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Rethinking RRSPs and TFSAs for incorporated doctors

Do you have a professional corporation set up to shelter the earnings you make in any given year? If so, you've no doubt had conversations with your tax advisor about how much you should draw from your corporation, and whether those earnings should be paid to you as a salary, or as dividends.

You likely incorporated your medical practice to reduce tax and save more than you could using registered retirement savings plans (RRSPs) or tax-free savings accounts (TFSAs) alone.

In the past, some tax experts may have advised retaining any and all earnings that you don’t need within your corporation. However, new rules about passive income earned inside your corporation has turned this thinking on its head.

If you haven’t done so already, you may wish to revisit this strategy with your tax advisor.

A new strategy to consider after passive income rule changes

When you’re incorporated, some of your professional earnings may be eligible to be taxed at the small business tax rate, which is about 13% but varies by province or territory.

Many incorporated physicians retain earnings in their corporate accounts, and this money generates passive income. Passive income includes interest, dividends, mutual fund income, capital gains and most real-estate rental income.

In 2018, the government introduced new tax legislation governing Canadian-controlled private corporations. If your medical professional corporation earns too much passive income, this could limit access to the small business tax rate on your active professional earnings.

Whether you will be impacted by passive income rule changes depends on not only the level of your passive income but also the level of your active professional income. You can use the following formula to calculate how much passive income your corporation may earn before your access to the small business tax rate is reduced:


For example, if your corporation has $350,000 of active professional income from your practice, your passive income must stay below $80,000 ($150,000 – [$350,000 / 5]) to avoid a higher tax rate on your active professional income.

For more technical details, please read Incorporated physicians and RRSPs: The impact of the new passive income rulesand New passive income rules starting in 2019: What incorporated physicians need to know.

RRSPs and TFSAs can help you keep more of your money

Here's where RRSPs and TFSAs come into play. By paying yourself a higher salary, you can reduce your corporate net active professional income. With less money retained in your corporation, it reduces the size of your corporate portfolio, thereby generating less passive income.

Paying yourself a salary also creates RRSP contribution room that allows you to shelter more money now (as RRSP contributions are deductible from your personal income) and defer paying taxes on it until you withdraw it in retirement (presumably at a time when you are in a lower tax bracket than you are today). To make the maximum allowable RRSP contribution of $26,500 in 2019, you would need to have earned a salary worth at least $147,222 in 2018.

Another way to reduce the passive income being earned in your corporation is to take the funds out of the corporation and contribute them to your TFSA. If you've never contributed to a TFSA before, the cumulative amount you can contribute before the end of 2019 is $63,500 (the TFSA annual limit for 2019 is $6,000). 

When you take the money out of the corporation to contribute to your TFSA, you will pay tax upfront. But once the money is in the TFSA, all income earned within the TFSA is not taxable, making it a powerful savings tool.  

Over the long term, the benefits of getting tax-free earnings from your TFSA will often be greater compared to the current tax savings you would get from retaining money in your corporation.

The point is, you have options when it comes to saving your excess earnings. It may not make sense to continue leaving all of your investment income in your corporation after all, particularly if your corporation's investment account has grown to the point where you’re impacted by the passive income rules.

Work with your tax advisor and MD Advisor to better understand the tax benefits of these strategies – and others as well. They will know and understand how to minimize your overall tax liability by looking at your whole situation. From there, you will know which combination of savings will be right for you your unique circumstances.