Rethinking RRSPs and TFSAs for incorporated doctors

           

If you’ve incorporated your medical practice, you likely did so to reduce tax and save more for retirement.

That’s because a professional corporation can be a way to shelter your earnings in any given year. In the past, some tax experts may have advised keeping any and all earnings that you don’t need right now inside your corporation. However, new rules about passive income earned inside your corporation have turned this thinking on its head.

In fact, you may find that smart use of RRSPs and TFSAs can help you keep more of your money.

The 2018 passive income rule changes explained

When you’re incorporated, some of your professional earnings may be eligible to be taxed at the small business tax rate, which is about 12% but varies by province or territory.

Many incorporated physicians retain professional earnings in their corporate accounts, and this money generates passive income. Passive income includes interest, dividends, mutual fund income, capital gains and most real-estate rental income.

In 2018, the government introduced tax legislation governing Canadian-controlled private corporations. If your medical professional corporation earns too much passive income, this could limit access to the small business tax rate on your professional earnings.

Whether you will be affected by passive income rule changes depends on not only the level of your passive income but also the level of your professional income inside the corporation. You can use the following formula to calculate how much passive income your corporation may earn before your access to the small business tax rate is reduced:

For example, if your corporation has $350,000 of professional income from your practice, your passive income must stay below $80,000 ($150,000 – [$350,000/5]) to avoid a higher tax rate on your professional income.

RRSPs and TFSAs can help you keep more of your money

Here's where RRSPs and TFSAs come into play. By paying yourself a higher salary, you can reduce your corporate net professional income. With less money retained in your corporation, it reduces the size of your corporate portfolio, thereby generating less passive income.

Paying yourself a salary also creates RRSP contribution room that allows you to shelter more money now (as RRSP contributions are deductible from your personal income) and defer paying taxes on it until you withdraw it in retirement (presumably at a time when you are in a lower tax bracket than you are today). To make the maximum allowable RRSP contribution of $26,500 in 2019, you would need to have earned a salary worth at least $147,222 in 2018.

Another way to reduce the passive income being earned in your corporation is to take the funds out of the corporation and contribute them to your TFSA. If you’ve never contributed to a TFSA before, the cumulative amount you can contribute before the end of 2019 is $63,500 (the TFSA annual limit for 2019 is $6,000). 

When you take the money out of the corporation to contribute to your TFSA, you will pay tax upfront. But once the money is in the TFSA, all income earned within the TFSA is not taxable, making it a powerful savings tool.  

Over the long term, the benefits of getting tax-free earnings from your TFSA will often be greater than the current tax savings you would get from retaining money in your corporation.

You have options when it comes to saving your excess earnings. It may not make sense to continue leaving all of your investment income in your corporation after all, particularly if your corporation's investment account has grown to the point where you’re affected by the passive income rules.

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 RRSP and 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.

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MD Financial Management

MD Financial Management
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