Bonus Episode: Life in the Margins | Marginal VS Average Tax Rates

It's that time again! Tax time. (OK, maybe the exclamation mark was a little misleading.) If you hear people saying they're paying 40% or 50% in income tax...that might also be a little misleading. Join Colin and Dan as they talk about marginal VS average tax rates. 

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Speaker 1:
You're about to get lucky with the Bearnaked Money Podcast, the show that gives you the naked truth about personal finance with your hosts, Dan LeBlanc and Colin White, portfolio managers with WLWP Wealth Planners, iA Private Wealth.
Colin White:
All right. Welcome to the next edition of Bearnaked Money, only a shower curtain between us. Dan and Colin are here today, just mixing it up a little bit. And it's tax time. So Dan's a lot more animated these days than he is normally, and we're going to take advantage of that and see what nuggets of wisdom we can pull from the Dan. So Dan, after we did our tax presentation last week to a few clients, you were doing that thing where you listened to talk radio and you got all wound up about something.
Dan LeBlanc:
I was listening and I did get wound up a little bit. And the News 95.7 local talk show in Halifax I listen to a fair bit, usually on the replay as I don't have time to listen during the day. And actually, I was listening to replays on the weekend. And the Thursday show came on. And this individual, regular caller, won't name him by name, but this regular caller called in and said he and his wife had just gone to their tax preparer. And as a result of that, they've found out that they paid 40% of their income in tax. Now, I've heard this caller call the radio show a number of times. And he's described a little bit in generalities their financial situation. And based on what he said in the past, I assume that they're not earning in the hundreds of thousands of dollars, but doing okay financially. So based on the conclusion of what he's shared on previous calls, I assume that he's making a mistake on the amount of tax they pay on their total income.
Colin White:
Yeah. But a lot of people think they pay 40% in tax. It was on the radio, that makes it true, doesn't it, Dan? Don't most people pay 40% of their income in tax?
Dan LeBlanc:
Well, you may pay 40% on some of your income. But one of our seminars, we clarified the difference between marginal tax rates and average tax rates. And I use the example in that seminar of a retiree over 65 earning pension income of, let's say, $65,000. And that individual would pay an average tax of 22%. And that's total income, total tax is 22% average. Now the marginal tax rate, which is the dollar of tax you're going to pay on any additional earnings you have at that marginal tax rate, it is indeed 40% for a 65-year-old. So if I can conclude that what may have happened is maybe they have pension income, CPP, OAS, maybe some superannuation pension, and they went to their financial institution to pull a little bit of money out of their RSP or RIF, assuming a RIF after age 65, and the tax on that income would've likely been 40%. And because they'd had 40% tax applied to their RIF withdrawal, they would've assumed that they pay 40% on their entire income, where that's just not the reality.
Colin White:
And just to clarify, because we're going to put this on the interweb and it's full of people who like to look for things, we're only talking about combined federal and provincial income tax. We're not talking about the total tax burden or the calculation of the tax-free day, which includes all the other taxes you pay. So we're strictly talking about federal and provincial combined income tax, right, Dan?
Dan LeBlanc:
That is correct.
Colin White:
All right. Just want to be clear. Because again, when you put it out on the interweb, then people can get taken all kinds of different directions.
Dan LeBlanc:
And we should clarify that we're talking about Nova Scotia taxes here as well. If you live in Ontario and BC, you're likely paying a much lower marginal tax rate at that level that I just mentioned, and your average tax rate would be a little bit less as well.
Colin White:
Well, let me ask you a question. At what point does your average tax rate become useful for decision-making? Is there any scenario that you can think of where somebody needs to know what their average tax rate is? Does that help anybody make any decisions?
Dan LeBlanc:
The marginal rate is much more important in making decisions. The average tax rate, it's important to understand the difference between your average and your marginal rate. Your marginal tax rate really is the important part of making financial decisions, whether it's contributing to RSPs, withdrawing from RSPs, when to convert your RSP to a RIF and start triggering some additional income in retirement. Should I work part-time? Should I work in retirement after I've retired? The one thing that grinds my gears a little bit is when I hear people say, "I don't want to earn any more income. I'm just going to pay it all in tax." And there is no situation in Canada, in any province where you can earn more money and be worse off.
Colin White:
Yeah. But what if I really don't want to work and this is a really good way to sound tough and smart about the reason I'm not working? You're going to take that away from me, Dan?
Dan LeBlanc:
No, that's a valid reason right there. You can choose not to work because you don't want to. But the whole concept of, "I don't want to jump another tax bracket because that's bad," that's not bad at all. That is a good situation if you have additional income that pushes you to another tax bracket. It's not going to change all of the income you've already earned up to that point. Jumping to another tax bracket is just the proportion of your income that falls in that bracket. I think there's a lot of misunderstanding around that. And people shy away from earning more money or don't want to jump in a new tax bracket thinking that it's a bad thing.
Colin White:
Well, then as we talked about in our presentation, it's the tax tail wag and the dog a little bit. There's this perceived, and in this case, not accurate impression of the taxes, but you're making a decision based on taxes rather than... Yeah. If you work another year, if you work another month, you're going to put more money in your jeans and you're going to be better off financially. There's not going to be enough tax savings in not earning the extra money to be worth more than the extra money. Again, I haven't seen that professionally either. Now, I suppose, all right, let's throw this at you because there are situations where your taxable income may affect your qualification for social programs.
Dan LeBlanc:
True. Very true. So if you're exceeding a certain threshold of income, maybe you get clogged back on old age security, for example. Into 2023, threshold is around $88,000. So if you exceed that level in collecting old age security, you're going to give some of it back to the government. But you are a pensioner that age receiving over $88,000 of income and government says, "We don't think you need all of this. So we're going to collect some of it back from you."
Colin White:
Yeah. Yeah. No, that's true. That's true. No, again, it's good to get a better... Try to educate people as to how to make decisions. I've got a conversation with a client coming up wanting to know whether it's better for him to retire in June or July. I'm going to say, "Well, you should cash an extra couple of paychecks because that's more money in your jeans." Again, there's not going to be enough of a tax savings to say, "Yeah, working the extra month is going to make you worse off." I still haven't seen that in my professional career.
Dan LeBlanc:
Yeah. I think some of our clients want to hear from us that they can retire earlier. And when we're asked the question, "Can I retire in January and June?" Or whenever the case may be, there is no scenario where you can retire sooner and be better off financially. That is very rare. There are situations though where somebody may get to a point they've maxed out their pension credits and maybe they can retire, take full pension and work part-time, and that puts them in a better financial situation because they've maxed out their pension up to that point. But from a tax perspective, yeah, it's hard to make that conclusion as a January, June, July, which is the better time.
Colin White:
Well, yeah. I think you're bang on. If clients are honest when they come forward and say, "Hey, is it okay? How big of a difference is it if I retire earlier? Is it going to be materially going to impact me?" Maybe that's a more fair question. Now, that puts the onus on them to make a decision that doesn't financially optimize them, like by not working for another six months. They'd have to take on that responsibility themselves. But maybe the better question or the better way to frame this is, "Am I going to affect my chances of having a successful retirement by retiring at this state?"
Dan LeBlanc:
Yeah. That's a much better question to ask from a planning perspective for sure. Again, comes down to you don't want to let the tax tail wag the dog. There are much more that goes into making that decision than just the tax side of it. And retirement, we can get on another conversation about retirement. What that means, there's a financial side, and then the practical side what people do in retirement. So timing of it is has many factors for sure.
Colin White:
Perfect. Is there anything else you want to get off your chest, any other rants that you've had listening to other call-in guests on the talk show, Dan?
Dan LeBlanc:
No. I guess that's it for today.
Colin White:
Well, I look forward to you getting all wound up again. Just for the audience's sake, Dan will be wound up between now and the end of April likely. So we should get him on for one or two more guest spots on the podcast. So hey, thanks for hanging out, Dan.
Dan LeBlanc:
Thanks, Colin.
Speaker 4:
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Speaker 1:
This information has been prepared by White Leblanc Wealth Planners, who is a portfolio manager for iA Private Wealth. Opinions expressed in this podcast are those of the portfolio manager only and do not necessarily reflect those of iA Private Wealth, Inc. iA Private Wealth, Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth, Inc. operates.
Speaker 5:
This should not be construed as legal, tax, or campaign advice. This podcast has been prepared for information purposes only. The tax information provided in this podcast is general in nature, and each client should consult with their own tax advisor, accountant, and lawyer before pursuing any strategy described herein as each client's individual circumstances are unique. We've endeavored to ensure the accuracy of the information provided at the time that it was written. However, should the information in this podcast be incorrect or incomplete, or should the law or its interpretation change after the date of this document, the advice provided may be incorrect or inappropriate. There should be no expectation that the information will be updated, supplemented, or revised whether as a result of new information, changing circumstances, future events, or otherwise. We are not responsible for errors contained in this podcast or to anyone who relies on the information contained in this podcast. Please consult your own legal and tax advisor.