Small business owners need to take retirement funding into their own hands. Unlike employees, who can take advantage of employer-sponsored pension plans, self-employed individuals must explore options such as registered retirement savings plans. The RRSP allows you to contribute a portion of your earnings that grow tax-free until you need to access the funds. At that point, distributions you take from the plan are subject to taxation, but ideally your tax bracket should be lower than it was when you owned your business. You should fund your RRSP early and often, maximizing contributions when possible.
There are annual limits to RRSP contributions. In 2017, if you’re a sole proprietor, you can contribute up to 18% of your employment income, up to a limit of $26,010. At that level, to maximize the yearly contribution, you’d need to take a salary of $144,500. If your business income isn’t quite there yet, the Canada Revenue Agency allows you to carry forward room in your maximum contribution limit. If you contribute $10,000 in 2017, you can add up to $16,010 to the RRSP in subsequent years. This rule is helpful if you’re a new business owner and you’ll earn more income as time passes. If your income in 2018 balloons to $250,000, you can reduce your taxable income to $207,980 by contributing the carry-forward amount of $16,010, plus your base allowance of $26,010. Many business owners get wrapped up in daily operations and tend to put off thoughts of retirement funding until it’s late in the game. You can gain advantages by maximizing your RRSP contributions as soon as you can. Starting a business at age 35 gives you significant time to allow your retirement accounts to grow. Over 30 years, an RRSP contribution of $15,000 annually amounts to just over $1.5 million at a 7% pre-tax annual rate of return. Wait 15 years to get started on contributing to your RRSP, and that total accumulation drops to $418,321.
Alternative Retirement Funding Strategies
If you’re fortunate enough to max out RRSP contributions, you can get some additional tax relief and increase savings amounts. Labour-sponsored funds provide more capacity to save for retirement. In Ottawa, eligible investments qualify for a 15% tax credit, up to a total of $750. However, lackluster investment returns have plagued these funds in recent years. You have to balance tax credits with poor performance in these funds, some of which could tie your money up for eight years. Hefty fees and penalties apply to withdrawals made prior to these lock-in periods. You may also want to consider borrowing money to maximize your RRSP contributions. In a low-interest-rate environment, you can take loans at 3% interest, while RRSP funds may earn market-based returns of 8% on average, for a 5% net rate of rate before taxes. Financial advisors can map out retirement planning options if you’re uncomfortable doing it yourself. Just don’t delay those plans; the cost of waiting may extend your working years beyond the age when you plan to retire.