I want to start by saying I don’t feel rich. Yes, I know, a six figure salary technically puts me in the upper middle class, but with its high cost of living in the City of Toronto, it’s hard to feel that way. Just to define that relative to Ontario, upper middle class is any single income earner with an income over $108,000.
I also acknowledge the more I make, the more I’m expected to pay in terms of tax. I just didn’t think it would happen so quickly or be so progressively punishing across all other forms of income.
So let’s talk about that today: tax on the upper middle class. I think tax can be a good thing (after all, I am a public servant myself), but we should all still strive for a level of tax efficiency, just like we would when it comes to any other form of spending.
Lesson #1: Marginal Rates on Income Tax level off after $93,000
What do I mean by level off? The bands for marginal rates become significantly larger after $93,208, holding at 43.41% up to an income of $144,489 for a differential of $51,281! Take for instance the marginal rate band just below it of 37.91% between an income earner making between $89,131 to $93,208. That’s a differential of just $4,077 before the income earner will start to see a new rate.
That’s huge difference. It means if you’re making $86,000 at a marginal rate of 33.89% and get a $10,000 raise switching jobs, your income grows to $96,000 but your marginal rate jumps 9.52% up to 43.41%!
How is this informative? Well it’s super useful come RRSP time. Assume you’re in your prime income earning years earning $75,000. Every raise you get will get taxed more and more. Sure, you could take the deduction now, but what if you waited until you hit the 43.41% marginal rate? At that point, you could strategically start claiming your deductions to obtain the optimal return for one of the highest, but attainable, marginal rates out there for basically guaranteed “returns” on your money.
All of this assumes you don’t have to wait too too long to get there, but it’s this precise strategy I’ve been using with my RRSPs.
Lesson #2: Dividend Income Starts to Really Suck.
There’s a lot of hoopla out there on the internet about how dividend income is the best form of income due to a series of tax credits for us Canadians. They’re not completely wrong. Anyone making less than $46,605 pays 0% tax on dividend income and even at a salary of $86,000, you’re looking at just 12.24% tax.
But dividend income tax starts to get especially punishing after that. The rates more than double once your income enters the $93,208 threshold to 25.28%. That’s insane. Suddenly, a quarter of your dividends are eaten away by the tax man! If you’re really rich and make over $220,000, the dividend tax rate is close to 40%!
So sure, dividend income is great, but make sure you re-assess at the beginning of each year to see if it really does make sense tax-wise.
Aside from maximizing your RRSPs and TFSAs, there aren’t many solutions around this, except…
Lesson #3: Capital Gains Income Becomes More Preferable.
Capital gains income has always been 50% of your marginal rate. If you make more than $93,208, your capital gains tax is 21.7% which ends up being LOWER than the dividend tax rate. The tables turn drastically on this one and grow more and more favourable the more you make.
The richest person making over $220,000? Their dividend tax rate is 39.34% but their capital gains rate is just 26.76%. A huge difference.
All this means the richer you get, the more you should focus on growth, and less on dividend stocks to be the most tax efficient.
There are two certainties in life: death and taxes. It’s important to keep healthy and know what your tax situation is.