- Create RRSP contribution room
- Pay into and build CPP
- Advantages of each depend on:
- Your career stage
- Personal factors like your income needs
One of the challenges for incorporated physicians is deciding whether to be compensated by salary, dividends or a combination of both.
When you incorporated your medical practice, you created a separate legal entity that owns the practice. It’s the corporation that is earning the practice income, not you.
That covers your business needs, but what about your personal spending? You can’t simply withdraw cash from the business the way you can from a bank account. You can, however, pay yourself. Generally speaking, you can take your compensation in the form of salary, dividends or a combination of the two.
Every physician’s financial situation is different and calls for different advice. There are many personal factors — time frame, your need for income, your capacity for risk — that can go into choosing salary or dividends as the better option for you.
In general, however, the compensation decision should be largely based on your career stage.
Early career: The case for salary
When the corporation earns practice income, it can pay you a salary. There’s no limit on how much you can be paid, so if the corporation earns $350,000 after overhead, you could technically take all of that in salary and pay personal income tax on it (though you would lose the tax deferral benefit of incorporating by doing so).
When you pay yourself a salary, you create RRSP contribution room, which can help you build tax-deferred retirement savings. On the downside, you’re required to pay Canada Pension Plan (CPP) premiums.
When you pay yourself using dividends, your total taxes (personal and corporate) are similar to salary.
However, dividends do not generate RRSP room, and RRSPs provide even better tax deferral than a corporation. You may be tempted to avoid paying CPP premiums, but you would lose out if you needed those benefits in the future.
Mid-career to late career: Salary and dividends
As you progress in your medical career, you’ll be earning and saving more. With more retained earnings in your corporation, compensating yourself with dividends makes more sense.
Think back to why you incorporated in the first place: Because your medical professional corporation pays the small business tax rate — about 12% on the first $500,000 of practice income annually1 — you can save much faster in your corporation. This money can be invested and will generate investment income (also called “passive income”), typically in the form of interest, dividends and capital gains.
Unlike practice income, though, passive income is highly taxed in most provinces. It can also reduce your access to the small business tax rate on your practice income.
But here’s where dividends come in: As your corporation earns more passive income, that passive income is taxed at high rates. When dividends are paid to shareholders, some of the tax that’s paid in the corporation becomes refundable. So, it may make sense to pay yourself dividends in order to recover your refundable tax at some point. That can tilt the optimal balance between salary and dividends toward dividends.
Retired: The case for dividends
When you retire from your medical practice, you have to decide what to do with your corporation. You can dissolve your corporation or convert it to a holding company. If you decide to continue with a holding company, it is still a corporation but not a medical professional corporation.
Since you are no longer working as a physician, you can’t pay yourself a salary from your holding company. In retirement, your compensation from your corporation will likely be exclusively in the form of dividends
If you have a spouse, you can split dividends with your spouse at age 65 to save on taxes, and it’s most advantageous if your spouse is in a lower tax bracket.
Where to get more guidance
While compensation decisions are often based on career stage, they can be affected by other factors. Your province may have salary-based health premiums or problems with tax integration.
If your corporation’s investment income is high enough that you lose access to the small business tax rate, this can be an important factor. So too can things like research grants, childcare expenses, or an individual pension plan.
Your MD Advisor* can work closely with your accountant to make sure that their recommended tax strategies are aligned with your other financial planning considerations.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
1 Both the active income threshold and small business tax rate vary by province and territory.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice, nor is it intended to replace the advice of independent tax, accounting or legal professionals.