Question from Jeremy, age 27, in Halifax: My wife and I are thinking about starting a family in a couple years. We’re both self-employed and since our income comes from an incorporated business, our earnings are not employment-insurance (EI) eligible – so no government maternity benefits for us. We’re wondering what the most tax-efficient way would be to self-fund a maternity leave. Would you recommend stocking up extra cash inside the business, or should we take the money out as salary and save inside a registered retirement savings plan (RRSP) to defer taxes or a regular savings account and pay taxes now?
Ms. Simmons work with young people to help them navigate the new economic climate with personal finance, ethical investing and small business advice.
Shannon Lee Simmons is a financial planner and founder of The New School of Finance in Toronto.
Answer: Hey Jeremy, this is a problem I’m seeing all the time with clients. As entrepreneurship in the under-40 crowd rises, so does the amount of self-funded mat leave. (Read more about maternity/paternity leave and how it works here.)
If you work for yourself you either need to self-fund your time off, or if you have a partner that will continue to work during your time off, the household needs to find a way to reduce overall costs to live off the one income. It also means you will need to plan ahead. I suggest you start saving at least 12 months before you bring a baby into the world.
If you are self-employed as a sole proprietor, or if you are self-employed as a corporation but own less than 40 per cent of the company, you could actually qualify for something called employment insurance (EI) special benefits – maternity leave for the self-employed. It’s worth checking out.
If you’re not sure whether to register for EI special benefits, crunch the numbers carefully. Once you sign up for EI special benefits, you must pay premiums forever on your earnings. People tend to get fussy about that, but they shouldn’t. All employees are paying the same premiums as you – even those who never take parental leave.
The bigger issue I see is that many self-employed people can’t afford to take a year away from their business. They’re worried that they’ll lose clients or have trouble paying employees. So they end up working throughout their leave. They don’t collect the money they should have and are left paying into this program forever.
Many of my clients have found that they could make more money working part-time in their business and keeping their business afloat than being on EI special benefits for a year. But it really depends on your daycare situation and your business.
Self-employed people – like me – who have incorporated business and own more than 40 per cent of the shares, need to fund 100 per cent of any time off that we take off. Hurray! (Note the sarcasm.)
Here’s how to calculate what you need:
1. Plan how much time you will take off. Many entrepreneurs I see say they are absolutely useless for the first six months after their baby is born. They are sleep-deprived and generally exhausted. You might luck out with an amazing sleeper, but brace yourself for at least one of you taking five to six months off with your newborn. If things settle down after that, consider going back on a part-time basis.
2. Calculate how much you’ll need to survive each month. Figure out how much money the household needs to survive each month. Include all your fixed costs (bills, housing, transit etc.) and also add in potential new costs like toiletries (baby wipes!), increased utility bills from washing bibs like crazy, food, and spending money. If you have a partner who is working during that time off, your shortfall will be smaller.
Side note: It’s okay if you aren’t saving during your newborn’s first year. We can’t do all things all the time. Most people won’t have the luxury of making enough money to live and save during this reduced income year.
3. Figure out new future child care costs. If you go back to work after six months, you’ll likely have an expensive daycare bill. Many daycares won’t take a six-month-old so you might have to hire a nanny. If you don’t have family support or flexible time, this could be tricky and expensive.
Since in your case, Jeremy, both you and your wife are self-employed, you may have flexibility with your child-care arrangement. You may each be able to swing part-time work after your time off and swap babysitting duties while the other partner works. This would keep nanny or daycare costs low during the first 18 months.
Generally, these three things should help you figure out how much you need to save in order to self-fund a leave.
Assuming you don’t have this money in your savings accounts, it is best for you incorporated folks to stockpile it in the corporation and then pay it out as salary during the months when you’re not working. Keep in mind, you need this amount after tax and deductions so be sure to stockpile enough to pay your CPP and income taxes. This will help to keep cash flow consistent for the household and the business.
You’re going to pay tax on the income when you take it out of the corporation, but it will be at a lower marginal tax rate than if you took your regular salary plus additional money to stockpile for parental leave outside of the corporation.
If you did pay yourself out above and beyond your regular salary, you’d pay more tax and you shouldn’t use the RRSP to reduce those taxes because you won’t be able to access that money without paying the tax during parental leave.
Lastly, keep all money that you are saving for your parental leave 100-per-cent liquid and safe. Do not invest it as you will need every penny and you don’t wan to run the risk of losing any of it because of volatility in the stock market.
Parental leave costs turn into daycare costs which turn into piano lessons. Kids are expensive and those costs aren’t going away any time soon. For a sense of how raising kids can affect your long-term finances, read here.