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Why TFSAs are a good option for incorporated physicians

If you’re an incorporated physician, you may be wondering whether you should leave most of your investable money in your corporate account or move some into your tax-free savings account (TFSA).

When you earn money through your medical professional corporation, you benefit from the small business tax rate, which is about 12%, depending on your province or territory. This is generally the rate that your corporation pays on your practice income up to $500,000 annually. Above that amount, your practice income is taxed at the general corporate tax rate — between 25% and 31% (again, it varies by province or territory).

Let’s take a step back to see what the two options mean.

Option 1: Keeping your money in your corporate account

By leaving money in your corporation, you avoid being taxed at the personal rate, which will be significantly higher than the small business tax rate. This annual saving gives you more money to invest, allowing your funds to grow faster.

Option 2: Moving money into a TFSA

When you withdraw money from your corporation, your total taxes on that money can rise to over 50%. However, you can use some of this money to contribute to your TFSA.

How TFSAs help incorporated physicians build wealth

To recap, when you keep money in your corporation, you’re saving on taxes because your practice income is taxed at only 12%.

When you pay yourself a salary or receive dividends from your corporation, you will pay higher taxes. But once the money is inside the TFSA, all the investment earnings are tax-free. And any withdrawals you make from a TFSA are tax-free, making it a powerful savings tool.

Over the long term, the tax saved on the earnings in your TFSA will generally be much greater than the tax saved if you’d kept the money in your corporation. The following fictional example shows the potential of tax-free growth.

Let’s say you contribute $6,000 a year to your TFSA for 40 years, for a total contribution of $240,000. Let’s also assume an annual growth rate of 5%, which makes the account actually worth $724,800. That’s 67% — or around $484,000 — in non-taxable growth.

Chart shows a TFSA contribution of $6000 annually for 40 years and the resulting non-taxable growth

This graph is presented for illustrative purposes only and is not indicative of any investment.

Generally, incorporated physicians should be contributing the maximum amount allowed to their TFSA. If you’ve never contributed to a TFSA before, the cumulative amount you can contribute before the end of 2020 is $69,500 (the annual TFSA limit for 2020 is $6,000).

If you compare contributing to your TFSA with saving within your corporation, it’s true that you might be able to save faster in your corporation at the start. But if you look at the end result, with long time frames, TFSAs generally come out ahead.

The TFSA is especially useful for estate planning. Since most physicians’ estates will be subject to top tax rates, the fact that TFSAs can be distributed tax-free to beneficiaries makes it an ideal vehicle for maximizing the value of your estate. 

Work with your tax advisor and MD Advisor* to better understand the tax benefits of these strategies — and others as well. They will know and understand how to minimize your overall tax liability by looking at your whole situation. From there, you will know which combination of savings will be right for your unique circumstances.

Thoughtful planning and advice from MD Financial Management can help you save more and rest easier. Contact an MD Advisor today to make the most of your TFSA contributions.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.