Lifestyle | What to prioritize, a salary or dividends?

When you own your own small business, you have the choice between paying yourself a salary or dividends. While both have advantages and disadvantages, it is wise to evaluate the impact of your choice and plan for your retirement accordingly.

The situation

Carl* is 53 years old and is an information technology consultant. He would like to retire around age 65. He created a company for which he is president, sole shareholder and worker. He invoices about $165,000 per year and always pays himself in dividends all the profit the company has made for the past 18 years. This strategy gives him tax advantages and means that he does not have to contribute to the Quebec Pension Plan (QPP) and the Quebec Parental Insurance Plan. This means more in his pockets.

In return, as he has not been paying his share of the QPP for a long time, the amount of pension he will receive upon retirement will be minimal. In addition, he does not accumulate contribution room for his registered retirement savings plan (RRSP).

Carl is not a homeowner: he lives in his partner’s house. In addition, he does not expect to receive an inheritance. After a difficult separation, he fell behind in paying his taxes and saving. Now that the situation is resolved, he estimates that he will be able to save $25,000 per year.

Advice

The question of salary or dividends is interesting according to Simon Préfontaine, financial planner at Lafond Financial Services. However, it is not the most important in Carl’s case, he assesses. “What is a priority for him is to think about his lifestyle. He is seriously behind on his retirement plan.”

Reduce your standard of living

Now that Carl has paid his tax bill in full, he really needs to look at how much money he needs to live comfortably, says Simon Préfontaine.

“If it’s $40,000 a year, he’ll be OK with his current retirement plan,” he says. “That’s what he would have in today’s dollars if he follows through on his plan of saving $25,000 a year until age 65, assuming inflation, a life expectancy of 94 and a return of 5.5% per year.”

Now, Simon Préfontaine estimates that since Carl earns $165,000 a year, has to pay about $55,000 in taxes and saves $25,000, he lives on about $85,000. “It’s quite a difference to go from a lifestyle of $85,000 to one of $40,000,” he says.

Save and work more

The financial planner calculated that if Carl wants to maintain his $85,000 lifestyle in retirement, he should save $52,000 a year and retire at age 70.

“These are big changes to his plan,” he says. That’s why my first piece of advice would be to look at your expenses to see if you can reduce your current lifestyle. He should also look at his budget in the coming years and once he retires to see if his lifestyle can later be significantly reduced. »

Being able to live on less will make a big difference in Carl’s retirement plan, estimates Simon Préfontaine. He calculated that if he decides to work until age 70 and saves $25,000 per year until he retires, that would allow him to have $57,000 per year for his retirement.

“Obviously, the more he manages to save and reduce his lifestyle, the more his scenario will improve,” he specifies.

The financial planner advises Carl not to be too optimistic, however, and to always keep in mind that he may have to pay more for housing. “He doesn’t own a home and he lives with his partner right now, but if he ever needs to rent an apartment, he’ll probably pay a lot more,” he points out.

Opting for a salary

Once all these reflections have been made, Carl will actually be able to refine his plan by reviewing his remuneration.

“I don’t have all the details of his situation and there are always exceptions, but I would tend to think that he would be better off moving towards a salary to accumulate RRSP contribution room,” says Simon Préfontaine. Currently, he has a marginal tax rate of 47% and in retirement, it will be more like 36 or 26%, depending on his savings and his lifestyle, so it is certain that the RRSP would be advantageous for him. »

However, the financial planner invites Carl to consult a financial planner and an accountant for their advice on this issue.

“Everything is not black or white,” says Simon Préfontaine. It is even possible that he will have divergent opinions and he will have to ask them what they base their recommendation on, and then make his decision. But one thing is certain, what will make the big difference in his situation is really the reduction in his cost of living and the increase in his savings. To get there, he will have difficult choices to make. It’s always hard to lower your lifestyle once you’ve increased it. »

* Although the case highlighted in this section is real, the first name used is fictitious.