Salary, Bonus, or Dividends? A Practical Guide for Canadian Owner-Managers

For incorporated small business owners in Canada, deciding how to pay yourself isn’t just a tax question—it’s a full-spectrum planning decision that affects retirement, borrowing power, cash flow, and risk. While there’s no one-size-fits-all formula, you can make a confident decision by weighing the trade-offs across five lenses: tax efficiency, CPP strategy, mortgage qualification, RRSP strategy, and personal risk preference.

Let's take a look at a practical framework to help you choose between salary/bonus and dividends, and where RRSPs and corporate investing fit in.

1) Salary vs. Dividends: The Core Trade-Off

Salary/Bonus

• Pros
  • Creates RRSP contribution room (18% of earned income up to the annual limit).
  • Contributes to CPP, increasing your future CPP entitlement (subject to YMPE limits).
  • Often favoured by lenders for mortgage underwriting because it’s straightforward “employment income.”
  • Eligible for personal deductions (childcare, moving, support payments) that require earned income.
• Cons
  • Requires payroll compliance (withholdings, remittances, T4).
  • CPP contributions can feel like a “tax” if you believe your portfolio can do better than the CPP’s implicit return.
  • Personal tax is paid sooner (less deferral) versus retaining funds inside the corporation.

Dividends

• Pros
  • Simple—no payroll setup, no CPP contributions.
  • May result in similar or modestly lower combined corp+personal tax in specific income ranges and provinces.
  • Keeps more cash inside the corporation (deferral) to reinvest at the corporate level.
• Cons
  • No RRSP room created.
  • No CPP accrual (potentially underfunds retirement if not offset by discipline in investing).
  • Mortgage underwriting can be trickier—lenders vary in how they treat dividend income, and they generally want a multi‑year history (more below).

Bottom line: salary provides the “infrastructure” for retirement and borrowing (CPP + RRSP + lender-friendly income), while dividends lean into simplicity and corporate deferral. Many owner-managers use a blend—enough salary to hit strategic targets (CPP, RRSP room, lender requirements), with dividends for flexibility and tax-rate smoothing.

2) The CPP Question: Contribute or Invest the Equivalent Yourself?

CPP is effectively a forced, inflation-indexed, lifetime pension with survivor and disability features. Whether you should keep contributing (via salary) or opt for dividends (and invest the “saved” CPP instead) hinges on these factors:

• If your age‑65 CPP estimate is already near the maximum:
  Additional CPP contributions as an owner-manager may have diminishing marginal benefit versus investing personally/corporately—especially if you expect higher returns, have strong discipline, and value liquidity. That said, CPP’s longevity insurance and inflation indexing are hard to replicate at low cost in private markets.
• Risk and behaviour matter:
  If you prefer guaranteed, indexed lifetime income and want to de-risk sequence-of-returns in retirement, CPP contributions are valuable. If you are a confident, disciplined investor with a long horizon and prefer portfolio control, you may choose dividends and invest the “CPP equivalent” instead.
• Tax integration and life expectancy:
  CPP’s actuarial value increases the longer you live (and if you delay CPP past 65). If you anticipate a shorter life expectancy or want maximum flexibility/liquidity for estate planning, you might lean to investing privately instead of maximizing CPP.

Practical take: If you’re already near max CPP, consider whether incremental contributions meaningfully change your CPP at 65. If not, your salary decision can be guided by RRSP needs and borrowing goals (below).

3) Will a Bank Count Dividends (T5) for a Mortgage?

Mortgage underwriting for business owners frequently turns on consistency and documentation:

• Salary tends to be “cleaner.” Lenders easily recognize it as employment income and often need fewer explanations.
• Dividends can work—but expect more scrutiny. Many lenders will accept dividends as qualifying income if you show a two‑year history of dividend payments and stable corporate financials. Some underwriters look at T1 generals, Notices of Assessment, T5s, and corporate financial statements to ensure the dividends are sustainable.
• Variability hurts. Sporadic or newly increased dividends may be shaded or not fully counted.
• Alternative lenders may accept corporate retained earnings and add-back methods (e.g., gross-up and credit for non-cash expenses), but at higher rates or with stricter terms.

Practical take: If you expect to apply for a mortgage in the next 24 months, consider taking a consistent salary (or a consistent salary+dividend pattern) now. If you prefer dividends, maintain a documented, stable track record and keep your corporation’s financials lender‑ready.

4) RRSP Strategy: Create Room or Skip It?

Key mechanics:

• Only salary/bonus creates RRSP room. Dividends do not.
• If you’ve accumulated significant unused RRSP room from prior employment, you can still contribute—even if you take only dividends now. The contribution room carries forward indefinitely.

Should you contribute? Consider:

• Tax bracket arbitrage: RRSPs shine when you deduct contributions at high current tax rates and withdraw later at lower rates. If you expect high-income retirement (e.g., from large corporate portfolio withdrawals), the benefit narrows—but tax‑free growth still compounds.
• Investment location and rate drag: Inside an RRSP, income and gains compound tax‑deferred; outside (corporate or personal), passive investment income in a corporation can trigger refundable tax mechanisms and potentially grind down the small business deduction at higher investment income levels. RRSPs can reduce corporate passive income exposure.
• Liquidity & control: Funds in RRSPs are locked for retirement (barring limited programs like HBP/LLP) and fully taxable on withdrawal. Corporate funds are more flexible but face their own tax friction when extracted.

Practical take:

• If you’re in a high personal marginal tax bracket, RRSP contributions are typically compelling.
• If your marginal rate is modest and you value liquidity or plan to income‑split using dividends later, you may prioritize corporate investing instead.
• If you’ve got lots of pre‑existing RRSP room, it’s a missed opportunity not to at least model the deduction/refund and compounding benefit—particularly if your corporate passive income is approaching thresholds that create negative tax side effects.

5) Keep Cash Inside the Corporation or Pay It Out?

Keeping surplus cash in the corporation can be attractive for tax deferral and reinvestment, but weigh:

• Passive investment tax regime: Passive income in a corporation is often taxed at a higher initial rate (with a refundable component), and large amounts of passive income can erode the small business deduction on active income. This reduces the advantage of leaving too much idle cash in the company.
• Creditor protection & purpose-built structures: Investing corporately can be paired with holding companies and insurance strategies to enhance asset protection and after‑tax outcomes (with proper legal/tax advice).
• Future extraction costs: You (or your estate) will eventually pay personal tax to get funds out. Planning for capital dividends, RDTOH recovery, and post‑mortem pipelines can materially change the optimal path.

Practical take: Combine corporate investing with targeted dividends or salary to manage passive income levels, RRSP usage, and lender-readiness. Don’t let passive income inadvertently grind the small business rate on your active business.

6) Risk Preference: The Tie-Breaker That Often Matters Most

Your risk tolerance and risk capacity should steer the mix:

• Conservative owners often prefer:
  • Stable salary (for underwriting and RRSP creation)
  • CPP participation (indexed, lifetime income)
  • RRSP contributions (tax-deferred, compartmentalized retirement savings)
• Growth-oriented owners may lean toward:
  • Dividends (simplicity, maximize corporate deferral)
  • Less CPP reliance (invest the equivalent with higher-return expectations)
  • Selective RRSP use (only when in high brackets), with a focus on corporate reinvestment or non-registered strategies
• Liquidity preference: If you prize ready access to capital for opportunities (acquisitions, hiring, inventory), you might prefer dividends and corporate retention over locking value into RRSPs or CPP.

7) A Simple Decision Framework

1. Upcoming mortgage or financing?
   • Yes → Take consistent salary (possibly plus dividends) for 2+ years.
   • No → Flexibility to optimize purely for tax and retirement.
2. RRSP need and bracket today?
   • High bracket and/or unused RRSP room → Lean into salary to create/use RRSP room.
   • Lower bracket or liquidity priority → Dividends may be preferable; use existing RRSP room selectively.
3. CPP stance?
   • Value inflation‑protected lifetime income → Salary to contribute.
   • Prefer investing the CPP equivalent, already near max CPP → Dividends (but be disciplined with investing).
4. Corporate passive income pressure?
   • High and rising → Use RRSPs and selective payouts to manage thresholds and preserve the small business rate.
5. Risk preference & behaviour:
   • Conservative → Salary/CPP/RRSP bias.
   • Aggressive but disciplined → Dividends + corporate investing, with deliberate risk controls.

8) Illustrative Blend Strategy

Many owner‑managers adopt a hybrid:

• Pay salary up to a targeted amount (e.g., enough to: satisfy lenders, generate desired RRSP room, and—if desired—contribute meaningfully to CPP).
• Top up with dividends to fine‑tune personal cash needs and manage overall tax rates.
• Annually reassess based on corporate profits, passive income levels, borrowing plans, and personal goals.

Final Thoughts

The “right” mix isn’t static. It shifts with your income level, time horizon, family situation, corporate profits, borrowing plans, and risk appetite. The best outcomes usually come from annual calibration—not a one‑and‑done decision.

If you’d like, I can build a side‑by‑side scenario for you (e.g., salary-heavy vs. dividend-heavy vs. hybrid) showing:

• After‑tax personal cash flow,
• RRSP room created/used,
• CPP trajectory,
• Corporate cash retained and passive income implications,
• Mortgage-readiness over the next 24 months.

Quick question to tailor it: Do you anticipate applying for a mortgage or refinancing in the next 1–2 years, and how close is your current CPP estimate to the maximum at 65?

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