As a business owner, you know reinvesting profits back into the company is important for business growth. But at the same time, you need to pay your bills. So what do you do? Should you pay yourself a salary, take withdraws from your company, or reinvest your profits back into your business? There’s not one right answer. But by weighing the pros and cons of each option, it’s pretty easy to decide on an option that works best for you and your company.
Withdrawing Company Profits
It’s important to reinvest profits back into your business but not if you are struggling to pay your personal bills. A lot of business owners assume that reinvesting their profits in their business is the right thing to do. Then, when they need money, they simply withdraw some of the company’s profits. But this method of paying yourself can really backfire on you. If you aren’t careful, you could wind up paying taxes on the money you withdraw on both your personal and business taxes.
Paying Yourself a Salary
If you don’t have a substantial savings account you can use to foot your bills, you should pay yourself an annual salary — even if it is a modest one. But your living expenses aren’t the only thing you should consider when it comes to taking a salary. Paying yourself a salary lets you show a legally recognizable personal income. Lenders need to see a personal income to approve you for loans, lines of credit, and credit cards. So if you plan to make any large purchases in the near future, you might want to pay yourself an annual salary.
On the downside, salaries are taxed at a higher percentage rate than dividend payments. For example, in 2017, salaries higher than $220,000 were taxed at 53.5%, while dividend payments in the same amount were only taxed at 45.3%. Also, when you pay yourself a salary, you have to go through the entire payroll process. This means you need to set up a payroll account with the CRA.
If you do pay yourself a salary, you need to put some thought into the amount you’re paid too. To maximize your CPP benefit, you need to pay yourself at least a $55,900 annual salary to maximize your CPP benefits, as of April, 2018. The threshold is much higher to maximize your RRSP. It’s about $145,722 per year — you can contribute up to 18% of your annual income up to a maximum of $26,230.
Paying Yourself in Dividends
If you’re disciplined about saving for retirement on your own and you have a good financial planner to help you invest properly, taking dividend payments instead of a salary might be a good option. When you take dividend payments, you eliminate the required CPP contribution. But you also won’t qualify for RRSP contributions — which is why you need to plan for retirement on your own.
Taking dividend payments also minimizes the amount of personal taxes you pay. It keeps the money with your company, which is what is needed if you want your business to grow. But if you pay yourself in dividends, there’s one thing you need to watch closely: your company’s bottom line. Any corporation that profits more than $500,000 for the year loses its small business tax credits and is required to pay corporate tax to the CRA. Because of this, many small business owners opt to take a combination of a small salary and dividends instead of choosing one or the other.
Ultimately, you need to choose a pay option that works well for you, your family, and your business. Make your decision with both your personal and business goals in mind. Then, before you set anything in stone, review your decision and the reasons behind it with your accountant to make sure you consider everything important.