Living in Alberta, I saw much discussion of child care leading up to this most recent election. Last year, when the 2018 Budget introduced adverse consequences of building up too much passive income within a corporation, many commentators pointed out that this would hurt prospective parents who might build up passive assets in their corporations to cover an absence while raising children. Business owners and the self-employed might experience a challenge in bringing kids into this world, and I hope to show one possible strategy to deal with this.
As you likely know, the self-employed do not have to contribute to EI. Incorporated business owners also do not have to contribute, if the combined control of the business among the family members exceeds 40%. However, these people do have the option to elect into EI. None of what I will show here applies in Quebec.
Before I present this concept, I will review the 2019 EI figures. For the remainder of this exercise, I will assume that EI rates do not change, and will also ignore any effects of inflation. I will also ignore taxes, or assume they are a wash, as contributions create a credit or deduction, and benefits are taxable. The relevant 2019 figures are:
- Maximum income for EI contributions and benefits: $53,100 (Maximum Insurable Earnings, or MIE)
- Employee contributions: 1.62%, for a maximum of $860.22 (this would generate a tax credit for the contributor)
- Employer contributions: 1.4 times the employee contributions, for a maximum of $1204.31 (this would generate a tax deduction for the contributor)
- Maximum EI benefit: $562/week (55% of the MIE divided by 52 weeks)
- Maximum EI contributions for self-employed: $2064.53
A self-employed person cannot claim EI benefits for unemployment/job loss, but can claim parental, maternity, sickness, compassionate care, or family caregiver benefits. We will focus here on parental and maternity benefits. Maternity benefits are available for up to 15 weeks, and parental benefits are normally available for 35 weeks, for a combined 50 weeks of benefits. It is now possible to extend parental benefits to 61 weeks, but the benefit is then provided at a reduced rate of 33%, rather than the 55% indicated above. It is also possible for a couple to get extra weeks of benefits if both of them use some of the parental leave. This can result in an extra 5 weeks of benefits if using the 35-week schedule, for a total of 40 potential weeks, or an extra 8 weeks of benefits if using the 61 week schedule, for a total of 69 weeks of benefits.
Let’s say that you are working with Brenda. Brenda is age 30, single, and self-employed. She has never had a child. She earns in excess of $100,000/a. She has not participated in EI since she was an employee in her early 20s. Brenda tells you that she is planning to have her first child in the next few years. You recommend to Brenda that she start contributing to EI, as a self-employed person. She applies to Service Canada using her My Service Canada account to start EI contributions.
Over the next 3 years, Brenda contributes $2064.53 per year to EI (ignoring inflation, taxes, and assuming that rates don’t change). After 3 years, she has contributed $6193.59. In the fourth year, she happily announces that she is going to have a baby, and takes a break from work. She plans to take 50 weeks off. During that 50 weeks, she collects $562/week of benefits, for a total of $28,100. This income is taxable, but she is in a low-income year, so the taxes are not a major concern.
Now, this sounds like an excellent deal, but also consider that Brenda will now be required, as long as she takes a salary, to continue contributing to EI. If she works until age 65, she will have contributed to EI for 34 years, for a total of $70,194.40. However, if we treat this slightly differently, she has ‘borrowed’ $28,100, and then is repaying that debt at a rate of $2064.53 for as long as she works. If that does end up being 34 years in total, then the effective rate of interest on this loan (N = 34, Int = solve, PV = 28,100, PMT = -2064.53, FV = 0) is 6.5%. Still not a great deal. If she has two kids, then she is effectively borrowing $56,200, and the math changes to (N = 33, Int = solve, PV = $56,200, PMT = -2064.53, FV = 0), which is an interest rate of 1.2%. As such, you would encourage her to continue contributing as long as she is in her child-rearing years. The effective interest rate would be even less if she is in a relationship with a partner who might take advantage of the additional 5 weeks of benefits.
Once the prospect of having more kids is passed, then you could advise her to move to an all-dividend compensation structure, if it’s available to her. If, for example, she decides at age 40 to have no more kids, after having had one child, she would have paid $18,580.77 of premiums for $28,100 of benefits.
Much is written about the challenges that younger generations have of balancing their myriad financial commitments. Anything that you, as the planner, can do to ease this burden will be appreciated. I would also urge you to consider EI for self-employed as a risk management strategy for those who may lack adequate disability insurance or other emergency funds.