As an incorporated physician, you have to determine the best strategy for managing the excess funds in your professional corporation. One option is to leave the funds in your corporation to invest and take advantage of tax deferral. Another is to withdraw the funds in the form of salary or dividends and invest them in a personal account such as aTax-Free Savings Account(TFSA).
This article discusses why withdrawing funds from your corporation to invest in a TFSA can often be the better long-term strategy.
Why invest in a TFSA vs a professional corporation
Why can’t you just leave funds in your corporation to invest?
Investments in your corporation are subject to corporate taxes, which can erode your returns over time. And changes to taxation of passive incomein a corporation means that building investments inside your corporate investment account could create tax problems down the line.
For example, you could face significant tax consequences once passive income in a corporation exceeds $50,000 in a year. Imagine holding an investment portfolio worth $2,000,000 that pays out 3% individendsand interest. That passive income of $60,000 could cause you headaches at tax time.
With a TFSA, you benefit from tax-free growth. The TFSA is often ignored in tax planning for incorporated individuals because of its relatively low annual contribution limit — the TFSA limit for 2023 is $6,500, and the limit for 2024 is $7,000. But if you have never used a TFSA, the lifetime contribution limit is $88,000 as of 2023, and $95,000 in 2024, assuming you have been eligible to accumulate contribution room since 2009, when the TFSA started.
And the TFSA’s contribution room will only grow over time, making it a potentially large tax shelter over your career. So, while it may be tempting to invest through the corporation to take advantage of the larger initial amount, investing in a TFSA may often lead to better outcomes in the long run.
For a young physician, ideally, youpay yourself a salary (or mix of salary and dividends) to max out your RRSP and TFSA contributions and meet your personal spending needs. So, your excess profits can remain in the corporation to be invested for tax-deferred growth and future withdrawals in retirement.
As a new-to-practice physician, you probably aren’t concerned with the recent changes to passive income rules because you haven’t built up investments in your corporation. But that’s all the more reason to get started maximizing your TFSA each year.
Let’s explore the benefits of investing in a TFSA in more detail:
Tax-free growth
One significant benefit of a TFSA is tax-free investment growth. Money earned on investments in a TFSA is not subject to tax, regardless of investment size or time it stays in the account. This makes TFSAs an attractive option if you are looking to save for the long term, particularly if you have high marginal tax rates. And tax-free investment growth can only get better as the lifetime TFSA limit increases annually.
Lower taxes
When you retire, withdrawals from your corporation will be subject to taxes. But TFSAs provide tax-free withdrawals, so the entire amount can be withdrawn without any tax consequences. This can be particularly advantageous if you have high marginal tax rates in retirement.
Increased flexibility
TFSAs provide greater flexibility than a corporation. Investments in a corporation are subject to corporate governance and legal requirements; TFSAs are entirely under the control of the account holder. This means that you can invest in a wide range of qualified investment vehicles, including stocks, bonds, mutual funds and exchange-traded funds (ETF).
Higher returns
Investing in a TFSA may also lead to higher returns over time. Investing through a corporation may mean a larger initial investment. But those tax consequences may erode returns over time — especially when you consider the changes in passive income rules. But with a TFSA, you benefit from tax-free growth and withdrawals, which may lead to higher returns in the long run.
The First Home Savings Account (FHSA) option
Another option for incorporated physicians looking to save for the future is theFHSA. This account is specifically designed forfirst-time homebuyers, providing a tax-free way to save for a down payment on a home. Even though the FHSA is also an attractive option, the account is subject to contribution limits of $8,000 per year and $40,000 over your lifetime, unlike a TFSA.
Now, let’s compare the long-term implications of the two investment strategies.
Comparison charts: TFSAs vs professional corporations
The first comparison involves investing $10,000 per year within a professional corporation. The second strategy involves withdrawing funds from the corporation (assuming a 40% tax rate) and investing $6,000 per year in a TFSA. This analysis is based on a 25-year investment timeline, as shown in Chart 1.
Chart 1: Investment Growth Over 25 Years
| Year | Corporate Investing | TFSA Investing |
|---|---|---|
| 1 | $10,400 | $6,300 |
| 5 | $56,232 | $34,812 |
| 10 | $123,819 | $79,241 |
| 15 | $203,955 | $135,945 |
| 20 | $297,930 | $208,316 |
| 25 | $407,112 | $300,680 |
Despite the initial difference in investment amounts, note that the gap between the corporation and TFSA shrinks over time. This decrease is because of the impact of taxes on corporate investments (assumed at 20%).
Now, let’s shift to the withdrawal phase. Starting with the balances at year 25, we will make annual withdrawals of $15,000 (net) from each account. For the corporation, we will need to withdraw $25,000 per year to put $15,000 into our own pocket, considering a tax rate of 40% on corporate withdrawals. Chart 2 demonstrates the depletion of these accounts over time.
Chart 2: Investment withdrawals until balances reach $0
| Year | Corporate Investing | TFSA investing |
|---|---|---|
| 1 | $380,400 | $285,680 |
| 5 | $273,680 | $225,680 |
| 10 | $140,279 | $150,680 |
| 15 | $6,878 | $75,680 |
| 16 | $0 (balance reached 0) | $60,680 |
| 20 | n/a | $680 |
| 21 | n/a | $0 (balance reached 0) |
This analysis underscores the long-term advantage you could achieve investing in a TFSA after withdrawing funds from your corporation because of tax-free growth and withdrawals.
These calculations are illustrative and simplified. But an MD Advisor* can help you determine the most effective financial strategies for your specific circ*mstances.
Final thoughts
Withdrawing funds from your corporation to contribute to a TFSA has several advantages in the long term over leaving funds in your corporation.
TFSAs offer tax-free growth and withdrawals, while keeping funds in your corporation could mean tax headaches from passive income changes despite the tax deferral advantage.
And your TFSA will help you maximize your investment accounts — RRSPs, FHSAs and your corporate investment account — to diversify your investments and future income streams.
So, to fully consider the potential tax implications and benefits of each investment option, consult with an MD Advisor* and reach out to your tax advisor.
*MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
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.
