July 1997

Understanding Tax
Brackets Pays Off

© Talbot Stevens

With a basic understanding of your current and future tax brackets, you can maximize tax deductions and minimize income tax paid.

If we ignore the relatively small differences among the provinces, the approximate marginal tax rates for income are as follows.

Approximate Marginal Tax Rates
Annual Income 0 - $6,500 $6,500 - $30,000 $30,000 - $60,000 over $60,000
Tax Rate 0% 27% 42% 53%

Your marginal tax rate tells you what portion of your income you lose to Revenue Canada if you earned one extra dollar. It also tells you how much of a refund you will get from tax deductions like RRSP contributions or interest paid for investment loans.

To clarify, let's say that you make $35,000. On the first $6,500, you pay no income tax. Income from $6,500 to approximately $30,000 is taxed at about 27%. On your last $5,000 of income ($30,000 to $60,000), you lose 42%.

Maximize your RRSP refund. Susan graduates in May with a $35,000 job. Because her first partial year's income is in the lowest tax bracket, she defers claiming her tax deduction from her RRSP contribution until the following year when she is in the middle tax bracket. By doing this, she gets a 42% refund, instead of 27%.

Withdrawing RRSP funds tax free. The only true way to get RRSP money out tax free is to withdraw up to $6,500 in a year where you have no other income. It also helps to not be married, otherwise spousal credits could be lost.

While most people don't set financial goals to have no income, there are times in one's life where this does occur and with a little planning ahead, can be taken advantage of.

Common “no income” periods include when you stay home to raise a family, take a sabbatical to study or travel, start a business, or retire before your pension kicks in.

Pay less on RRSP withdrawals. A related strategy is to withdraw RRSP funds when you know you are in a lower tax bracket. For example, after always being in the middle tax bracket, you retire at age 58 with a reduced pension between age 60 and 65.

Even if you didn't need the money, consider withdrawing enough each year to get your taxable income to $30,000, but no higher. This way, you pay a maximum of 27% tax on your RRSP withdrawals, instead of the 42% you might have to pay later — or worse if you face the seniors benefit clawback.

As mentioned before, the seniors benefit clawback means that most middle income Canadians will face tax rates of about 40% before age 65, and about 60% after age 65.

To avoid losing an extra 20% of your RRSP funds to this “hidden” tax called the clawback, partial RRSP withdrawals before age 65 will make sense to some yet-to-be-defined degree.

By understanding the tax brackets, we can minimize the tax paid on withdrawals, and maybe even get some RRSP funds out tax free.

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