Self Employed
The self-employed must carry out all of the associated administrative tasks on their own. One such task that they often put off is retirement planning.
But, this is one area that is especially important for the self-employed to think about. Failure to save enough while you work may mean you don't retire with enough savings. Worse, maybe you won't be able to retire when you want.
Here are some of the retirement saving options available to those who are self-employed.
Canada Pension Plan
Canada has a three-part pension system:
- The first pillar is the Old Age Security (OAS). The OAS also includes the Guaranteed Income Supplement (GIS.
- The second pillar is the Canada Pension Plan (CPP).
- And the third pillar comprises employment pension plans and individual retirement savings.
All employees pay into the Canada Pension Plan in the form of salary deductions. Employees with a staff position share the burden equally with their employer. Each pays 4.95 percent of pensionable income into the CPP.
Self-employed individuals are on the hook for the full amount or 9.90 percent of pensionable income. They must pay these contributions with the taxpayer's estimated tax payments. These must be paid in quarterly instalments if they exceed a threshold of $3,000 in tax due at year-end.
When are quarterly taxes due?
The schedule for the quarterly instalments is as follows:
- March 15th
- June 15th
- September 15th
- December 15th
Self-employed individuals need to calculate the amount of their contribution to the Canada Pension Plan based on their T4 income and pay it along with their estimated tax. If, like many self-employed people, you don't receive a T4, you can always use tax preparation software to calculate the contributions automatically.
The Canada Pension Plan provides a basic retirement income based on the amount of money the taxpayer has contributed over their lifetime. Taxpayers are eligible to begin collecting a pension the month after they turn 65 (or a reduced pension as early as age 60). But don't expect to live high on the hog with what you collect each month in retirement.
The maximum monthly payment (as of 2018) is just over $1,100. And that's assuming you start drawing the pension when you reach the full retirement age of 65. You'll get less if you decide to retire earlier.
In this case, it's a good idea to have another option in addition to the CPP. That's where the next retirement plan comes in handy.
Registered Retirement Savings Plan
The Canadian government introduced Registered Retirement Savings Plans (RRSP) in 1957 to encourage people to save for retirement. The plans are called "registered" because they must be registered with the Canada Revenue Agency.
Unlike the Canada Pension Plan, contributions are voluntary, though there is a limit of 18% of an individual's income up to a maximum of $26,230 (as of September 2018; the maximum amount will be adjusted to $26,500 for 2019 in November 2018). RRSPs provide two major advantages:
Tax-deferred growth
All of the funds in an RRSP grow on a tax-deferred basis. In other words, investors do not pay tax on the assets in their account until they withdraw them. The main benefit to this approach is that the money saved on taxes allows an individual's retirement assets to grow faster. In addition, income tends to be lower after retirement, meaning the marginal tax rate will be lower as well. This allows individuals to save what may potentially be a substantial amount of money.
Tax credits
In addition to the money that may be saved on tax later in life, the RRSP also provides taxpayers with tax credits. These credits reduce the individual's tax burden each year. For example, an individual who has an income of CAD 50,000 and puts CAD 5,000 into his or her RRSP will only be responsible for paying T4 income tax on CAD 45,000.
A variety of assets can be included in an RRSP account. Following are some of the assets that can be saved in the RRSP:
- Stocks
- Bonds
- Mutual funds
- Investment-grade gold and silver bullion
- Depository receipts
The following asset classes are not allowed:
- Precious metals
- Gems and precious stones
- Land
- Puts and uncovered call options
Registered Retirement Income Fund
A Registered Retirement Income Fund (RRIF) is used to withdraw the funds that an individual has put in a Registered Retirement Savings Plan. Under Canadian law, individuals must withdraw the funds in their RRSP or convert them into an RRIF or life annuity by age 71.
The advantage of converting an RRSP into an RRIF is that this process defers taxation of the assets.
As with the RRSP, an RRIF is registered with the Canada Revenue Agency.
Tax-Free Savings Account
With a Tax-Free Savings Account (TFSA) contributions are made with post-tax dollars. This means any growth or gains on the funds accrued in the account are tax-free and no tax is due when the money is withdrawn either. The accounts are subject to limits - with the current limit on contributions to this type of account set at $6,000 for 2019, up from $5,500 in 2018.
The government also allows unused contributions - in other words, the amount of deposits permitted but not made - to be rolled over. If you've never made a TFSA contribution since its introduction in 2009, then you are allowed to contribute up to $63,500. As a result, taxpayers can use this type of account to make up for lost time.
Aside from the issue of taxation, another important difference between the TFSA and the RRSP is that the TFSA can be used for any purpose, not just retirement. For example, an individual can use it to fund the purchase of a home or invest money tax-free to save for a rainy day. This makes the TFSA a more flexible option than the RRSP.
Individual Pension Plan
Self-employed individuals who have maxed out their RRSP may want to look into an Individual Pension Plan (IPP). This type of account is ideal for someone looking to maximize their retirement and supplement their RRSP.
Tax-free contributions to the IPP may be made in the form of "past service funding," which enables lump-sum payments that represent contributions for previous years, and "terminal funding," which allows employees to top up their retirement savings tax-free. As with RRSPs, the maximum age at which the IPP must be drawn is 71.
One negative aspect of the IPP, however, is that they are complicated to set up and maintain. In order to maintain such an account, you'll have to hire an actuary and an investment manager to manage your funds.
PPP
Another option for the self-employed is the Personal Pension Plan. The PPP, an INTEGRIS product, is similar to the IPP, but it offers more flexibility for the self-employed and business owners. In addition, it is more generous than the RRSP. The advantages of the PPP include:
- Higher tax-deductible contributions than the RRSP
- Stability of a defined benefit plan without the costly overhead
- Easy to set up - the PPP is a turnkey solution
- Funding flexibility - with the ability to adjust annual contributions
- Assets that cannot be invested in an RRSP account can be invested in a PPP account
- All management and other related fees are tax deductible
- The assets can be bequeathed with no tax implications
For the above reasons, the PPP may be an ideal complement to the CPP and serve as a replacement for RRSPs for the self-employed and small business owners. This option is especially appealing to those individuals who have substantial investing experience.
Choosing the Right Plan - Or Combination of Plans
So which plan or combination of plans is right for you? It depends. As with all financial decisions, the answer is based in large part on your personal needs and objectives. If you're self-employed, these tools are a great way to help you plan your financial future.
