Canadian tax brackets: Marginal tax vs average tax
Updated for 2021
In Canada, we operate under a marginal tax rate system which simply means the more money we make, the more tax we are privileged to pay. Marginal tax is simply the amount of tax paid on an additional dollar of income. As income rises, so does the tax rate. This is different than a flat tax rate where you pay the same rate of tax no matter what your income level is.
Knowing your marginal tax rate can help you make effective financial decisions. From a planning point of view, it is not good enough to just know how much money you make. It is essential to understand how much you keep. Making a dollar doesn’t allow you to count on spending that dollar. Knowing your marginal tax rate will tell you how much of that dollar you can utilize toward your lifestyle. If you are planning your finances or retirement, the focus should be on your net income.
Canadian and provincial tax brackets
In Canada we have two layers of income tax – federal and provincial. To illustrate how marginal tax rates work, my example shows tax rates for Alberta residents and encompasses both provincial and federal tax.
For the year 2021, there are many tax brackets:
|Lower Limit||Upper Limit||Marginal Tax Rate|
If you earn $50,000 in income in 2021, then you would be in the 30.5% marginal tax bracket and you would pay 30.5% of any additional dollar you made to the federal government. If you earn $100,000, then you would be in the 36% marginal tax bracket.
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One of the biggest misconceptions about tax rates is that your entire income will be taxed at your marginal tax rate. Here’s an example to show you how it actually works:
The person making $50,000 per year would not pay $15,250 in tax ($50,000 x 30.5%). Instead, his/her tax would be calculated like this:
$13,808 at 0% = $0
($19,369 minus $13,808) at 15.0% = $834.15
($49,020 minus $19,369) at 25.0% = $7,412.75
($50,000 minus $49,020) at 30.5% = $298.90
Total tax = $8,545.80
The marginal tax rate of 30.5% is the amount of tax paid on any additional dollar made up to the next tax bracket. In this example, the average tax is only 17.1% ($8,545.80 divided by $50,000 of total income). Average tax is the percentage of tax paid based on your total gross income and reflects the total tax you are paying. It is the total amount of tax you will pay through all the brackets divided by total income and will mathematically always be lower than the marginal tax rate.
The tax system varies from province to province. With 10 provinces and 3 territories, you can imagine the complexity of the Canadian tax system. Add in the fact that the rules can change every year because of provincial and federal budgets and you have an ever-changing and complex tax system.
There are a lot of tax calculators online. Some are complex and detailed. The one tax calculator I like to use often is super simple and free by Simple Tax. For 2021, it appears that WealthSimple has purchased this calculator.
Here’s a quick screenshot of the calculator:
Pay more tax, not less tax
Lastly, paying tax is not such a bad thing because it means you are making more money. You hear people complain about paying tax and the desire to pay no tax. I have a solution . . . make no money and you will pay no tax.
But also know that no matter what tax bracket you are in, you should never ever turn down money. Our tax system works in such a way that the more you make, the more tax you will pay but you will still always win by making more money. You will never lose by making more money. Someone making $350,000 per year will pay more tax than someone making $250,000 or $100,000 or $50,000 but they will also take home more money after paying tax at the higher rates. Ironically, your goal should be to pay as much tax as possible by making more gross income in higher marginal tax brackets.
My advice to people. Learn how the tax system works before you complain. Learn how to use the system to your advantage. Spend more time on tax planning than investment planning and trying to predict the future of the markets. That’s time better spent!