Tax Planning: Your Marginal Income Tax Rate

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Most people have never come across that financial term. The marginal tax rate is the combined federal and provincial income tax that an individual will pay on the next dollar of income.

Many financial planning and investment decisions are made based on the individual’s tax situation. Here are some typical financial questions that I was asked when I was working as a financial adviser

  • Put money into a RRSP or pay down the mortgage?
  • Invest in a dividend paying stock or buy a bond?
  • Contribute money into a TFSA or RRSP?
  • Contribute money into your RRSP or your spouse’s?
  • Buy a cottage or a vacation property in Florida?
  • Apply for CPP early or wait until age 65?

The answer to those questions and many others depends on your tax situation. It isn’t always about how much money you earn but how much you keep.

Here is an example of why knowing your marginal tax rate is important. One of my former clients was a retired teacher. He was collecting a pension of $70,000 and his wife was working part-time earning $10,000 a year. The teacher’s marginal income tax rate was 31% but his wife’s rate was only 20%. By transferring $25,000 of his pension to his wife, he would reduce his income tax by $7,750. However, his wife at a 20% tax rate would have to pay $5,000 on the transfer of pension income. The couple reduced their total tax bill giving them an extra $2,750 to invest or spend on a vacation.

How to find your approximate marginal tax rate:

    1. Go on-line to the CRA web site and print off Schedule 1
    2. Print off your provincial tax schedule (AB428, BC428, ON428)
    3. Take your gross annual income from your T-4
    4. Add the appropriate tax brackets together

For example; an income of $70,000 is in the 9.15% tax bracket in Ontario and the federal Schedule 1 is in the 22% tax bracket for a marginal tax rate of 31.15%. However, if you live in Manitoba the $70,000 falls in the 17.4% tax bracket plus 22% federal tax equals a marginal tax rate of 39.4%!

The tax man is always there picking your pocket. Some taxes are visible; they are added to the purchase price of things you buy. Some are hidden in the price, like in the price of gasoline. I goggled “Tax Freedom Day in Canada” and found that the average Canadian family pays 43.5 % of their income in taxes. If you had to pay all your taxes upfront, you wouldn’t be free of paying tax until June 9, 2014!

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