Making Dreams A Reality
Tax 101

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By Doug Carroll (Vice President Tax & Estate planning at Invesco Trimark)

 

Fundamental Tax Learning Points:

If you understand these, you will be well on your way from financial literacy to financial prosperity.

1. Marginal vs. average tax rates

The amount of taxes paid divided by income is your average or effective tax rate (ETR).

The rate you pay on the next or last dollar earned is the marginal tax rate (MTR). A $75,000 income tax payer has an ETR of 25% and an MTR of 35%.

 

2. METR

Building on the prior point, let’s look at marginal effective tax rate (METR). An often-cited example of this is the Old Age Security clawback, which causes 15 per cent of the OAS to be returned to the government when earnings are over a specified income level. For example, a $75,000 income retiree has an MTR of 35% on the next dollar out of a registered retirement income fund (RRIF), but an METR with the clawback of 50%

 

3. Income by Source

RRSP/RRIF income is taxed at a person’s MTR at progressive rates as one moves through the federal-provincial brackets. Outside of tax-sheltered structures, interest is similarly taxed at MTR, but only one-half of capital gains are taxable and the rate on Canadian eligible dividends (those generally arising in an investment portfolio) can range from zero toa little more than the rate on capital gains. At a $75,000 income level, the rate on these dividends can be as little as one-third the rate applying to interest or even less, depending on the province.

4. Income splitting with RRSPs

We income split with ourselves using an RRSP, pushing income from high MTR working years to expected lower MTR retirement years. A spousal RRSP likewise splits from now to retirement, and also with another person. If a person expects to be at a higher MTR when the funds will be used, a tax-free savings account (TFSA) will produce a better result relative to an RRSP. Strategically, the TFSA & RRSP complement rather than compete with each other.

 

5. Understanding the TFSA

The $5,000 of TFSA contribution room is an after-tax allotment, whereas RRSP room is pre-tax. Let’s say a $75,000 income taxpayer had maxed out her RRSP & wanted to know how much more of her current income she could get into a tax-sheltered investment. At a 35% MTR, approximately $7,692 would allow her to make full use of her $5,000 TFSA room.

 

If you wish to discuss this information further or, tax strategies that could work for you, please call Betty-Anne Howard, Certified Financial Planner at 613-547-1554 or 877-455-3953 or bettyanne@teamipg.com