How to pay yourself as a business owner

Being your own boss comes with lots of perks. But one of them — deciding how much to pay yourself — can be a bit of a balancing act. Some owners keep so much money in the business that they’re perpetually underpaid, while others take so much out that their business is starved of cash.

Whether you’re a freelancer, sole proprietor, in a partnership or an incorporated business, having a plan for how much you take from your business can make it easier to manage your budget, savings and day-to-day finances. Here, we outline the basics for entrepreneurs to decide how much to pay yourself so you can put that money to work and prepare for your future.

What should you do before paying yourself?

If your personal finances and business finances are all intertwined, consider this your cue to put up a virtual fence. After all, it’s hard to know what you can afford to take out of the business if you don’t have a clear picture of what’s coming in and going out.

To start with, you need:

• A dedicated business banking account

• Consistent record-keeping of all your business income and expenses.

• A clear line between business and personal financial matters (and yes, that means keeping personal expenses in your personal bank account).

Once you’ve separated the two, you’ll have a much better idea of how your business is really doing.

Don't forget about taxes

If you're self-employed, setting aside money for income tax and other tax obligations can help prevent an unpleasant surprise at tax time. The amount you'll need to set aside depends on your business and personal circumstances, so consider working with a tax professional to estimate what you'll owe.

How much should you pay yourself?

There’s no magic amount, and an accountant or other tax professional can help you figure out what makes sense for your situation. But it really comes down to two key numbers:

1. What the business can afford. Look at your cash flow, expected expenses, tax obligations and the amount you want to keep in the business as a cushion — not just your current income

2. How much money you need. Add up your monthly personal expenses: housing, food, savings, debt payments and other essentials.

These two numbers might be close, or they might be wildly far apart. Together, they can help you land on an amount that feels realistic for both you and your business. Start with an amount you can comfortably stick to and set up a regular schedule for withdrawing that money from the business. As your business (and profit) grows, you can revisit and, hopefully, increase it.

As Erik Mohr, owner and creative director at the design agency Made by Emblem, recalls: “At first, I was paying myself $25,000 a year. I thought, depending on how the business does, I’ll take dividends from there — which was a bad idea because I wasn’t factoring in how much tax I’d have to pay.”

He turned to his accountant for advice, and she suggested using the salary he wanted as a starting point and then adjusting according to the business’s finances. This strategy helped him pay himself a reasonable wage without putting too much pressure on the business’s finances.

What are the main ways to pay yourself as a business owner in Canada?

There’s more than one way to pay yourself, and the best option depends on how your business is structured and what you’re trying to achieve. Some ways to do it include:

• Owner draw (for sole proprietorships and partnerships): You can take money from the business for personal use, but those withdrawals aren't a business expense. As a sole proprietor, you generally pay personal income tax on your business's net income, regardless of how much you withdraw.

• Salary (for corporations): The corporation pays you employment income through payroll and generally withholds applicable income tax and CPP contributions. Depending on your circumstances, EI rules may also apply. Salary is considered earned income for Registered Retirement Savings Plan (RRSP, called an RSP at Tangerine) purposes, so it can help you build RSP contribution room.

• Dividends (for corporations): the business pays you regular or lump-sum payments from after-tax corporate profits; you gain no RRSP room, but it may have tax advantages depending on your circumstances; it's worth discussing your options with a tax professional.

Some use a combination of salary and dividends. The right approach depends on your business and personal financial circumstances. This is where an accountant or tax professional can help you weigh your options and figure out what makes sense for you.

What should you do with the money after you pay yourself?

You’re now paying yourself from your small business income — great! Now what do you do with that money?

First, of course, you’ll need to cover your everyday expenses. But once the bills are covered, it’s worth thinking about the bigger picture, too — like saving for retirement and building your long-term financial security. That means pay yourself first: set aside some of your income for personal savings and registered accounts before spending on discretionary purchases.

Depending on how you pay yourself and your personal financial situation, you might want to start by contributing to your Tax-Free Savings Account (TFSA) or RRSP. Remember that contributions may be deductible from your taxable income, which can reduce the income tax you pay for the year. Withdrawals are generally taxable.

TFSA contributions aren't tax-deductible, but any income you earn in the account and withdrawals you make are generally tax-free.

TFSAs and RRSPs work differently, so it’s worth understanding the pros and cons of each before deciding where to put your money.

You may also want to consider where to keep money you've set aside for your business's future needs. Depending on when you'll need the money, a business savings account may be an option.

READ MORE: RSP vs TFSA: Understand the difference

When should you start paying yourself?

When you’re in startup mode, you might not be able to take a regular payment right away. If your business has consistent cash flow, relatively stable costs and enough money set aside to cover upcoming expenses, it may be a good time to establish a regular amount to take from the business. Start with an amount you can commit to as a regular payment, and revisit that number as your business grows and profit rises. After all, one of the goals of building a business is being able to make a living from it. Even if you’re starting small, you can give yourself a consistent income while working toward your longer-term financial goals.

Make your money work as hard as you do

Paying yourself from your small business is just one piece of the puzzle. Making smart choices with that income is important, too. From Business Savings Accounts to your personal , there are plenty of places where your business profits can grow.