Benjamin Franklin said, “In this world nothing can be said to be certain, except death and taxes.” You can attest to the fact that taxes are real and they eat away at your earnings. Whether you are an employee, self-employed, or owner of a corporation, everyone must file a tax return. Understanding the federal and provincial tax brackets will help you determine appropriate tax planning strategies. Just as much as the government needs money to support their spending habits, so do we. The question is how we can keep more change in our pockets.
The first step is being aware of your annual income. As an employee, both your T-4 Statement of Remuneration Paid and last pay statement of the year indicate the total amount you have earned. This information is significant so you can identify how you will be taxed according to Canada Revenue Agency’s tax brackets. As your income climbs so will your tax bill. If you wonder where some of your money is hiding, check Box 22 on your Statement of Remuneration Paid. Your savings may be hidden there. Your annual income will determine whether you want to regain some of this money.
These two charts illustrate the tax rates for each respective bracket. Since every province has different tax brackets and rates, you will need to check the province where you reside. For example, Alberta has only a flat tax rate of 10% regardless of income. You can expect both governments, federal and provincial, to be waiting for your dollars.
Don’t be fooled into believing that all your income is taxed at one rate. The marginal tax rate (MTR) refers to the rate of tax a taxpayer will pay on his next dollar of income. What this means is you start at the bottom and pay the lowest rate until your income crosses the threshold to the next bracket. Only then will your next dollar of income be calculated at the next level. If you live in Saskatchewan, your tax rate starts at 26% (15% Federal + 11% Provincial) until your income is higher than $43,292. Once you step over this line, you can expect the portion of your income above $43,292 to be taxed at 35% until you reach the next bracket.
As discussed in the last week’s blog, A Season and A Reason for Your Investments, knowing your annual income today and in retirement is important. This information determines whether you use a Registered Retirement Savings Plan or a Tax Free Savings Account for saving money. Since you can’t run away from paying taxes, your best hope is paying the least amount. When you cross over the threshold to the next tax bracket, contributions to Registered Retirement Savings Plans become beneficial. Depending on your available RRSP contribution limit, reducing your taxable income to the top of the lowest bracket, $43,292, (or to the nearest bracket) with an RRSP contribution will fatten your savings in two ways. You will pay less in taxes and your money will now be in your hands earning income inside a tax-sheltered investment. Your options then multiply.
- You may receive a tax refund to place inside a Tax Free Savings Account to fund other goals.
- The withdrawals from your RRSP may be “pension-split” with your spouse in retirement to create more tax saving opportunities.
- Money withdrawn from your RRSP can be use either for a home purchase or post- secondary education.
The most complicated topic in the financial planning spectrum has to be taxes. How can it not be when the Income Tax Act is 3,259 pages? Generally, if there are any savings to be had, it’s in the taxes you pay. When you examine your previous year’s tax returns, notice the three income levels before the Canada Revenue Agency determines your taxable income: Total Income, Net Income, and Taxable Income. Not only do they determine your taxable income but also whether you are eligible for government benefit programs such as Child Tax Benefits, Old Age Security, Guaranteed Income Supplement, and Allowance.
Writing about various tax saving strategies is best completed in segments. So for now, the most significant step is to understand the tax brackets. Knowing your annual income is the starting point. Even if you are self-employed and your income continues to rise significantly, setting-up a corporation to allocate income differently is a valuable strategy. Savings may be hiding in everyone’s tax bill.