As CWB endeavours to find the best tax savings for business owners, many questions about RRSPs and TFSAs are brought up with CWB Wealth Management’s Wealth Advisory Services team. Entrepreneurs may be under the impression that RRSPs and TFSAs are important to have, but are unsure why this is the case.
Is a TFSA or RRSP right for my particular situation?
“Instead of asking why it’s important, we ask if it’s important,”
explains Kim Stevens, Senior Planner, Wealth Advisory Services at CWB Wealth Management. Kim further explains that how a business owner builds their personal income can make a pretty important difference as to whether an RRSP or TFSA is a good option. “It all depends on whether they take employment income or dividends,” he says. “If there’s employment, salary or bonus income, then the RRSP can make sense to offset some of the income from taxation there. If they’re just taking dividends, then RRSPs might not make sense.”
In the case of TFSAs, the main benefit for business owners, says Kim, is if it’s a part of an exit strategy by providing an emergency account. Whether a business owner is taking a salary or being paid in dividends, plugging some of that money into a TFSA can help ensure that business owners have the capital available to walk away from the business if need be. “With TFSAs, it’s not tax-free on the way in, but you do get tax-free growth and it comes out tax-free, which is in contrast to RRSPs where you are taxed on the way out,” says Kim.
What are my options year-round?
In his years of working with business owners and their personal wealth, Kim notices a spike in questions about RRSPs during the first few weeks of the year. This is because within the first 60 days of a new year, RRSP contributions can be used towards the previous year’s taxes, potentially reducing the tax payable for that year. Alternatively, those same contributions may be used for the current year.
“Your decision on which tax year to apply your deposit to would be dependent on what your marginal tax rate is for last year and what you anticipate it to be this year,”
says Kim. He goes on to explain that if a business owner’s marginal tax rate is higher in the current year as compared to the previous year, the RRSP deposit made in the first 60 days will have more impact on the current year taxes than if applied to the previous year. Ideally, the maximum deposit would be made for both years, provided there is taxable income to deduct against. Working with a wealth management expert to plan your RRSP strategy can become that much more important.
What are my contribution limits?
Another area that Kim advises business owners to be aware of are the contribution limits. He notes that TFSAs and RRSPs only have so much room in them for new contributions, which changes from year to year.
He explains that the 2018 contribution RRSP limit is 18 per cent of the previous year’s reported earned income to a maximum of $26,320. The limit for 2019 increases to $26,500. RRSPs do allow for the opportunity to deposit up to $2,000 over the limit, though an excess contribution can’t be used towards a tax deduction. Anything contributed beyond $2,000 over the limit is subject to a penalty of one per cent each month.
For TFSAs, the maximum contribution amount for the current year is $6,000 while the cumulative amount is $63,500. And any unused room carries forward to subsequent years. TFSA account holders may withdraw money without tax consequences, and the TFSA contribution room for the value of the withdrawal is restored. “If you take money out of a TFSA account, the contribution room doesn’t rebuild again until the next calendar year,” says Kim. “So if you take it out one year and put it back in the same year, you might be in an over-contribution situation and be subject to a one per cent per month penalty,” he adds.
What are all of the potential options available to me?
If business owners have maxed out the opportunity to invest in TFSA and RRSP accounts and they are still looking for tax-sheltered investment opportunities, Kim points to whole life insurance as another tax-free asset class that historically has provided internal rates of return similar to a balanced fund but without the risk of loss. Cash value can be accessed in multiple ways if needed and, on death, the death benefit enhances the estate. If the insurance is held corporately, the death benefit gives rise to a tax-free capital dividend, creating a vehicle for tax efficiently flowing wealth out of the corporation. Kim says, “Some people call this a corporate TFSA account.”
For Kim, the best investment options for business owners always start with asking the right questions of a wealth management professional. Whether it’s TFSAs, RRSPs or other investment options, the CWB Wealth Management team can help business owners plan an investment strategy to help their bottom line at tax time and take full advantage of preferential tax growth opportunities.