Salary vs Dividend: is this example wrong?

Question

I saw a link to a great article in old (2012) question. **http://vereecke.ca/index.php/articles/will-that-be-salary-or-dividends/** I've tried understanding the article well, but I think that the author is making a mistake in one area. That, or **I** am not understanding something right. In the article, in the "Salary" example, $2,163 CPP (pension) contribution is deducted from employee's salary to go towards employee's pension plan. The company is required to match that amount with a further $2,163 that is paid from the company income to employee's CPP. In the "Dividend" example, the author argues (and I agree), that to compare apples to apples, an equivalent $2,163 should be deducted (by employee) from employee's dividend payment and put into a savings account "like self-directed pension plan". The author further says that since this is no longer a real CCP contribution, the company is not required to match that amount. But doesn't that mean that in "Salary" example, the employee got $4,326 invested into his pension plan (personal + corporation contribution), whereas in the "Dividend" example, employee only got $2,163 into his "self-directed pension plan"? Not apples to apples. Employee should contribute $4,326 into his "self-directed pension plan", no? Which means his final paycheck in "Dividend" example *should* be $69,799, which is only $938 more than in "Salary" example. And if that's the case, is there still a reason to go through all the hoops of dividends vs salary?

Answer 1

You have identified an important issue, but there is one complication: CPP contributions are not the same thing as deposits into an individual investment account.

Under the salary scenario, the employee contributes $2,163 and the corporation contributes another $2,163 to CPP, so a total of $4,326 is indeed being contributed to CPP as a result of that employment. However, that does not mean the employee has a personal CPP account containing $4,326. CPP is a social-insurance pension system, and the contributions help determine the employee's future pension entitlement rather than becoming an individually owned investment balance.

Therefore, putting only $2,163 into savings under the dividend scenario does not create a perfect apples-to-apples comparison. But simply putting $4,326 into a private account is not perfectly equivalent either, because a private investment account and CPP provide different benefits and risks.

There are also other important differences between salary and dividends. Salary generally creates RRSP contribution room and involves CPP contributions, while dividends generally do not. The corporation's tax treatment also differs, and the individual's tax treatment depends on the type and amount of dividend.

So I would not make the decision based solely on the apparent $2,163 CPP savings in this example. The proper comparison is the total after-tax economic benefit of each alternative, including CPP benefits, RRSP room, corporate taxes, personal taxes, and the individual's retirement objectives.

Also, because the article is from 2012, its specific tax rates, CPP limits, and dollar amounts should not be used for a current decision without updating them.