The Canadian Business Owner’s Guide to RRSPs

As a business owner in Canada should you or shouldn’t you invest into your RRSP?

This is a big question we get all the time and if I was trying to game social media to get clicks I would take a hard yes or no stance and really make this an either or thing.

But the reality is that it depends. Like with all financial accounts, assets and strategies there are pros and cons to business owners investing in their RRSPs.

So, now here’s the no hyperbole should you or shouldn’t you invest into your RRSP as a business owner in Canada.

When you have your own business you have 2 main options for deferring tax when investing your business profits – you can keep the money in your corp and invest there or you can withdraw the money and invest through an RRSP.

There’s a limit to how much you can put into your RRSP – it’s usually 18% of your previous year’s earnings up to a maximum. This year the maximum is $31,560 but this changes every year so you should check if you’re not watching this in 2024.  The best way to check is to login to your MyCRA account and there’s a tab that tells you your personal maximum RRSP and TFSA contribution room for that year and any previous years.

The pros and cons of investing in your RRSP as a business owner in Canada.

The Pros

  1. Your contributions to the RRSP are tax deductible

The first reason Canadian business owners would choose RRSPs is for the immediate tax benefits. Contributions are tax-deductible, lowering your taxable income and potentially resulting in a tax refund.

What does this mean? Let’s say you pay yourself a salary of $150,000 this year and make your maximum contribution of $31,560.  Your taxable income in that year would be your salary minus whatever you contributed to your RRSP. So $150 thousand minus $31 thousand = your taxable income this year would be $118,440.

You would pay tax on this lower amount of $118 thousand.

The deductibility generates this immediate advantage of lowering your income so that your overall personal tax bill is lower.

The other potential advantage is if your contribution deduction drops your income into a lower tax bracket. Depending on how much you pay yourself you could drop from the top 33% tax bracket into the 29% tax bracket or down to the 26% tax bracket or 20.5% tax bracket or 15% federal income tax bracket.  You can Google Canada federal tax bracket and see the thresholds for each tax bracket and if your RRSP contribution would drop you down into a lower one.

  1. Tax Deferred Growth

The second big advantage of investing through your RRSP is that the growth is tax deferred until you withdraw it. What this means is that as the value of your investments inside your RRSP goes up you don’t pay tax on it every year.

That doesn’t mean it’s completely tax free.  The government wants their money and they’re going to get it.  You will pay tax at your marginal tax rate when you withdraw the money from your RRSP.

The benefit is that any growth in your funds inside the RRSP are allowed to compound over time which should get you a higher portfolio value if you make good investments.

  1. Retirement Savings

Investing in an RRSP is one way to build your retirement savings.  Most people know about RRSP and sort of how they work so doing these types of investments is beneficial because it’s easy to understand for most people.

Also when using an RRSP for retirement income  you don’t have to manage your company. So if you sell your company or close it when you retire you don’t have all the corporate maintenance and fees that go along with keeping your company or holding company open during retirement.

  1. Income Splitting in a Spousal RRSP

Traditional income splitting has gone away for business owners. With an RRSP you can still sort of split income by contributing to a spousal RRSP which is a powerful tax-saving strategy. By contributing to a spousal RRSP, you can equalize retirement income and reduce overall taxes in retirement. Also, with a spousal or partner RRSP, you could theoretically split up to 100% of your RRSP income with your lower-income spouse or partner, this can lead to significant savings and a more comfortable retirement for you and your family. For sure consult with your financial advisor or possibly accountant before doing this to make sure you’re doing it correctly and stay within the rules.

  1. Lots of Investment Options

You can invest in all sorts of things inside your RRSP depending on what you like to invest in and depending on your risk tolerance.

You can choose from stocks, bonds, mutual funds, segregated funds, ETFs, REITs, and some exempt market investments inside your RRSP. This flexibility can let you invest in quite a broad range of things to help grow your wealth over time. If someone’s pitching you an exotic type of investment, always ask if it’s RRSP eligible.

  1. Home Buyers’ Plan

If you’ve never owned a property before, you can use the First Time Homebuyers Program that let’s you withdraw up to $35,000 from your RRSP tax-free to use towards a down payment on your first home. When you use this in conjunction with the new FHSA, you could get up to $75,000 tax free combined from both accounts to put towards a down-payment on your first home.

If you’ve got some cash now and you’re looking to buy a home soon, a good strategy is to put the money into your RRSP now, get the tax deduction, and then withdraw the $35,000 for first time homebuyers.

Now why wouldn’t you contribute to an RRSP as a Canadian business owner?

The Cons

Here are some reasons not to invest in an RRSP as a business owner.

  1. Limited Contribution Room

We work with some high income earners earning $600,000 or $700,000 a year or maybe $1 or $2 million a year so using the RRSP contribution limit of $31 thousand doesn’t really move the needle in terms of tax savings when you’re earning that much. There’s other things they can do that would have a greater tax effect for them.

You can still do it and it does help, but it’s not solving your whole problem.

  1. Low Income Levels

On the opposite end of the spectrum, maybe you’re not earning that much right now and investing in an RRSP might not provide significant tax benefits. You might want to save your RRSP contribution room for later when you’re earning more and the deduction will have a more significant impact.

If you’re note earning that much and you’re in one of the lower tax brackets it doesn’t always make sense to save into your RRSP.

  1. Short-Term Financial Goals

If you need your money in the next couple of years – maybe you’re buying a car or taking a vacation and you’ll need the money, investing in an RRSP may not be the best option.

RRSPs are designed for long-term retirement savings, and withdrawing funds early has tax implications. So if you’re going to deposit into your RRSP and you’ll need to take it out in the next couple of years then investing into your RRSP probably doesn’t make a lot of sense.

We’d usually say to keep any short term cash in something liquid like a high interest savings account that doesn’t have the restrictions of a registered account like an RRSP.

  1. You’re Going to Continue to Make Money in Retirement

The general concept of an RRSP is to contribute now when you’re in a higher tax bracket and withdraw later when you’re in a lower tax bracket. But what if you’re never going to be in a lower tax bracket? Does it make sense? Maybe, sometimes and also maybe not.

For example if you’re building up a rental portfolio and you plan on having rental income for the rest of your life – you could have significant cash flow that keeps you in a high tax bracket forever. And then later when you want to withdraw from your RRSP that counts as income and you have to pay even more tax – even if you didn’t need the money.

  1. You Don’t Know What Taxes Are Going to be in the Future

The government is your partner in your RRSP. They are “giving you” the tax advantage now when you deposit and not charging you tax while you’re invested – but they definitely want their taxes when you take the money out.

Generally you’re going to be saving in your RRSP for 20 or 30 or 40 years when you retire.  You know what the tax brackets are today – but do you know what they’re going to be in the future when you want to retire? Can you guarantee that they’ll be the same or lower than they are today? Or will taxes be higher in the future? I mean the way things are going right now I know which way I would bet and I wouldn’t bet that taxes are going down.

  1. You Might Need Your Money for Things Other than Retirement

You’re a business owner and things come up. If you’re money is in an RRSP it’s tied up. And it doesn’t have to be a business emergency that needs your money. You might want to reinvest in your own business to grow. Or you might want to buy real estate or buy your office. You generally can’t do that in your RRSP.

A lot of business owners we work with don’t want to have their money locked up inside an RRSP because they know that a business emergency might happen or other opportunities that don’t work inside an RRSP might come up.  You might have an opportunity to buy a competitor or a business partner – you can’t do that with your RRSP and there’d be a big tax fee if you had to take your money out of an RRSP to fund this kind of purchase.

  1. Over-contribution is a Real Thing That You Should Know About

I’m not talking about putting more than the CRA allows into your RRSP an “overcontributing”.  I’m talking about having too much money inside your RRSP when you retire and the money becomes trapped.

We’re actually working with a few clients like this right now – I’ll give you an example of a couple that did what they thought they were supposed to do and contributed to their RRSPs and now they each have over a million dollars inside their RRSP. The problem is they are still earning  a few hundred thousand dollars in their retirement years and they don’t need the money in the RRSP.

But when they turn 71 they will be forced to start taking money out of their RRSP. If you don’t start taking money out of your RRSP, the government makes you take it out starting at age 71. They’re still in a high tax bracket, they don’t need the money right now but they are forced to take it out – so basically 50% of whatever is in their RRSP is going to go to taxes.

Don’t they wish they never put the money in there in the first place. They’d love to rather give that money to their kids and to support a certain charity that they are a part of, but they can’t. 50% of whatever’s in that RRSP account is going to Ottawa and to their provincial governments rather than to their own kids and the charity they work with.

Business owners definitely need to be careful and not put “too much” money into their RRSP, especially if you plan on having cash flow in retirement or if you plan on making more money later than you are today.

Final Notes

For a lot of Canadians, investing in your RRSP is the only way to get a tax deduction and to let your investments grow tax deferred.  But business owners can have some other options so it’s not always the right answer to invest through your RRSP – especially if you’re going to continue earning in your retirement years or if your business is successful and you’re going to make more money later than you’re making now.

That doesn’t mean you shouldn’t do it. There are some valid reasons that Canadian business owners should contribute to your RRSP like the upfront tax deduction, the tax deferred growth, the ability to sort of income split, lots of investment options available and the First Time Homebuyers Plan if you’re looking to buy your first property. All of these make investing in your RRSP a great idea.

But there are valid reasons why a Canadian business should not invest in an RRSP.

The contribution room might not make a big difference if you’re a very high earner, you might need the money for other short term goals, you might need to keep the liquidity for your own business to deal with emergencies or to take advantage of opportunities. You might end up making “too much” money in your retirement years that makes the RRSP taxes very expensive and you might get into a situation where you’ve contributed too much into your RRSP and now the money’s trapped and really expensive to take out. You also don’t know what taxes are going to be like in the future so taking that deduction now might turn out to be really expensive later.

Standard financial advice says to max your RRSP all the time. But we take the approach that you should look at your RRSP options every year and sometimes it makes sense and sometimes it doesn’t make sense to take the money out of your corp. and contribute to your RRSP.  We generally recommend our clients to look at RRSP contributions on a year-by-year basis and contribute when it makes sense and don’t contribute when it doesn’t make sense.

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