Wages vs. Dividends - Part 2

The Meeting

Last time, I met with a client who wanted to know: what was the best way to pay themselves out of their new business, wages or dividends?

We determined that the dividends result in the least demand on cash flow. Even though wages incur less tax, the payroll remittance for CPP can result in an extra $7,000 per year demand on cash reserves.

The CPP remittance is an investment toward your retirement savings, however. When paying yourself only by dividends, you should consider making a similar payment to your own retirement savings.

With that assumption, we'll look at some other factors you should consider before deciding if wages or dividends are best for you.

Cash Flow

If you are paying yourself wages, you must make monthly payroll remittances for income tax and the "retirement investment" to the CPP fund.

Often I hear, "I can't do wages because I can't afford the payroll remittance." What this means is…

You want or need to take out all the money in the company rather than leave money to pay for corporate taxes, GST, or instalments towards your personal taxes. Or said another way, "I want to take out more than my company is making!"

You want to worry about paying your taxes later, next month, or next year when your business might be more profitable. You might as well be saying, "I have a line of credit from Revenue Canada that I can draw on anytime I need it, interest-free, with no repayment terms, and they will be ok with it."

The Cash Flow Blues

I have seen many new businesses and some established businesses get into trouble by taking out more money than the company can support.

For example, let's assume a 33% average tax rate on your income. That would mean on $1,500, you would owe 1/3 to taxes or $500. That means if you make $1,500 you only get to spend $1,000.

So, when you take $1,000 as a dividend, plan to pay the government $500 at some point. For every dollar you take out, put aside another 50 cents or 50% for taxes.

Both corporate and personal taxes are going to be triggered eventually. If you can't pay the personal portion of the tax now, how are you going to pay personal and corporate taxes later?

The Bottom Line

Dividends have a less immediate demand on cash flow than wages. Wages force you to live within your means and at least pay for the personal portion of your taxes as you go.

You can choose to pay yourself only what your company can afford. That choice requires you to make decisions about what you really need day to day to live.

Unless you are very disciplined about managing your money and saving for taxes and retirement, you should strongly consider paying yourself a regular wage.

RRSP Contributions

RRSPs are one of the basic foundations of investment and retirement tax planning. The idea is to contribute to your RRSP when your income is high (in a high tax bracket) and get a deduction so you can invest more. Then take the money out when you retire and likely have a lower income (lower tax bracket).

What does this have to do with paying yourself by wages or dividends? Well, only wages contribute to your RRSP limit each year. Dividends do not.

A $100,000 wage in 2022 will allow you to contribute $18,000 to an RRSP sometime in the future.

There might come a time when you want to wind up your company and take out your earnings. We often use a shareholder's RRSP contribution room to move excess cash out of their company tax free and into their RRSP.

Your personal situation, savings and needs will influence how you lean on this issue.

Let Us Help You

You and your business are unique. There is no one size fits all answer for us business owners. We have to figure it out for ourselves.

That said, you don't have to do it alone. For over 30 years our firm has been listening to business owners, helping them resolve their issues and lessen their stress.

We have been their business ally.

Give us a call - let us help you
Contact Us

Next article - Wages vs. Dividends (part 3)