“There is no point in working more, because I end up paying more to the government”. This is a statement that I have encountered far more than I would have thought; whether it be during a client meeting or at my own dinner table.
Many Canadians shudder at the thought of sending more than their share to the CRA, and this feeling often leads to change in behaviour. It’s not uncommon for us to make financial decisions based on tax avoidance, tax mitigation, or tax deferral. With that in mind I am here to reassure you – working more or taking that bonus will not leave you ‘in the hole’!
The Canadian tax system is graduated, or progressive, meaning each dollar earned is not taxed at the same rate. In fact, Canada has a basic personal exemption that allows an individual to earn up to a certain amount of income without having to pay any income tax at all.
This graduated system consists of different marginal tax rates, where each rate is only applied to a range of income earned. Think of this system like a set of stairs – each new step corresponds with a slightly higher tax rate. Each different rate, or bracket, is only applied to the dollars earned on that stair. The following chart is based on 2019 Ontario and Federal tax rates:
Let’s take a closer look at this diagram with a real-life example. An individual earns a salary of $80,000 per year. By referencing the ‘stair case’ above, we can easily find their marginal tax rate: 31.48%.
But what does this mean? Will this rate be applied to their full salary? The answer is no! Looking back at the diagram, we can see that income in excess of $77,317 is taxed at 31.48%. All previous ranges are taxed at the corresponding rates:
The common misconception lies in the math. We don’t simply apply the highest marginal rate to an individual’s entire income. We break the income into segments, or ‘stairs’, in our example, and tax each segment accordingly.
With this in mind, the thought process of ‘more income = more tax’ is technically correct. But it is often misunderstood. Even if taxed at a higher rate, additional income resulting from a bonus or an extra shift will still leave you with more money in your pocket.
While this may be true, there are plenty of reasons to not take that overtime shift. Achieving balance is something many of us strive for – rightfully so. Opting to spend time with family, friends, or a significant other, or taking personal time for hobbies can allow for a much needed break from the workplace.
Turning down additional hours for tax reasons would be equivalent to turning down a raise, a bonus, or per diem. These extra earnings can always be redirected to an RSP to offset the additional tax if that is a concern. In turn, this can create more resources down the road for retirement that you may not have had otherwise.
Another consideration in this scenario is time value of money. A dollar earned today has more purchasing power than a dollar earned tomorrow. As inflation raises the cost of goods, the purchasing power of a dollar erodes. This holds especially true for younger income earners who are planning for larger purchases. For example, many young would-be homeowners have seen their affordability and purchasing power eroding at a rapid rate given current housing market conditions. For extra income earned that is intended to be saved or invested, the same concept applies. Through compound interest, a dollar invested today holds more long term purchasing power than a dollar invested tomorrow.
In fact, if we look at historical return rates, a dollar invested in your 20’s is more valuable than a dollar invested in your 30’s; which in turn is more valuable than a dollar invested in your 40’s, and so on. There are many tools such as this compound interest calculator to help illustrate this concept. Try it out for yourself!
If the goal is having more money in your pocket, today, tomorrow or for retirement, don’t be quick to pass up those extra hours.
Joe Murray is an Associate Consultant at Rettinger & Associates Private Wealth Management. With a background in economics and a passion for financial planning, Joe’s ability to simplify the complex is unmatched. By identifying opportunities in risk management, tax planning, investment strategies and budgeting, Joe builds a road maps for success, today and in the future.