Entrepreneurs wear many hats. The last thing you’re thinking about is how much salary to pay yourself, but it’s an important consideration, especially for tax purposes. Not only do you need to figure out how much you’re going to pay yourself, you also need to determine how to do it. For instance, are you going to pay yourself a base salary or a percentage of sales? Will your income be in salary or dividends? Each of these decisions can impact the amount of taxes you pay in the future.
How To Pay Yourself: Salary vs Dividends
One of the most important considerations is whether to pay yourself in salary or dividends. There are advantages and disadvantages of both. If you pay yourself a salary, it will be taxed at a higher rate than dividends, but you also have a legally recognizable personal income. This allows you to save for retirement with involuntary CPP and voluntary RRSP contributions. You can also pay yourself through a payroll process, which means setting up a payroll account with the CRA.
If you pay yourself through dividends, you avoid the mandatory retirement contribution rule, so you have more flexibility in terms of your retirement plans. Unlike salary, dividends do not trigger CPP contributions. They also don’t count toward RRSP. Dividends also don’t count toward salary calculations on loan applications, so you may have a harder time applying for a mortgage.
Due to the advantages and disadvantage of both methods, many business owners use a combination of both payment methods. You can also set up a trust through a small business corporation and as the head of your family. The family trust can then legally become a shareholder of the corporation and receive dividends. The recipients of the trust have the advantage of reduced taxes due to exceptions and tax credits.
Calculate Your Salary With Your Budget
It can be unrealistic to think in terms of hourly wages for yourself because you probably work all the time. Instead, think in terms of a base salary or a percent of sales. For example, if your primary job is generating leads, you can pay yourself a percentage of each sale. You can also refine your budget based on an incentive plan. For example, if you sell 10 widgets, you get a bonus of 10 percent, but if you sell 20 widgets you get a bonus of 30 percent. As you fine tune your own incentive strategy, do it with the intention of hiring someone else to do the job. That is, think about what incentives you might put in place for someone to do your job effectively.
Perhaps the best way to determine how much you can pay yourself is by developing a budget. Your budget should be a living document that you reference often. Include a sales forecast and a cost of getting the work done to ensure you have a viable business model. Sometimes, the amount you pay yourself is dependent on what’s left over.
Final Thoughts: Start Small
When you’re first getting started, focus on reinvesting your income back into the business, but be sure to pay yourself. As your business grows, you can slow your rate of reinvestment and increase your salary, but it’s important to keep your salary small when first starting out. Creating a budget and adhering to it can greatly reduce the amount of stress that comes along with running a business, and a daily, weekly, or monthly budget can help ensure your own financial needs are also met.