Today I will be discussing an option that business owners have when they have some cash inside the corporation that they do not need to fund their business.
The question is
“I have some money. Where should I invest? Inside my corporation, or should I invest it personally inside an RRSP?”
Imagine we have a person who owns a corporation they have $100,000 of cash. When deciding where to invest that $100,000 of cash, they have two options.
Number one, they could pay themselves a salary of $100,000. If they have the RRSP contribution room, they could make an immediate RRSP contribution. This would avoid paying any personal tax on that today, deferring that tax payment into the future. Now they have that money invested personally, in the future when they make withdrawals out of this RRSP, they will pay taxes. That is option 1, using those funds personally.
Option 2, Instead of pulling the money out of the corporation, they could just leave it inside the corporation and invest it.
Instead of using the RRSP, they would open an investment account for the corporation and invest it.
Corp vs RRSP
Now, which of these two options makes the most sense? Which will lead you to have the most after-tax dollars in the future?
It is a very tough question to answer. There are a few conditions that must be met to determine which one makes more sense.
When the following two conditions are met,
- You’re an investor that’s comfortable with an all-equity portfolio,
- so, you have no fixed-income investments like bonds or GICs that are paying you interest so you’re strictly in 100% equities.
- If you will defer all the capital gains on your investments
- You are not going to be realizing capital gains each year. You are going to defer those and just realize it all at once in the future.
If these two conditions are met, then the corporation will outperform the RRSP on an after-tax basis. Only if these two conditions are met.
If you’re in a balanced portfolio, where you have
- 60% of your money in stocks and 40% in fixed income
- if your investments are going to be paying you dividends or interest
- if you are going to be realizing gains on an annual basis.
If any of these three conditions are met in your investment portfolio then in that case, the RRSP will outperform the corporation.
If you are an all-equity investor and you are going to defer all the capital gains of your investments inside your corporation, then the corporation will provide you with a larger after-tax value for your dollars.
If any of these conditions are met: you’re a balanced investor, you’re receiving dividends or interest annually, or you’re realizing your capital gains annually, then investing in your RRSP will outperform the corporation
In future videos, we will discuss a little more in detail why that is the case. For today if you have any questions or this situation applies to you and you’re wondering what makes the most sense for you give us a call. We’d be happy to go through a risk profile questionnaire to determine if you are an all-equity investor.