Now here is the important part: What happens to the $110,000 ($260,00 – $150,000) you’re leaving in the holding company?
In Ontario, the small business tax rate is 12.2%, so on $110,000, your company will only pay tax of $13,420, leaving you with $96,580 to invest.
Bottom line: You will pay $41,167 less tax by splitting your income between your personal income and your holding company. Sure, you’ll have to pay some tax when you eventually draw dividends from your corporation, unless, of course, the accumulation of your $41,167 tax savings leaves your corporation as a tax-free dividend created by a tax-free life insurance death benefit.
Investing in your holding company
If you continue working for the next 10 years at your current income, $96,580 per year will be available to invest within your holding company. You can invest all of this money or you can divide it between an investment portfolio and a life insurance policy.
The challenge that comes with investing within a corporation is that your investment earnings are taxed at the highest marginal tax rate. In Ontario, that means interest is taxed a 53.53%, eligible dividends at 39.34% and capital gains at 26.76%. So, if you have a $100,000 GIC earning 2.2%, you will earn $2,200 minus 53.53% for tax = $1,023. The after-tax return on that GIC is 1%. (Ouch!) That is why it makes sense to avoid, as much as possible, investments with some form of distribution.
One solution is to purchase an insurance policy that allows you to accumulate funds (cash value) within the policy. Once the money is in the policy the cash values grow tax-deferred and upon death, the insurance proceeds pay out tax-free, and in most cases can be paid tax-free out of your corporation.
Does the plan really work?
This all sounds good on paper, but does it really work? To simplify things and help you make a good decision, I have modelled your situation and run a few different comparisons. You can view the outcome in this video.
To model this out I have made the following assumptions: