs. the American Express Gold Rewards Card.

Not sure how to get the most out of Aeroplan? Read how I maximized Aeroplan flight rewards for our epic trip to Scotland and Ireland.

Millennials are facing all the risk and none of the reward in today’s financial realities.

Millionaire Teacher Andrew Hallam explains how retirees can withdraw more than 4 percent per year from their investments.

Shane Parrish says better “mental models” are vital to improve society. How what’s in our heads changes what’s in the world:

“When we understand how someone sees the world, a lot of their actions and beliefs start to make sense. The medical profession offers a helpful model. Would you think highly of a doctor that offered a diagnosis without first understanding your symptoms?”

Collaborative Fund’s Morgan Housel explains what a spectrum of wealth would look like if you described it with words, not numbers.

Here’s a hodgepodge of smart investing commentary from Downtown Josh Brown and the Irrelevant Investor Michael Batnick:

Dale Roberts looks for an explanation as to why Canadians have given robo-advisors the cold shoulder? I’ve also wondered this.

Another reason to avoid time-shares. A Thornhill woman said she can’t get out of her timeshare agreement more than three years after she paid a company over $4,000 to break the contract.

My Own Advisor’s Mark Seed gives an update as he zeroes in on his financial independence goals.

Finally, this man tested Canada’s tax laws by moving in a canoe – and he won.

Have a great weekend, everyone!

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18 Comments

  1. Garth on November 16, 2019 at 1:12 pm

    I don’t think it is true that you pay less tax when you take dividends as you are ignoring the corporate tax that the company paid on your behalf. When a proper comparison is made, you will find little if any advantage in that regard.

    I question why you would choose to incorporate (and incur the costs of doing so) rather than just form a simple joint venture and split income that way?

    • jeff on November 16, 2019 at 2:07 pm

      Leaving retained earnings inside the corp gives you about 20% more to invest and can be removed later when income drops . This is what we did with our company and has worked well, but if you need all your profit generated by the company a corp is not worth the time or expense.

      • Robb Engen on November 16, 2019 at 5:00 pm

        Hi Jeff, this is the idea now as we should have significant profits inside the corp annually compared to what we need to withdraw for our living expenses.

    • Robb Engen on November 16, 2019 at 4:58 pm

      Hi Garth, you’re right in that we’ll still pay tax on the corporate side. I should have made that clear in the comparison. Dividends are just taxed lower on the personal side.

      I incorporated back in 2012 with a long term vision in mind – income splitting in the short term while I still worked full time and my wife stayed home, then eventually getting to the point where we’d have significant retained earnings inside the corporation.

  2. William Goldstein on November 16, 2019 at 1:17 pm

    Rob,
    The issue of dividends versus salary is not quite as straight forward as you’ve made it out to be. You state “My quick estimate is an average tax rate of 13 percent with dividends, versus 27 percent with a salary.” Assuming you/your wife own the corporation, you have ignored the 11-12% corporate tax that has to be paid on the company profits prior to paying out the dividends (which comes out of your pockets). Whereas the salary is fully deductible. So your comparison of 13% versus 27% is closer to 24%-27% (and again, there are complexities here). I have done numerous comparisons on this subject as a financial planner, and the dividend versus salary tax rate is fairly close. Many consider CPP a “tax”, which it really is not. To say that you are “saving” money now by not paying CPP is really the same as saying “you are saving money now” by not contributing to your RRSP or TFSA (or savings account). CPP is a retirement savings plan, not a tax. Lastly, while one might view the advantage of taking dividends being simply writing a check, it does create a deferred tax liability. Depending on one’s year end, this deferred liability could be as far away as 28 months. As a planner, I find this more of a problem in that one owes taxes for monies that were spent 1-2 years in the past. For most of my clients I recommend taking salary (if possible) up to the maximum RRSP deduction, and possibly dividends after that.
    Bill Goldstein

    • Robb Engen on November 16, 2019 at 5:04 pm

      Hi Bill, thanks for your comment. I certainly didn’t mean for this to sound straightforward (it’s not), as I’m still wrestling with the decision myself. Taking salary up to the maximum RRSP deduction would be ideal, but not possible for us right now. That’s why I’m thinking a happy medium would be to take it up to the CPP YMPE and then top-up with dividends after that.

  3. Brien Stewart on November 16, 2019 at 1:22 pm

    Instead of using Amazon for your reading material use your local library. You can request the books you want to read online and get an email when you can pick it up.

    • Robb Engen on November 16, 2019 at 5:06 pm

      Hey Brien, great point and I am a big user of my local library. Unfortunately, many of the books I purchased either weren’t available or they had 20+ holds. I had some money to use up from a professional supplement at work so I tapped into that source before I leave.

      • Brien Stewart on November 16, 2019 at 7:02 pm

        Understand you will wait some time to get the ‘best seller’ books. I have 17 books on my request list at the moment but I’m retired and can wait. I move back and forth between Ontario & Florida so before I leave either location I request books at the other location library. Get over whelmed some times when I just arrive.

  4. Maria @ Handful of Thoughts on November 16, 2019 at 6:14 pm

    If you like listening to audio books Profit First is read by Mike Michalowicz and he adds a lot of extra commentary that’s not in the book. I was able to download it from the library and luckily there were no holds at the time.

  5. Jamie on November 17, 2019 at 5:11 am

    I don’t get it…why are you taking $60-70k each from the corp? So you can save outside the corp? Just leave it in the corp to grow tax deferred. Especially if there are kids involved, and you are getting CCB and other tax goodies.

    I leave ALL of my income in my corp, as every dollar I take out as wages means I lose 50%+ in taxes and lost benefits, with 2 kids.

    • Robb Engen on November 17, 2019 at 2:06 pm

      So I can eat…

      • jeff on November 17, 2019 at 5:03 pm

        I agree. Life is more than saving money and deferring taxes. Working hard and enjoying life is the reason we keep this game going . I might be off subject a bit but just saving money is no fun and it gets very boring unless you enjoy some of your hard work.

  6. Betty Therriault on November 17, 2019 at 2:20 pm

    I incorporated some 30 years ago. At that time it was advantageous for a wife to do so. Since then the rules have changed and so has my position. (divorced).
    I have never paid Corp. tax but my accountant has declared Mgmt. salary annually on my personal tax return. This was adjusted according to my personal income. Dividends were never suggested but I do have a huge S/H loan.
    Is this good Financial Planning?

  7. Jean-Pierre Andre Laporte on November 17, 2019 at 3:08 pm

    Let’s not forget the biggest disadvantage of doing dividends: they are not ‘pensionable’ so that your company is unable to establish a Personal Pension Plan or PPP for yourself, the business owner.

    The PPP gives so many tax deductions that don’t exist with an RRSP: past service, higher current service, special payments, IMF deductibility, GST refund, interest refund, terminal funding etc.

    Not only that but on death, assets in the PPP can pass tax free to the kids if they are on the payroll and added to the plan.

    And, if that wasn’t enough, the pension benefits paid out are eligible for pension income splitting rules with a spouse and the $2,000 per person per year pension amount credit!! This can be set up as early as age 50 (unlike the RRIF where you need to be 65!!)

    For business owners, there is no debate between salary and dividends: Salary and a PPP wins.

  8. Will on November 18, 2019 at 7:26 am

    I’m always interested to know what people are reading. Could you publish a list of books you have read and or are planning to read.

    Or recommend lists that may already exists from some of the other blogs.

    • alana on November 18, 2019 at 10:25 am

      Second this!

  9. Robb Engen on November 18, 2019 at 11:13 am

    Hi Will & Alana, thanks for your comments. I’ve had a few emails about this as well so I’m thinking I’ll make it a regular feature of the Weekend Reading column called “What I’m Reading” or something like that. I’d love to hear what others are reading as well.

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