or a number of years now, dentists across Canada have had an opportunity to accelerate the tax deductions their professional corporation can claim when saving for retirement. This is because since 2012, dentists who receive T4 income from their professional corporation have the ability to set up a Personal Pension Plan (“PPP”) for themselves and any family members also on the payroll of their dental practice.
But to truly appreciate the incremental improvement to tax minimization under a PPP, there is no substitute to reviewing a simple case study with dollars and cents.
Tax minimization under a personal pension plan case study: Facts
- Dr. Anna McDentosh incorporated in 2016
- Her salaries since have been 70,000 (2016), 70,000 (2017), 100,000 (2018), 100,000 (2019) and 100,000 (2020)
- This year in 2021, she decided to increase her salary to $150,000
- She has been very successful with her RRSP investing and now has $1,000,000 in registered dollars
- She is conservative and insists on an annual rate of return on her money of 5%
- She is currently 30 years of age, and would like to retire at age 65 in 35 years
- She has no carried forward RRSP room
- Whether she saved in an RRSP or a PPP, she wants to contribute the maximum amount allowed by the tax legislation in any given year.
- Her investment advisor charges 1% on assets under management (whether it be in an RRSP or a PPP)
- Her practice is successful and she pays corporate tax at 26%
Results of implementing a tax minimization strategy under a personal pension plan
By the time she retires, thanks to the upgrade to the PPP, Dr. McDentosh will have an extra $977,848 in registered dollars above the maximum she could have achieved had she maximized her RRSP contributions every year.
If she works until age 65, the additional tax deductions available under PPP rules will exceed those under the RRSP system by $538,778.
In other words, given that her professional corporation pays tax at 26%, it will have saved $140,082 in corporate taxes.
To be fair, she would have to pay PPP administration fees over that same period of $64,260, such that, if we net out the fees from the taxes saved, she will actually have made an extra $75,822 on top of having $538,778 more to retire on.
Of course, the corporate tax deductions could be significantly higher if she decided to turn on the pension income sooner than age 65, whilst continuing to work and continuing to receive dividends (more on the difference between salaries and dividends) in her capacity as a shareholder of her professional corporation.
For example, if she decided to turn on the pension at age 55, her corporation would be able to claim a terminal funding corporate tax deduction of $1,540,857. Recall that since her corporation is presumed to pay tax at 26%, this represents $400,622 in taxes that can stay in the corporate bank account since the tax is deferred.
To be fair, from age 30 to age 55, her additional contribution beyond those permitted by RRSP rules would not be $538,778 but only $232,409. Thus, the total additional PPP tax relief would be the sum of the terminal funding and this difference at age 55, or $1,773,266.
This represents taxes saved by the practice of $460,049.
Many commentators often point to the administration fees owning to establish and maintain the PPP as a reason to defer establishing the pension plan.
If the PPP is set up using a life insurance contract, the current annual fee is usually $1,775. We ignore sales taxes because these can be recouped fully under the Input Tax Credit system.
To counter-balance these additional fees that don’t exist within an RRSP, we must recall that investment management fees under a PPP are fully tax deductible to the dental practice since it is a legitimate corporate tax deduction.
The table below summarizes the impact of this tax treatment from age 30 to age 65:
In other words,
this single feature (tax deductibility of investment management fees) not only covers 100% of the additional cost of being in a PPP, it even generates an annual surplus that increases as the size of the plan expands over time.
One last note, at age 55, if Dr. McDentosh decided to take an early retirement payment her annual pension would be $203,609. That income is eligible for ‘pension income splitting’ treatment if she has a spouse.
Let’s assume she is based in Ontario. If the tax rates in 2046 when she turns 55 are the same as in 2021, she would have to pay tax on that full amount of $70,982. However, unlike a RRIF where she would have to be 65, with the PPP she can allocate up to 50% of her pension income (or $101,804) to the tax return of her stay at home spouse.
This means that each member of the couple would now pay combined Federal/Ontario personal taxes of $24,238. As an economic unit they end up paying $48,476.
In other words, the PPP just saved Dr. McDentosh and her spouse $22,506 every single year. Even if the INTEGRIS annual fee were to increase by 400% ($7,100 in 2046) the couple is still netting $15,406 annually.
With no additional market risk taken, Dr. McDentosh has significantly increased the assets she can rely upon in retirement, and has given her largest asset, her professional corporation, significant new tax deductions along the way. Moreover, the income she will enjoy in retirement could potentially be taxed at a much lower rate thanks to the pension income splitting rules. Interestingly-enough, all of these outcomes are achieved without expending any additional resources, since the PPP fees are paid for multiple times over by the taxes saved by the system, making this a self-financing investment akin to buying a condo with no down payment and leasing it at a monthly rent that covers the mortgage and the taxes/expenses of its upkeep.
Viren Parmar, Financial Advisor, Karma Financial
Karma Financial provides a plan that covers all aspects of wealth and ensure each element works together to ensure all your needs are met.