PREC pension plan – the myth of the RRSP refund
Contributor: Pension lawyer Jean Pierre Laporte, BA, MA, LLB. (Jp.laporte@integris-mgt.com)
The human brain can play tricks on us, especially when it comes to numbers and tax rules. One issue I’ve encountered many times over the past decade is the belief that it’s “better” to make a personal contribution to an RRSP than to have a Canadian Controlled Private Corporation (CCPC), such as a Personal Real Estate Corporation (PREC), make a direct contribution into a registered pension plan (IPP or PPP).
Here’s how that argument usually goes:
If I’m taxed personally at a 50 per cent rate, and my taxable income is $300,000, I’m better off contributing $30,000 to my RRSP because CRA will provide me with a $15,000 refund (50 per cent of the $30,000 contribution). If instead, my PREC (taxed at only 12.2 per cent) contributed the same $30,000 to my IPP/PPP, it would only save $3,660.
On the surface, what I call the “back of the napkin” analysis seems convincing. But is it accurate, or just a flawed perception?
Setting some ground rules
The first principle is that “after-tax, take-home” income is the only true measure that matters. In other words, the cash in your bank account after all taxes—personal or corporate—are paid is the real bottom line.
With that in mind, let’s look at a numerical example. You want to ensure your take-home pay after all taxes is $150,000 per year. Your PREC has corporate income of $500,000.
You have two choices:
- Pay yourself enough salary to have $150,000 net of taxes and $30,000 going into the RRSP.
- Pay yourself enough salary to have $150,000 net of taxes and $30,000 into your pension plan.
Assume personal taxes are at 50 per cent (for ease of calculation) and corporate taxes are at 12.2 per cent.
The RRSP route
Corporate income: $500,000
Salary paid: $330,000
- $30,000 contributed to RRSP
- Taxable salary: $300,000 (taxed at 50 per cent)
- Personal taxes: $150,000
- Net take-home pay: $150,000
Taxable corporate income: $170,000 [$500,000 – $300,000 – $30,000]
Corporate tax at 12.2 per cent: $20,740
Net retained earnings: $149,260
So far, you’ve achieved both goals: $30,000 in savings via the RRSP, and $150,000 in net take-home income.
The pension route
Corporate income: $500,000
Salary paid: $300,000
- PREC contribution to IPP/PPP: $30,000
- Taxable salary: $300,000 (taxed at 50 per cent)
- Personal taxes: $150,000
- Net take-home pay: $150,000
Taxable corporate income: $170,000 [$500,000 – $300,000 – $30,000]
Corporate tax at 12.2 per cent: $20,740
Net retained earnings: $149,260
Preliminary conclusion
In both cases, the net take-home income is $150,000.
In both cases, the savings are $30,000.
In both cases, the net retained earnings are $149,260.
Yet, the initial perception was that going the RRSP route is much better.
The reality is that a large RRSP refund is no gift. It simply reflects that you exposed income to the highest possible tax rate (50 per cent in this example) and then parted with that money for an extended period, without earning any interest on it.
The federal government isn’t creating new money for you. It’s simply relinquishing tax revenue it can no longer claim because of your RRSP contribution.
Final thought
Beware of “back of the napkin” calculations.