Business owners have more options regarding income and taxation than employees. As a business owner, you can take a salary or income in the form of dividends. With careful planning, you can make the right choices to impact your retirement positively. One common question business owners ask is, “Should I pay into the Canada Pension Plan (CPP) or not?” Your choice can have significant consequences for your retirement years. To contribute to the CPP as a business owner, you must pay both the employee and employer portions, which is a key consideration in your decision-making process.
What is the Canada Pension Plan?
The Canada Pension Plan is a source of income for individuals typically 60 years of age and older. It is a type of asset similar to an annuity. The CPP is an asset because:
- You will receive a guaranteed income in retirement if you contribute to it.
- It protects against inflation.
- You don’t need to worry about outliving it because it makes payments for your entire life.
- Your payment won’t be affected because of investment losses.
- A portion will go to your surviving spouse if you pass away while collecting CPP.
Why do business owners want to avoid the CPP?
All this sounds great, and for employed Canadians, it is. So, why don’t some business owners want to pay into it?
Many business owners don’t want to contribute to the Canada Pension Plan and will receive dividends instead of a salary to avoid it. Three reasons many business owners prefer to avoid making CPP contributions are:
- They have to pay both the employee and employer portions. Employees pay only the employee portion, and their employer covers the rest.
- They view it as a tax that won’t benefit them.
- They believe the CPP will not be there for them when it’s time to start taking payments.
Are the concerns legit?
Paying the employer and employee portion of the CPP is costly, and business owners often believe they’ll get a better return on their money by investing it elsewhere. However, avoiding CPP premiums doesn’t significantly improve a company’s bottom line in the long run.
Most employees and business owners think the CPP is a type of payroll tax. In reality, it’s not. Governments use taxes for many purposes, which may or may not benefit you as a taxpayer. Conversely, the CPP is a fund you pay into that will help you in your later years. Your payment is determined by the amount you contributed. If you contribute to the CPP, you can expect a guaranteed income in retirement, which can be a significant source of financial security. This is a key benefit that should be considered when making your decision.
The Canada Pension Plan is not run by the government but by a separate investment board, the Canada Pension Plan Investment Board. This board is responsible for managing the CPP contributions and ensuring a good return on investment. Over the last 10 years, the plan has averaged a 10% return, which is a testament to its effective management. Plus, CPP premiums have increased since 1997 to ensure that workers pay more and the plan is sustainable.
Drawbacks to CPP contributions
When you’re self-employed, you have more to think about when planning for the future. The CPP is a fantastic benefit for most Canadians but employed Canadians don’t have the same options as business owners.
Here are some potential disadvantages to CPP contributions:
- You could invest the money yourself or with a financial advisor and earn a higher return.
- You retain complete ownership of the investments and can leave them to your beneficiaries if you pass away. If you pass away before you collect the CPP, your beneficiaries will not receive anything from your contributions.
- You have full control over the payout of your investments, including how much to withdraw.
Is it more beneficial to avoid CPP contributions?
There’s no simple answer to this question. While there can be benefits to investing on your own instead of the CPP, doing this may have serious financial consequences in retirement. Ask yourself:
- Will I be able to invest regularly?
- Do I have the knowledge to earn the return I need on my investments?
- Can I afford to give up earning RRSP contribution room by paying myself dividends?
- What happens if I can’t sell my company when I retire?
How to Decide
Before deciding to skip CPP contributions, it’s crucial to consider the long-term implications. Working with an experienced financial advisor will give you the insights and guidance you need to make the right choice for your financial future.
At MDL Financial, we’ve been helping business owners make the best choices regarding contributing to the CPP for their goals. Contact us to book an appointment, and we’ll work with you to plan your financial future so you can live your dreams.
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