Choosing Between Salary & Dividends: Pros and Cons for Business Owners
The Stanley Cup playoffs have wrapped up for another year and I was both impressed and disappointed to find the Golden Knights and the Panthers battling in the finals; I was cheering for Edmonton… Coaches and players must adapt their strategies on the fly, between games, and between series if they ever hope to kiss Lord Stanley’s Cup. Just as a team alters its approach to counter its opponent’s tactics, successful Portfolio Managers and financial planners continuously assess the ever-evolving financial landscape, adjusting their plays to navigate economic shifts, regulatory changes, and client needs. As a business owner, one of the many decisions you must make is how to pay yourself. Business owners typically pay themselves with a salary, dividends, or a combined approach. Just like a team must adjust their strategies, so must a business owner if they wish to succeed financially. Let’s take a moment to talk about the pros and cons of each option so that you can make an informed decision.
Salaries
Let’s start with salaries. When you pay yourself a salary, you are paying yourself a set amount of money on a regular basis. This can be weekly, bi-weekly, or monthly, and it is usually a fixed amount. One of the benefits of taking a salary is that it is a reliable source of income. You know exactly how much money you are going to make each month, which can make it easier to plan your budget, expenses, and what type of investment account to use.
Another benefit of taking a salary is that it can help you build up your credit score. When you have a regular income, it can be easier to get approved for loans and credit cards, which can be helpful if you need to borrow money for your business or personally. Taking a salary can also impact the type of medical and health benefits plans that are best suited for you and your family. Taking a salary also increases your RRSP contribution room which means that this investment vehicle becomes a more strategic option to invest and save for your retirement. Other deductions, such as childcare expenses, are only available when you take a salary as well.
However, there are also some drawbacks to taking a salary. The main disadvantage is that you will have to pay the employer and employee CPP contributions, which is $7,5081 in 2023. The size and scope of your business may dictate other negative factors that could come into play and are beyond the scope of this article.
Dividends
Now let’s talk about dividends. When you pay yourself dividends, you are paying yourself a portion of the profits that your business has made. A benefit of taking dividends is that it can help you retain more money in your business. When you take a salary, you are usually taking more money out of your business, which can reduce the amount of money that you have to reinvest in your business. However, when you take dividends, you are likely leaving more money in your business, which can help it grow and expand.
However, there are also some drawbacks to taking dividends. The main disadvantage is that it can be unpredictable. Also, you are also no longer paying into CPP which means that in the event of a prolonged injury or illness you can no longer count on CPP disability to provide a benefit and when you retire this is one less source of cash flow for you to count on. In addition, taking dividends can also make it more difficult to get approved for loans and various types of credit. When you take dividends, you are not showing regular income, which can make it harder to prove to lenders that you are a reliable borrower. Strategically, receiving compensation via dividends means that we shift to building investment portfolios inside the corporation and/or utilizing TFSA’s to save and invest for your future.
Summary
Each business owner will have unique circumstances to consider and the decision of which is best is not always so clear. We work with many business owners who adopt various compensation strategies, including salaries, dividends, or a combination thereof, with the aim of fulfilling their daily requirements, optimizing tax efficiency and saving for the future. Our objective is to understand the game that is being played, collaborate with your other professional advisors, and to adjust our strategies and tactics so that you can succeed financially. Please connect with us so that we can review your personal situation and help you devise a plan that meets your unique situation.
Sincerely,
Shawn Fetter, CIM®, CFP®, CLU®
Certified Financial Planner
Insurance Advisor
sfetter@alitis.ca
